Transaction Lacks Economic Substance; Charitable Deduction Denied

Transaction Lacks Economic Substance; Charitable Deduction Denied

Internal Revenue Service

In heavily redacted field attorney advice, the IRS concluded that a purported donation of limited liability company membership interests to an organization and related transactions lack economic substance and should be disregarded.

In heavily redacted field attorney advice, the IRS concluded that a purported donation of limited liability company membership interests to an organization and related transactions lack economic substance and should be disregarded.

In heavily redacted field attorney advice, the IRS concluded that a purported donation of limited liability company membership interests to an organization and related transactions lack economic substance and should be disregarded. In its analysis, the IRS said it used the term “transaction” to refer to steps the taxpayers took to create a structure to avoid income taxes while maintaining control of the underlying assets. The IRS concluded that the transaction lacks economic substance, both subjectively and objectively, and must be disregarded for federal income tax purposes under the economic substance doctrine of <a href="/research/federal/usc26/7701#cq5n-0000293" resolve="/lr/resolve//cq5n#cq5n-0000293">section 7701(o)</a>. Aside from tax consequences, the IRS found that the transaction did not meaningfully change the taxpayers’ economic position nor did they have a substantial purpose in participating in the transaction. In its subjective inquiry, the IRS determined that the transaction didn’t fit with the taxpayers’ stated reasons for engaging in the transaction. Further, the taxpayers’ conduct of business did not change because of the transaction, and a tax promoter devised most, if not all, aspects of the transaction. Taxpayers engaged in the transaction to obtain tax benefits, which is evidenced by their use of tax advisers and promoters to structure the transaction and draft specified documents. Not only did tax advisers draft agreements, apparently with the motivation of avoiding taxes, taxpayers did not follow those agreements. The IRS also found the timing of the transaction problematic. Objectively, the IRS determined that the organization wasn’t, in substance, a partner in the LLC. It was a partner in name only because it didn’t share in the potential upside or downside risk of the LLC, among other things. The IRS also determined that a reasonable investor would not enter the transaction. Based on the facts and circumstances, the IRS also determined that the organization isn’t recognized as a member of the LLC for income tax purposes under <a href="/research/federal/usc26/704#cpfs-0000027" resolve="/lr/resolve//cpfs#cpfs-0000027">section 704(e)</a>, which provides that a donee of a partnership interest in a partnership in which capital is a material income-producing factor may be recognized as a partner for income tax purposes. The IRS also concluded that the taxpayers’ claimed noncash charitable contribution to the organization must be disallowed under <a href="/research/federal/cfr26/1.170A-13" resolve="/lr/resolve//ct81">section 170</a>. The taxpayers did not comply with <a href="/research/federal/usc26/170#cpyg-0000226" resolve="/lr/resolve//cpyg#cpyg-0000226">section 170(f)(11)</a> because a qualified appraisal was not attached to the return as required under <a href="/research/federal/usc26/170#cpyg-0000234" resolve="/lr/resolve//cpyg#cpyg-0000234">section 170(f)(11)(D)</a> for noncash charitable donations over $500,000. Further, the appraisals were authored by an adviser who was not qualified to perform the appraisal and barred from valuing the LLC interests because of his relationship to the transaction. The taxpayers also did not comply with <a href="/research/federal/cfr26/1.170A-13#ct81-0000045" resolve="/lr/resolve//ct81#ct81-0000045">reg. section 1.170A-13(c)(2)(i)(B)</a>, which requires that a taxpayer attach a fully completed appraisal summary to the tax return. In addition to the compliance issues, the IRS determined that the charitable deduction should be denied because it is an improper conditional gift. The LLC’s claimed amortization expense for a specified operating method must also be disallowed, the IRS said.

In heavily redacted field attorney advice, the IRS concluded that a purported donation of limited liability company membership interests to an organization and related transactions lack economic substance and should be disregarded. In its analysis, the IRS said it used the term “transaction” to refer to steps the taxpayers took to create a structure to avoid income taxes while maintaining control of the underlying assets. The IRS concluded that the transaction lacks economic substance, both subjectively and objectively, and must be disregarded for federal income tax purposes under the economic substance doctrine of section 7701(o). Aside from tax consequences, the IRS found that the transaction did not meaningfully change the taxpayers’ economic position nor did they have a substantial purpose in participating in the transaction. In its subjective inquiry, the IRS determined that the transaction didn’t fit with the taxpayers’ stated reasons for engaging in the transaction. Further, the taxpayers’ conduct of business did not change because of the transaction, and a tax promoter devised most, if not all, aspects of the transaction. Taxpayers engaged in the transaction to obtain tax benefits, which is evidenced by their use of tax advisers and promoters to structure the transaction and draft specified documents. Not only did tax advisers draft agreements, apparently with the motivation of avoiding taxes, taxpayers did not follow those agreements. The IRS also found the timing of the transaction problematic. Objectively, the IRS determined that the organization wasn’t, in substance, a partner in the LLC. It was a partner in name only because it didn’t share in the potential upside or downside risk of the LLC, among other things. The IRS also determined that a reasonable investor would not enter the transaction. Based on the facts and circumstances, the IRS also determined that the organization isn’t recognized as a member of the LLC for income tax purposes under section 704(e), which provides that a donee of a partnership interest in a partnership in which capital is a material income-producing factor may be recognized as a partner for income tax purposes. The IRS also concluded that the taxpayers’ claimed noncash charitable contribution to the organization must be disallowed under section 170. The taxpayers did not comply with section 170(f)(11) because a qualified appraisal was not attached to the return as required under section 170(f)(11)(D) for noncash charitable donations over $500,000. Further, the appraisals were authored by an adviser who was not qualified to perform the appraisal and barred from valuing the LLC interests because of his relationship to the transaction. The taxpayers also did not comply with reg. section 1.170A-13(c)(2)(i)(B), which requires that a taxpayer attach a fully completed appraisal summary to the tax return. In addition to the compliance issues, the IRS determined that the charitable deduction should be denied because it is an improper conditional gift. The LLC’s claimed amortization expense for a specified operating method must also be disallowed, the IRS said.