GTH Estate Planning Blog

Before we learn of Uncle Nils's decision on major gifts, let's look at a second case about a "defined value clause." In 2004 Mr. and Mrs. Wandry made gifts of interest in their Colorado limited liability company as follows: $261,000 worth to each child, and $11,000 in value to each grandchild. The gift document stated that a third-party valuation would be obtained to determine the ownership percentages equivalent to these dollar amounts. Gift tax returns were filed reporting the dollar amounts of the transfers.

The IRS audited the returns, objecting for much the same reason as in the McCord case we reviewed last week. As the Tax Court opinion put it, the IRS argued "that the adjustment clause does not save [taxpayers] from the tax imposed by section 2501 because it creates a condition subsequent to completed gifts and is void for Federal tax purposes as contrary to public policy." The gift formula, if successful, shielded the taxpayers from any additional tax consequence by audit; if the family LLC interests were found to be worth more, then the only result would be that a smaller percentage was transferred to children and grandchildren.

We're taking a break from our four-part series on Uncle Nils's using his $5 million gift tax exemption, to look at a couple of important recent cases on the valuation of gifts. In each the IRS tried to revalue the gift to cause a greater gift tax liability.

In the first case, Mr. and Mrs. McCord of Shreveport, Louisiana gave all their remaining family partnership interests to family members and charities. The gift document first transferred specific dollar amounts (in the millions) of family partnership interests to a generation-skipping trust, and the sons of the McCords. The balance of the partnership interests were directed by the same document to two charities. The gifts to family members were subject to gift tax, but the interests going to charity were not.

A valuation of the interests was obtained, and the family and charities then entered into a Confirmation Agreement on the partnership percentages going to each recipient. Gift tax returns were filed and then audited. What was it the IRS didn't like about this arrangement?

Lars stays late at the CPA firm this Thursday to try to formulate a recommendation on how to do Uncle Nils's major tax-saving gifts. He grabs materials off his desk and takes them to a small but windowed conference room. He likes to do this for big decisions. Everyone is gone. Outside are trees.

He starts sketching out tentative conclusions on a yellow pad, based on what he's thought so far, and without organizing them or committing to them yet. This is another working device of his, pretty much like writing a draft. He gives himself the freedom to reorder them and drop some. Here are some of the things he writes down:

"Keep liquid + income, give illiquid and 0 income."

"Give appreciation" (here he means potential growth in value, not thankfulness).

"Marital deduction" (for Sylvia's portion of the inheritance).

"State vs. Federal calc" (for the differences in estate tax rules).

So let's look at Nils's financial statement for assets he might give away, particularly illiquid ones. There are real estate investment LLCs, and a couple of homes.

Two of the LLCs have very well-functioning real estate. One owns an in-town-but-trendy shopping center that has great tenants and generates a ton of cash flow. Nils's 60% interest in it is his most valuable asset, likely worth well over $5 million. The second LLC has an apartment building, also a good income-producer. Nils owns 60% of this also, with a value about half the commercial property.

There are two other less mature real estate LLCs. One with a newer commercial property is in a promising location but has a few too many vacancies and too much debt for Nils's liking. This one has been a struggle to the point where Nils has to feed it a little each year.

The fourth and last LLC also reflects the recent tough years: it was formed to invest in a certain large project but that fell through, leaving it with a little more than $2 million that was to be used for the down payment. Nils and Lars have left it in that state, ready to pounce on another good deal when it comes along.

Nils could give a portion of any of these LLCs to relatives, or a trust for them.

Our CPA friend Lars is turning 55 on August 4th. He's aware this makes him a Leo in the world of astrology. Masculine, energetic, and generous? Well, maybe a 75 on each of these. Loyal? Lars hopes so (he is very much so). He's thinking he needs to exercise his energy and masculinity, to the extent he has these, on rich Uncle Nils to prod him on the numerous benefits of making tax-saving gifts in 2012.

Nils has used only about $1.3 million of the $5 million lifetime gift tax exemption that might well be reduced after this year. There's a decent chance it will go back down to $1 million, thus foreclosing Nils from making significant gifts in the coming years. This is why Lars has resolved to press the case with him, and with thirty or so other clients, well before year-end is upon us. It's not just out of self-interest; Lars and Kyra are already comfortable and there are other relatives who might receive gifts from Nils. It's more that it's just good estate planning to make smart moves to reduce the future tax, and giving guidance on estate planning is part of Lars's professional role with clients.