The U.S. Tax Court has held for the first time in Wandry v. Commissioner (Tax Court, March 26, 2012), that a donor may make a non-cash gift of a stipulated dollar amount and retain any portion of the transferred property value in excess of the stated dollar amount the donor gave away. Gifts of property other than cash have been problematic because the donor cannot be sure how large a gift he has made until the Internal Revenue Service audits his gift tax return and either accepts the value claimed, or establishes a higher value (and resulting gift tax liability).
A donor may wish to give away units in a family limited liability company that are worth $5,120,000 in order to use his lifetime gift tax exemption in 2012 before the exemption amount reverts to $1 million next year. The donor would normally get an appraisal of the units and make a gift of the number of units that are worth $5,120,000 based on that appraisal. He would then have to wait for the IRS to audit his gift tax return. If the IRS established a higher value upon audit, the donor would owe gift tax on the value in excess of $5,120,000 – an unexpected (and unpleasant) consequence. As a result, the donor may act too conservatively and gift fewer units to provide a gift-tax cushion.
A number of years ago, a donor had the idea to address this problem by giving away property but providing, as a condition of the gift, that any of the transferred property that gave rise to a gift tax must be returned to the donor. The donor essentially attempted to describe the gift as a fixed dollar amount.
In the Procter case, the U.S. Court of Appeals for the 4th Circuit in 1944 held that a gift structured in this manner violated public policy for several reasons, including that it would effectively prevent the IRS from challenging the value of the gift. Other courts followed this reasoning in the Ward and Harwood cases. In Harwood the U.S. Court of Appeals for the Ninth Circuit affirmed the decision of the U.S. Tax Court , although without the issuance of an opinion. (Case law from the Ninth Circuit governs cases involving taxpayers who live in California).
In another series of cases (McCord, Estate of Christiansen, Estate of Petter), taxpayers prevailed, because instead of providing that the donor retained any excess value amount, they gave any excess value to charity. The Ninth Circuit approved this approach in the Petter case. For some donors, however, including a charity in what was intended to be a family gift arrangement presented unacceptable complications.
Now, in the Wandry case, the U.S. Tax Court has decided that the gift of property equal to a fixeddollar amount does not violate any public policy and therefore is permitted. The court noted that the role of the IRS is to enforce the tax laws, not merely to maximize tax receipts. The court distinguished the earlier cases such as Procter on the basis that in those cases, the gift was worded in manner such that the donor “took back” any value determined to be in excess of the value he intended to give away. The donor structured the gift in Wandry differently, simply giving away a number of units the value of which was equal to a fixed dollar amount. The gift was simply described by dollar value rather than by number of units, and no condition subsequent that could cause a part of the gift to revert to the donor. The court distinguished a “formula value” clause as different from a “savings clause.”
The IRS may still decide to appeal the Wandry decision to the U.S. Court of Appeals for the 10th Circuit, (the taxpayers lived in Colorado). While the Tenth Circuit previously has not addressed this exact issue, it did approve a similar clause in connection with a sale of property in the King case.
If you are considering making a significant gift in 2012 to use your lifetime exemption and do not wish to transfer any excess value amount to a charity, you may want to use the Wandry formula approach. Gifts using this kind of formula value clause normally should be made to a grantor trust so the donor continues to report any income from the transferred property on his income tax returns. This will avoid the need to file amended returns if the number of units the donor originally believed equaled the gifted value subsequently must be changed because the value of the units is changed upon audit.