Tax Ruling Protects Transfers of Family Businesses

 
The recent US Tax Court ruling in Wandry v Commissioner, T.C. Memo. 2012-88, March 26, 2012 of Internal Revenue implies that a gift of a share in the business is always tax-free if it is specified to fall within the gift tax exemption, even if the IRS later challenges the business valuation.

The taxpayers were advised that they could institute a tax-free gift-giving plan through transfers of Wandry LP partnership interests by using their annual gift tax exclusions of $11,000 per donee under section 2503(b) and additional gifts in excess of their annual exclusion of up to $1 million for each petitioner under section 2505(a) (Federal gift tax exclusions). Petitioners’tax attorney was also a certified public accountant (C.P.A.) with 9 years of practice in public accounting and 19 years of practicing law.

 On January 1, 2004, petitioners executed separate assignments and memorandums of gifts (gift documents). Each gift document provides:

I hereby assign and transfer as gifts, effective as of January 1, 2004, a sufficient number of my Units as a Member of Norseman Capital, LLC, a Colorado limited liability company, so that the fair market value of such Units for federal gift tax purposes shall be as follows: 

Name Gift                                                                Amount

Kenneth D. Wandry                                                   $261,000

Cynthia A. Wandry                                                    $261,000

Jason K. Wandry                                                        $261,000

Jared S. Wandry                                                         $261,000

Grandchild A                                                              $11,000

Grandchild B                                                              $11,000

Grandchild C                                                              $11,000

Grandchild D                                                              $11,000

Grandchild E                                                              $11,000

Tatal                                                                           $1,099,000

Although the 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.

Respondent argues that petitioners are liable for the tax imposed by section 2501 because they transferred completed gifts of fixed percentage interests to the donees and the gifts exceed petitioners’ Federal gift tax exclusions.  

Respondent presents three arguments to support this conclusion:
 

(1) the gift descriptions, as part of the gift tax returns, are admissions that petitioners transferred fixed Norseman percentage interests to the donees;

 

(2) Norseman’s capital accounts control the nature of the gifts, and Norseman’s capital accounts were adjusted to reflect the gift descriptions; and

 

(3) the gift documents themselves transferred fixed Norseman
                                                       percentage interests to the donees.

 

Respondent further argues that the adjustment clause does not save petitioners 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. See Commissioner v. Procter, 142 F.2d 824, 827-828 (4th Cir. 1944), rev’g a Memorandum Opinion of this Court.  

Respondent’s final argument raises an old issue that has evolved through a series of cases where the Commissioner has challenged a taxpayer’s attempt to use a formula to transfer assets with uncertain value at the time of the transfer.

Here, under the terms of the gift documents, the donees were always entitled to receive predefined Norseman percentage interests,5 which the gift documents essentially expressed as a mathematical formula. For each of petitioners’ children, this formula was expressed as:

 x = $261,000 FMV of Norseman

Similarly, for petitioners’ grandchildren this formula was expressed as:

 

x = $11,000 FMV of Norseman

The Court, in reaching its holdings, has considered all arguments made, and, to the extent not mentioned, concludes that they are moot, irrelevant, or without merit.

To reflect the foregoing, Decisions will be entered for petitioners.

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