As reported in Newsletter #1, in John W. Fisher and Janice B. Fisher v. United States of America (March 11, 2010), the U.S. District Court of Indiana held that the interests in Good Harbor Partners, LLC, the Fisher’s limited liability company, gifted by the Fishers to their children and grandchildren were transfers of future interests in property and, therefore, not subject to the gift tax exclusion under §2503(b)(1). The determining factor in the case was the IRS argument that the children could not unilaterally transfer the gifted interests and, therefore, had no present interest in the gifts. Under the Good Harbor operating agreement, the LLC had a right of first refusal, which the court said effectively prevents the children from transferring their interests in exchange for immediate value, unless the transfer is to a Fisher descendant. On September 1, the court followed up on its decision to determine whether Good Harbor was engaged in a bona fide business arrangement.
One of the benefits of a Family Limited Partnership or Family Limited Liability Company is that the majority owners can make gifts of minority interests to their descendants while discounting the value of such interests for Gift Tax purposes for lack of marketability and minority interests. However, under the U.S. Tax Code, a restriction on the right to sell or use transferred property may be taken into consideration for valuation purposes only if such restriction is part of a bona fide business arrangement. In other words, the Fishers must establish that Good Harbor is a bona fide business in order to claim a lack of marketability discount for the value of the gifted interests.
The Fishers contended that “holding real estate for investment or development” was indeed a bona fide business. However, the court found that there was no evidence that the Fishers had an investment strategy that was preserved by Good Harbor’s formation and that neither the Fishers nor their descendants took actions that would demonstrate a business purpose, such as making ongoing investments in the lakefront property to increase its commercial value or acquiring additional properties on behalf of Good Harbor.
Since the Fishers failed to raise an issue of fact regarding whether Good Harbor was a bona fide business, the court granted the federal government’s Motion for Partial Summary Judgment against the Fishers and Good Harbor. For estate and corporate planners, the decision provides further guidance on what will constitute a legitimate family business entity that can survive the government’s scrutiny. Based on this decision, it is evident that the best practice is to use an operating, functional business interest, such as rental property, to fund such an entity. Undoubtedly, each court decision in this area gets us closer to a proper definition of the requirements of the IRS.