Court Opinion

ID: 4474966
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:11:14.622201+00
Date Added: 2024-06-11T14:53:53.047346
License: Public Domain

Kroupa, J., dissenting: The majority opinion allows an octogenarian taxpayer to give away $4.25 million in cash and marketable securities at a substantial discount in gift taxes because she put them in a limited liability company (llc), despite a regulation telling us that “for federal tax purposes,” that LLC should be “disregarded.” The majority is either ignoring the plain language of the regulation or silently invalidating it. I must respectfully dissent. The majority fails to apply the plain language of sections 301.7701-1 through 301.7701-3, Proced. & Admin. Regs, (collectively the check-the-box regulations), which require that a single-member LLC be disregarded for “federal tax purposes.” As the trier of fact, I find no fault with the facts upon which the majority addresses the legal issue. I take exception, however, to how the majority frames the legal issue. Neither party argued that the regulations are invalid. Yet the majority has, in effect, invalidated the check-the-box regulations for Federal gift tax purposes without providing the necessary legal analysis to do so. I. The Plain Language of the Check-the-Box Regulations The check-the-box regulations provide that an “entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner.” Sec. 301.7701-3(a), Proced. & Admin. Regs. The regulations further provide that “[wjhether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.”1 Sec. 301.7701-l(a)(l), Proced. & Admin. Regs, (emphasis added). The crux of my dispute with the majority is how the majority interprets these provisions. The majority ignores the plain language of the check-the-box regulations and holds instead that Pierre LLC must be respected as an entity separate from petitioner for Federal gift tax purposes. The majority fails to discuss, however, what it means for an entity not to be “separate” from its owner. The regulations provide that the owner of a disregarded entity is treated as the owner of its property. See sec. 301.7701 — 3(g)(l)(iii) and (iv), Proced. & Admin. Regs. Likewise, the Court of Appeals for the Second Circuit, the court to which this case is appealable,2 has said: “‘if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship * * * of the owner.’” McNamee v. Dept. of the Treasury, 488 F.3d 100, 107-108 (2d Cir. 2007) (quoting section 301.7701-2(a), Proced. & Admin. Regs.). Yet the majority ignores these authorities and minimizes the check-the-box regulations as simply rules of classification for Federal income tax purposes. See majority op. pp. 30-32, 35. In doing so, the majority limits the phrase “federal tax purposes” to Federal income tax purposes. See majority op. p. 35. The majority’s interpretation is wrong for several reasons. First, the check-the-box regulations do not read “for federal income tax purposes.” Instead, the regulations are drafted broadly. The check-the-box regulations apply to the entire Code. See sec. 7701(a). Had the drafters of the check-the-box regulations intended that they apply only for income tax purposes, the drafters would have used the phrase “federal income tax purposes.” This phrase is used extensively throughout the regulations. See, e.g., sec. 1.6050K-l(e)(2), Income Tax Regs.; sec. 53.4947-l(b)(2)(iii), Foundation Excise Tax Regs.; sec. 301.6362-5(c)(l)(i), Proced. & Admin. Regs. The drafters expressed their intent when they chose not to limit the regulations’ scope to Federal income tax. In addition, the drafters could have specifically excluded gift tax from the regulations’ scope had the drafters intended that result. They did not do so when the regulations were originally drafted. See T.D. 8697, 1997-1 C.B. 215. They also did not do so when the regulations were subsequently amended specifically to exclude employment and certain excise taxes from the regulations’ scope concerning disregarded entity status. See sec. 301.7701-2(c)(2)(iv) and (v), Proced. & Admin. Regs.; T.D. 9356, 2007-2 C.B. 675 (effective January 1, 2009). Tellingly, the preamble to the amended regulations states that single-owner entities “generally would continue to be treated as disregarded entities for other federal tax purposes” after amendment. See Notice of Proposed Rulemaking, 70 Fed. Reg. 60475 (Oct. 18, 2005). I fail to see how “for other federal tax purposes” means “for other Federal tax purposes except gift tax purposes.” The check-the-box regulations expressly tell us to treat the owner of a single-member LLC as the owner of its assets. Sec. 301.7701 — 3(g)(l)(iii) and (iv), Proced. & Admin. Regs. In addition, the owner of a disregarded entity that elects to have the entity treated as a corporation is deemed to have contributed all of the assets and liabilities of the entity to a corporation in exchange for stock. Sec. 301.7701 — 3(g)(l)(iv), Proced. & Admin. Regs. Similarly, a single-member corporation that elects to be disregarded is treated as distributing all of its assets and liabilities to its single owner. Sec. 301.7701 — 3(g)(l)(iii), Proced. & Admin. Regs. The check-the-box regulations consistently treat