Estate Planning to Ensure Gifts are Tax Free

Many people who make Estate Planning gifts are giving away assets that don’t have obvious market prices. Because the gift tax is based on the value of an asset, these people have to be careful.

When the donor places a value on an asset and makes the maximum tax-free gift, the IRS later can step in and argue that the donor understated the value. The IRS puts a higher value on the asset and assesses a gift tax on the additional value. This is likely for those who give away interests in real estate, small businesses, collectibles, and other assets without public market values.

A recent court case shows how a taxpayer can use smart estate planning to establish protection against the IRS’s revaluing gifts.

In the case, the taxpayers were a married couple who gave interests in a family-owned limited liability company to their children.

Instead of giving a specific amount of units in the LLC, they drafted a document that said they were giving each donee a specified dollar value of interests. They placed a value on the LLC units and transferred title of the appropriate number of units. But the document said that if the IRS revalued the interests upward, then the number of units given would be adjusted accordingly so that each donee received only the value specified in the document. The excess units would be in the name of the donor.

The IRS challenged both the value placed on the interests and the validity of the document. It said the taxpayers gave away more value than they said and owed gift taxes on the excess.

The Tax Court disagreed. It said taxpayers can use formulas to make gifts. If they understate the value of property, the IRS and the court simply reallocate the number of units owned by the parties so the gift was of the value intended. In the past, such formulas were allowed when any excess value went to a charity instead of back to the donor. But the court didn’t require a charity to be involved.

If the case is upheld after an appeal, it means taxpayers can make gifts of hard-to-value assets without the fear of being assessed substantial gift taxes years later.

(Wandry, T.C. Memo 2012-88)

RW October 2012.