For the first time, in Wandry v. Commissioner, the Tax Court approved a defined value formula clause without a charitable component. In this federal gift tax case, the Tax Court determined, in a memorandum opinion, that the taxpayers’ respective defined value gift clauses were enforceable under state law, were defined value gifts of LLC membership interests instead of gifts of percentage interests and, thus, were to be respected for federal gift tax purposes.
Albert and Joanne Wandry (“Petitioners”) and their children formed Norseman Capital, LLC (“Norseman”). The Petitioners wanted to make gifts to their children and grandchildren using their annual exclusion and lifetime exemption amounts, so they consulted a tax attorney to begin a gift-giving program. On January 1, 2004, the Petitioners transferred gifts of specific dollar amounts of membership units in Norseman to their children and grandchildren. The gift documents stated that if the IRS challenged the eventual valuation of the units, the capital accounts would be adjusted so that the number of units transferred equaled the specified values. An independent appraiser determined the value of the LLC and the Petitioners’ CPA used the appraisal to report the number of units transferred on the Petitioners’ gift tax returns. However, the IRS determined that the values of the gifts exceeded the Petitioners’ Federal gift tax exemptions and issued a deficiency notice on February 4, 2009.
The Commissioner (the “Respondent”) argued before the court the following four points: (1) the gift descriptions on the gift tax return were admissions that the Petitioners transferred fixed Norseman percentage interests to the donees; (2) Norseman’s capital accounts controlled the nature of the gifts and their capital accounts were adjusted to reflect the gift descriptions; (3) the gift documents transferred fixed Norseman percentage interests to the donees and the adjustment clause was not effective; and (4) the adjustment clause was void as against public policy.
The Court ruled in favor of the Petitioners stating the following on each point respectively: (1) Petitioners used specific dollar amounts to describe the gifts and their consistent intent and actions proved that the dollar amount gifts, rather than specific percentages, were always intended; (2) because the IRS has the ability to review the accuracy of capital accounts, such accounts are not final until the statute of limitations runs, thereby allowing the taxpayer to make a similar adjustment; (3) based upon the analysis set out in a similar case of Petter, the Court upheld the validity of a value formula clause because the “ascertainable dollar value of the stock” transferred was a fixed set of rights, even though the units themselves had an unknown value; and (4) there is no public policy issue in this case because there is a mechanism outside of an IRS audit to ensure accurate reporting (ie each donee had a competing interest to make sure the transfer was accurate). The Court went on to further point out that it is “inconsequential” that the adjustment clause allocated units among the Petitioners and donees, rather than a charitable organization.
See Wandry v. Cmmr. Of Internal Revenue, T.C. Memo. 2012-88 (March 26, 2012).