single owners who choose noncorporate status for their LLCs as holding the property of these disregarded entities.3  The majority also fails to address other guidance from the Commissioner that treats the owner of a single-member LLC as the owner of its underlying property. Rev. Rul. 99-5, 1999-1 C.B. 434, describes the Federal tax consequences when a disregarded single-member LLC becomes an entity with more than one owner and is classified as a partnership for Federal tax purposes. The ruling requires that the single owner be treated as selling an interest in each of the assets if an interest in the LLC is sold. Id. The ruling also states that, if the interest is obtained through a capital contribution, the single owner is treated as having contributed all of the assets of the LLC to the new partnership for an interest. Id. In both instances, the single owner is treated as the owner of the assets of the LLC as required under the check-the-box regulations. The majority further ignores the Commissioner’s consistent treatment of single-member LLC owners as the owners of the LLC’s underlying assets. The Commissioner has issued numerous private letter rulings on this issue.4 For example, the owner of a single-member LLC is treated as owning the LLC’s underlying assets for purposes of determining like-kind exchange treatment on the exchange of property under section 1031(a)(1), though the owner has no State law property interest in the LLC’s assets.5 See Priv. Ltr. Rul. 200732012 (May 11, 2007); Priv. Ltr. Rul. 200251008 (Sept. 11, 2002); Priv. Ltr. Rul. 200131014 (May 2, 2001); Priv. Ltr. Rul. 200118023 (Jan. 31, 2001); Priv. Ltr. Rul. 199911033 (Dec. 18, 1998); Priv. Ltr. Rul. 9807013 (Nov. 13, 1997); Priv. Ltr. Rul. 9751012 (Sept. 15, 1997). Despite the Commissioner’s consistent treatment of single owners as the owners of the LLCs’ underlying property, the majority insists that the check-the-box regulations do not apply to determine what property the single owner owns for Federal gift tax purposes. See majority op. p. 35. I know of no provision in the Code that requires us to treat the term “property” used in section 1031(a)(1) differently for purposes of section 2501, which imposes a tax on the transfer of property by gift. The Supreme Court has already told us that the meaning of the word “property” in the Code is a Federal question and Federal courts are “in no way bound by state courts’ answers to similar questions involving state law.” United States v. Craft, 535 U.S. 274, 288 (2002). The majority’s reliance on what it calls the longstanding gift tax regime to create such a difference addresses neither the plain language nor the intent of the check-the-box regulations. II. The Majority Invalidates the Regulations for Federal Gift Tax Purposes The majority concludes that the check-the-box regulations do not apply for Federal gift tax purposes. See majority op. p. 35. I disagree. I do not minimize a plain language interpretation of the regulations as merely respondent’s litigating position. To do so promotes a distinction without a difference. Instead, I interpret “federal tax purposes” to mean “federal tax purposes,” including Federal gift taxes. The majority, in effect, invalidates the check-the-box regulations to the extent that the term “federal tax purposes” encompasses Federal gift tax. The majority does not, however, provide the necessary analysis to do so. How could they, given that this Court and the Courts of Appeals for the Second and Sixth Circuits have recently blessed the regulations as “eminently reasonable”? McNamee v. Dept. of the Treasury, 488 F.3d at 109; Littriello v. United States, 484 F.3d 372, 378 (6th Cir. 2007); see Med. Practice Solutions, LLC v. Commissioner, 132 T.C. 125 (2009). Instead, the majority concludes that the Commissioner cannot by regulation overrule the Federal gift tax regime as interpreted by this Court and others. See majority op. p. 36. The majority must provide further analysis. An agency may promulgate regulations that overcome the judiciary’s prior construction of a statute, even an entire “regime’s” worth of construction, unless that prior construction followed from the statute’s unambiguous terms. See Natl. Cable & Telecomms. Association v. Brand X Internet Servs., 545 U.S. 967, 982 (2005); Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 863-864 (1984) (an agency may change its prior interpretation of a statute to meet changing circumstances); Dickman v. Commissioner, 465 U.S. 330, 343 (1984) (“it is well established that the Commissioner may change an earlier interpretation of the law, even if such a change is made retroactive in effect”). Thus, the majority’s reliance on the longstanding gift tax regime before the issuance of the check-the-box regulations is not enough to invalidate the regulations if the related statute is ambiguous. The Court of Appeals for the Second Circuit has already held that section 7701 is ambiguous as to the Federal tax treatment of single-member LLCs. McNamee v. Dept, of the Treasury, supra at 107. Further, the court concluded that the check-the-box regulations reasonably interpret, and fill gaps in, an ambiguous statute and are entitled to