By Danielle T. Zaragoza,
Esq., Morrison &
relatively large federal gift
tax applicable exclusion amount
available for taxable gifts in 2011 and 2012, many clients have made or are
considering making significant gifts before the end of this year. For a client who wants to make gifts of
hard-to-value assets to use his or her full exclusion amount, but not exceed it
this year, there is a risk that the IRS could challenge the valuation claimed
on the gift tax return which could result in an unintended gift tax liability. In Wandry
v. Commissioner,1 the Tax Court has provided some
comfort that a properly drafted defined value clause is not contrary to public
policy and should be respected by the IRS, thereby allowing taxpayers to take
advantage of their full applicable exclusion amounts with little risk that
challenges by the IRS to valuation would result in gift taxes being due.
A defined value clause generally provides that if the IRS successfully
challenges the valuation claimed by the taxpayer, the amount gifted would be
reduced to fit within the annual exemption or credit amounts. A defined value clause is a technique used by
estate planners to reduce the risk of an unintended gift tax liability. However, there is the additional risk that the
IRS and the courts would not respect such a clause because they are seen as
contrary to public policy. As noted in Commissioner
v. Procter,2 a
defined value clause would likely discourage the government's tax collection
because "the only effect of an attempt to enforce the tax would be to defeat
the gift" and is therefore against public policy.
However, in recent years, formula clause gifts have been upheld in
previous Tax Court cases when excess value would have been transferred to
charity. The presence of a charitable
beneficiary was seen as a third party who could and would insure valuation
accuracy and as supporting another favorable public policy-encouraging
Wandry, decided in
March 2012, is significant because no charity was involved and the court
expressly stated that the formula clause in the transfer documents is not void
as contrary to public policy. Given this
recent decision, it is likely that formula clauses that describe gifts as a
specific dollar amount, rather than a specific number of units or percentage
interest of a hard-to-value asset, may become a standard planning tool for
Below is a summary of the Wandry case and the decision.
number of Units gifted is fixed on the date of the gift, that number is based
on the fair market value of the gifted Units, which cannot be known on the date
of the gift but must be determined after such date based on all relevant information
as of that date. Furthermore, the value determined is subject to challenge by
the Internal Revenue Service ("IRS"). I
intend to have a good-faith determination of such value made by an independent
third-party professional experienced in such matters and appropriately
qualified to make such a determination. Nevertheless,
if, after the number of gifted Units is determined based on such valuation, the
IRS challenges such valuation and a final determination of a different value is
made by the IRS or a court of law, the number of gifted Units shall be adjusted
accordingly so that the value of the number of Units gifted to each person
equals the amount set forth above, in the same manner as a federal estate tax
formula marital deduction amount would be adjusted for a valuation
redetermination by the IRS and/or a court of law."
inconsequential that the adjustment clause reallocates membership units among
petitioners and the donees rather than a charitable organization because the
reallocations do not alter the transfers.
On [the date of the gift], each donee was entitled to a predefined
Norseman percentage interest expressed through a formula. The gift documents do not allow for petitioners
to 'take property back.' Rather, the
gift documents correct the allocation of Norseman membership units among the
petitioners and the donees because the [valuation report] understated the
Of course, Wandry is only a
Tax Court memorandum opinion, subject to appeal by the IRS. Even if the IRS does not appeal the decision,
it is unlikely that the IRS will acquiesce to this decision. Therefore, conservative planners and clients
may still want to include a charitable beneficiary in gifting plans that use
defined value clauses to take advantage of a client's full applicable exclusion
amount before the end of 2012.
1. TC Memo
2012-88 [enhanced version available to lexis.com subscribers].
2. 142 F.2d
824, 827 (4th Cir. 1944) [enhanced version available to lexis.com subscribers].
* * *
Morrison & Foerster's Trusts and Estates group provides sophisticated planning and administration services to a broad variety of clients. If you would like additional information or assistance, please contact Patrick McCabe at (415) 268-6926 or PMcCabe@mofo.com.
© Copyright 2012 Morrison & Foerster LLP. This article is published with permission of Morrison & Foerster LLP. Further duplication without the permission of Morrison & Foerster LLP is prohibited. All rights reserved. The views expressed in this article are those of the authors only, are intended to be general in nature, and are not attributable to Morrison & Foerster LLP or any of its clients. The information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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