The Fifth Circuit reaffirmed that under IRC section 2512, a gift’s value is determined on the date it is given. The court also decided that a discount used to determine the present value of a previously transferred interest was allowable if it was the amount a willing buyer would require to cover any additional taxes under section 2035.
Charles T. McCord Jr. and his wife, Mary, along with their four sons, established McCord Interest Ltd. (MIL), a Texas limited partnership. The couple received all the class A limited partnership interest in MIL and 82% of the class B limited partnership interest, for a total contribution of $12.3 million.
On Jan. 12, 1996, the McCords gave all their class B limited partnership interest to two charities, their sons and each son’s generation-skipping trust by executing an assignment agreement. The gifts were in dollar amounts of the net fair market value of MIL and not stated in percentages of interest. An independent appraiser determined the value on the date of the gift as $89,505 for each 1% of class B limited partnership interest. In March 1996, all the recipients signed a confirmation agreement, which translated the dollar value of the gifts into percentages of interest.
The McCords timely filed a 1996 gift tax return that reflected the appraiser’s value of their gifts. They took annual exclusions of $60,000 each and charitable contribution deductions of $209,173 each. In addition, they reduced the value of their gifts by the amount of the gift tax payable for gifts to the nonexempt donees, which reflected the fact that the donees assumed the payment. They also deducted the actuarially determined present value of the nonexempt donees’ liability (which the donees had agreed to pay) for any additional estate taxes if one or both taxpayers died within three years of the gift, based on section 2035.
The IRS issued a deficiency to both taxpayers, saying the McCords understated the gifts’ fair market value and should not have taken the discount for the nonexempt donees’ potential liability under section 2035. The McCords contested the deficiencies in the U.S. Tax Court. The Tax Court initially found in favor of the taxpayers on all issues, then two years later, in what the Fifth Circuit would later call an unusual proceeding that employed a “novel methodology,” the Tax Court reversed its earlier decision.
Result. For the taxpayers. The Fifth Circuit reversed and remanded the case, saying the Tax Court majority erred in relying on the recipients’ agreement, since it came two months after the gift and the donors were not a party to it. The appellate court also determined the value of the gifts was properly discounted because:
The transfer tax rate on the date of the gift would be of interest to a willing buyer for discount purposes. Section 7520 provides the interest rates.
A willing-buyer/willing-seller test would allow a discount for potential additional federal estate taxes if one or both of the taxpayers died within three years of the gift and it is sufficiently determinable to be taken into account.
Succession of McCord Jr. v. Commissioner, 98 AFTR2d 2006-6147 (8/22/2006).
Prepared by Gary D. Rider, J.D., instructor of business, and Darlene Pulliam, CPA, Ph.D., professor of accounting, both of the College of Business, West Texas A&M University, Canyon.