deference under Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., supra. McNamee v. Dept. of the Treasury, supra at 105-107; see Littriello v. United States, supra at 376-378. The majority ignores this relevant Second Circuit precedent and concludes, without discussion of any degree of deference, that an entity’s classification for income tax purposes is irrelevant to how a donor must be taxed under the Federal gift tax provisions on a transfer of an ownership interest in the LLC. See majority op. p. 35. The majority misstates the issue. The majority writes that While we accept that the check-the-box regulations govern how a single-member LLC will be taxed for Federal tax purposes, i.e., as an association taxed as a corporation or as a disregarded entity, we do not agree that the check-the-box regulations apply to disregard the LLC in determining how a donor must be taxed under the Federal gift tax provisions on a transfer of an ownership interest in the LLC. * * * Majority op. p. 35. The check-the-box regulations determine whether a single-member entity exists at all for Federal tax purposes rather than how that entity will be taxed. The majority distinguishes between the “classification” and the “valuation” of an entity. But that distinction is false. The gift tax regulations provide guidance on how to value interests in a corporation, a partnership, and a proprietorship. See secs. 25.2512-2 and 25.2512-3, Gift Tax Regs. They do not provide guidance on how to value an interest in a single-member LLC. Accordingly, we must first “classify” the entity, and only then can we “value” its interests. I submit that the ambiguity of section 7701 extends to gift tax valuation. The majority cannot trivialize the check-the-box regulations by dismissing them as irrelevant. III. The Majority’s Reliance on the Gift Tax Regime The majority concludes that it would be manifestly incompatible with the gift tax regime if we did not respect Pierre LLC for gift tax purposes because New York law provides that a member has no interest in specific property of the LLC while a membership interest in an LLC is personal property. N.Y. Ltd. Liab. Co. Law sec. 601 (McKinney 2007). I disagree. The check-the-box regulations provide the Federal tax consequences of what is, in effect, an agreement between the taxpayer and the Commissioner to treat an entity in a certain way for Federal tax purposes despite the entity’s State law classification. There is simply no LLC interest left to value for Federal gift tax purposes when a single-member LLC elects to be disregarded. It therefore does not matter whether State law recognizes an LLC as a valid entity or provides that a member has no interest in any of the specific property of the LLC. See sec. 301.7701-l(a)(l), Proced. & Admin. Regs. The check-the-box regulations specifically say that Federal law determines whether a single-member entity is recognized as separate from its owner. Id. The majority dismisses relevant precedent from two Federal Courts of Appeals addressing this conflict between State law rights of single-member LLC owners and the consequences of disregarded entity status under the check-the-box regulations. See McNamee v. Dept. of the Treasury, 488 F.3d 100 (2d. Cir. 2007); Littriello v. United States, 484 F.3d 372 (6th Cir. 2007). The Court of Appeals for the Second Circuit rejected a taxpayer’s argument that he was not liable for his single-member LLC’s unpaid payroll taxes because Connecticut law provided that the owner is not personally liable for the LLC’s debts. See McNamee v. Dept, of the Treasury, supra. The court noted that, while State laws of incorporation control various aspects of business relations, they may affect, but do not necessarily control, the application of Federal tax provisions. Id. at 111 (quoting Littriello v. United States, supra at 379). Accordingly, a single-member LLC is entitled to whatever advantages State law may extend, but State law cannot abrogate its owner’s Federal tax liability. Id. The majority minimizes this relevant analysis in McNamee and Littriello. The majority summarily concludes that it is not relevant because the courts did not specifically address gift tax. See majority op. p. 32. The courts had no reason to address gift tax issues. That does not mean, however, that the courts’ analyses should be ignored. Both the McNamee and Littriello courts recognized that the check-the-box regulations applied equally to the non-income-tax issue of employment tax liability. Determining an owner’s liability for employment taxes is as far removed from determining the owner’s income tax liability as is determining the owner’s gift tax liability. The Code imposes both Federal employment tax liability and Federal gift tax liability separate and apart from determining a taxpayer’s income tax liability. The majority fails to recognize that the single owner’s liability for employment taxes turns upon disregarding the LLC for Federal tax purposes rather than upon the identity of the taxpayer. See Med. Practice Solutions, LLC v. Commissioner, 132 T.C. at 127 (a single-member LLC “and its sole member are a single taxpayer or person to whom notice is given”); see also McNamee