on Decision 2012-004, the IRS stated it will not acquiesce to
the Tax Court’s decision in
T.C. Memo. 2012-88, in which the court accepted a taxpayer’s use of a
defined value formula clause.
In Wandry, decided in March 2012, the taxpayers, Joanne and Albert Wandry, executed assignments and memorandums of gifts to their four children and five grandchildren designed to not exceed their annual and remaining lifetime gift exclusion amounts of $1,099,000 for each taxpayer. Each gift document transferred an unstated number of units of the couple’s member interests in their family limited liability company (LLC) having a fair market value (FMV) equal to $261,000 to each child and $11,000 to each grandchild. The documents further stated that although the number of units was fixed on the date of the gift in 2004, the number was based on the FMV of the gifts as determined after that date, based on “all relevant information.” The donors stated their intent to base the value on an independent third-party appraisal by a qualified appraiser, but that, if the IRS or a court later made a final determination of a different value, the number of gifted units would be adjusted to maintain the dollar values stated in the documents. They obtained an appraisal that determined the value of a 1% member interest in the LLC as of the date of gift.
On their gift tax returns for 2004, the couple reported the dollar amounts of the gifts and, based on the appraisal, further described the gifts as interests of 2.39% and 0.101% in the LLC to each child and grandchild, respectively. The LLC’s financial records for 2004 showed capital account transfers from the donors to the donees that were greater than the dollar amounts in the gift documents.
The IRS redetermined the value of an LLC member interest unit and, applying the gift percentages, increased the values of the gifts. After negotiations, the parties agreed that the percentage interests given each child and grandchild would yield values of $315,800 and $13,346, respectively. However, the taxpayers continued to argue in a petition to the Tax Court that they had not transferred fixed LLC percentage interests. The IRS contended that the gift tax returns, capital accounts, and the gift documents themselves all supported fixed percentages. It also argued the adjustment clause created a “condition subsequent” to completed gifts and thus was void as contrary to public policy, as courts have held in a line of cases from Procter, 142 F.2d 824 (4th Cir. 1944). Such “savings clauses” allow donors or estates to “take property back” in an amount necessary to avoid transfer taxes.
The Tax Court held that despite the gift return’s percentages, there was no evidence the donors intended to give more than the fixed dollar amounts, and that the capital accounts were not controlling. The gift documents did not state a number of LLC units transferred, but the number was nonetheless predefined as a mathematical formula of which the only unknown was the LLC’s FMV, the court said. This, the court noted, was similar to the holding of the Ninth Circuit in Estate of Petter, 653 F.3d 1012 (9th Cir. 2011), aff’g T.C. Memo. 2009-280. In Petter, the additional property transferred under a formula clause was transferred to a charity, and the estate claimed a charitable deduction of the amount (see previous Tax Matters coverage Nov. 2011, page 74). The lack of a charitable component in Wandry did not raise any “severe and immediate” public policy concern, the Tax Court said. The mechanism to determine the allocation between donors and donees did not operate to take property back and was a valid adjustment, not an impermissible savings clause, the court held.
Following the decision in Wandry, the IRS filed an appeal with the Tenth Circuit but in October withdrew it without explanation. In the action on decision, the IRS reiterated its long-held position that “the final determination of value for federal gift tax purposes is an occurrence beyond the taxpayers’ control.” A gift is complete for federal tax purposes when the donor parts with dominion and control and any power to change its disposition, the IRS said, citing Regs. Sec. 25.2511-2(b). The gifts in Wandry were complete on the date of gift as fixed percentage interests, it said. In Petter, any adjustment went to a charity, not to the donor, so the court did not have to consider whether the gift was complete, the IRS said. Thus, in Wandry, the IRS said, the Tax Court erred in considering the gifts as anything other than fixed percentage interests.
For more, see “Formula Clauses: Adjusting Property Transfers to
Eliminate Tax” in the February 2013 issue of The Tax Adviser
Life for Charitable Lids,” JofA, Sept. 2010, page 50.