v. Dept. of the Treasury, supra at 111 (an entity disregarded as separate from its owner “cannot be regarded as the employer”); Littriello v. United States, supra at 375, 378 (recognizing a single owner as the individual who “owns all the assets, is liable for all debts, and operates in an individual capacity”). Despite the majority’s wish, Pierre LLC does not exist apart from petitioner for gift tax purposes, and petitioner should be treated as holding its assets. Further, the Second and Sixth Circuit Courts of Appeals stressed that the taxpayer could have escaped personal liability for the LLC’s tax debt if the taxpayer had simply elected corporate status for the single-member LLC. McNamee v. Dept. of the Treasury, supra at 109-111; Littriello v. United States, supra at 378. The same principle applies here. Petitioner could have elected to treat Pierre LLC as a corporation. She did not. The Supreme Court has repeatedly recognized that “while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not.” Commissioner v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974). I would hold petitioner to her choice. Finally, the majority overlooks the broad scope of the gift tax statutes in concluding that the check-the-box regulations are manifestly incompatible with the gift tax regime. Congress intended to use the term “gifts” in its most comprehensive sense. Commissioner v. Wemyss, 324 U.S. 303, 306 (1945). The gift tax applies whether the gift is direct or indirect. Sec. 2511. Accordingly, transfers of property by gift, by whatever means effected, are subject to Federal gift tax. Dickman v. Commissioner, 465 U.S. at 334. Moreover, we have used substance over form principles to get to the true nature of the gift where the substance of a gift transfer does not fit its form. See Kerr v. Commissioner, 113 T.C. 449, 464-468 (1999), affd. on another issue 292 F.3d 490 (5th Cir. 2002); Astleford v. Commissioner, T.C. Memo. 2008-128; Estate of Murphy v. Commissioner, T.C. Memo. 1990-472. We have also used the step transaction doctrine, which has been called “‘well-established’” and “‘expressly sanctioned’” in the area of gift tax where intra-family transactions often occur. See Senda v. Commissioner, 433 F.3d 1044, 1049 (8th Cir. 2006) (quoting Commissioner v. Clark, 489 U.S. 726, 738 (1989)), affg. T.C. Memo. 2004-160. The majority would instead have us apply the opposite approach, accepting petitioner’s own label rather than the substance of her choice. Despite this broad expanse of gift taxes, the majority would require Congressional action before any State law property right could be disregarded for Federal gift tax purposes. See majority op. p. 36. The majority cites four special valuation statutes (sections 2701-2704) to imply that Congress will take action when necessary to overcome the “willing buyer, willing seller” gift tax valuation rule. See majority op. p. 36. I know of no authority, however, that prevents the promulgation of regulations affecting the so-called gift tax regime. IV. Conclusion The plain language of the regulations requires Pierre LLC to be “disregarded as an entity separate from its owner.” Unlike the majority, I give meaning to these words. I do not minimize this language by labeling it a classification. A plain language interpretation of the check-the-box regulations must prevail. It is an interpretation of relevant regulations. It is not manifestly incompatible with the gift tax statutes. For the foregoing reasons, I respectfully dissent. Colvin, Halpern, Gale, Holmes, and Paris, JJ., agree with this dissenting opinion.   The Commissioner has set forth specific, limited exceptions in the regulations to this general rule that took effect after the year at issue. See sec. 301.7701-2(c)(2)(iii), Civ), and (v), Proced. & Admin. Regs. He has also issued Chief Counsel Advice 199930013 (Apr. 18, 1999) concluding that a single-member LLC could not be disregarded for collection purposes under secs. 6321 and 6331.   . Petitioner resided in New York when she filed the petition. See sec. 7482(b)(1)(A).    There is nothing radical about this. It is essentially a limited form of piercing the corporate veil “for federal tax purposes.” The State-law concept of piercing the corporate veil means, and the regulations echo, that a “court will disregard the corporate entity * * * and treat as identical the corporation and the individual or individuals owning all its stock and assets.” 14 N.Y. Jur. 2d, Business Relationships, sec. 34 (2009).    Private letter rulings may be cited to show the practice of the Commissioner. See Rowan Cos. v. United States, 452 U.S. 247, 261 n.17 (1981); Hanover Bank v. Commissioner, 369 U.S. 672, 686-687 (1962); Dover Corp. & Subs. v. Commissioner, 122 T.C. 324, 341 n.12 (2004).    This treatment has not been limited to like-kind exchange situations. See Priv. Ltr. Rul. 200134025 (May 22, 2001) (single member of a disregarded entity is treated as the owner of property it receives for purposes of the exemptions under sec. 514(b)(1)(A) and (c)(9)); Priv. Ltr. Rul. 9739014 (June 26, 1997) (a single-member LLC is a qualified subch. S shareholder because the LLC is disregarded under the regulations).