Taxpayers have prevailed in two cases where the amount given to a charity was to be determined by reference to asset values as finally determined for estate or gift tax purposes. In Estate of Christiansen, Helen Christiansen left her estate to her only child, her daughter Christine Christiansen. However, her will provided that if Christine disclaimed any portion of the estate, 25% of the amount disclaimed would pass to a charitable foundation. Christine disclaimed her interest in her mother’s estate as to all amounts over $6.35 million, using values as finally determined for federal estate tax purposes. The value of the estate was adjusted upward on audit and the estate sought an increased charitable contribution deduction because 25% of the amount of the increase passed to the foundation. The IRS challenged the estate’s entitlement to the charitable contribution deduction and the Tax Court held in favor of the taxpayer. The IRS then appealed the case to the United States Court of Appeals for the Eighth Circuit.
In November, the court of appeals upheld the Tax Court’s decision in favor of the taxpayer. The IRS had raised two arguments. First, it argued that the amount disclaimed was contingent upon a subsequent event. Therefore the disclaimer was not a qualified disclaimer and there should be no charitable contribution deduction. The court found that the amount disclaimed was not contingent. The disclaimed amount and the amount of the resulting gift to the foundation were fixed at Mrs. Christiansen’s death. Because a qualified disclaimer relates back to the date of death, once the daughter disclaimed the amount of her mother’s estate in excess of $6.35 million, the amount of property that would pass to the foundation was fixed. It was simply a matter of determining the value of the estate as of the date of death and then the amount of property that would pass to the foundation would be known. The amount of the gift was not based on any factors that could change the value of the gift after the decedent’s death.
The second argument raised by the IRS was that allowing an increased charitable deduction where the IRS increased the value of the estate would provide a disincentive for the IRS to audit estates. While the court agreed that this may be the case, that did not change the result. The court pointed out that the role of the IRS was not simply to maximize tax receipts; its proper role is to enforce the tax law.
A second case involving the use of a fixed value formula clause is Estate of Anne Y. Petter, decided by the Tax Court on December 7, 2009. The taxpayer had inherited shares of United Parcel Service stock from her uncle. She contributed shares of the United Parcel stock to a family limited liability company. She then made three types of transfers of the units of the company. She made a gift of some units to trusts she set up for her children, she sold some units to the trusts for her children and she gave some units to charities. The units given and sold to the trusts were not described as a fixed number of units, but instead with reference to a specific dollar value. In the case of the gift, the number of units given was whatever number of units was worth an amount equal to her unused gift tax exemption. In the case of the units sold to the trusts, the number of units sold was that number equal in value to a stipulated dollar sum, which in turn was the same amount that the trust paid her for those units. The charities received all of the rest of the units. Initial transfers were made based on an estimate of the value and the transfers were then adjusted based upon a third party appraisal of the value of the units.
The taxpayer’s objective here was to insure that she would not owe any gift tax. If the IRS increased the value of the units above the appraised amount, then more units would be allocated to the charities for which she would receive a charitable contribution deduction and she should have no resulting gift tax liability. An increase in value simply meant that her children’s trusts would receive a lesser number of units and the charities would receive more.
The IRS challenged this approach and said that fixed value formula transfer clauses violate public policy. The IRS thought this case to be similar to a prior case, Commissioner v. Procter. In Procter, the taxpayer had transferred property to trusts for his children but had provided that if the value transferred was determined to be in excess of his gift tax exemption, then the excess amount of property reverted to him. There, the court held that this was an attempt to undo a gift by the use of a condition subsequent, which was contrary to public policy. It would not only frustrate tax collection, it would also require courts to pass on meaningless cases. If the court decided a gift had occurred, then the condition subsequent would undo the gift and there would have been no point in the court hearing the case to determine whether there was a gift.
However, the Tax Court felt that the Petter case was different. The taxpayer was not trying to get any property back if the value turned out to be higher than expected. Under all circumstances, the taxpayer had parted with all of the property. The only thing that the valuation affected was who would get the property as between the taxpayer’s children and the charities. A higher value meant that the charities would get more and her children would get less. The court’s determination was not meaningless as it allocated the property between the children and the charities. Finding that gifts to charities should be encouraged, the court determined this case was different from Procter and that Ann had not made any taxable gift. The court described Procter as involving a “savings clause” which violates public policy and the Petter case as involving a “formula value clause” which does not violate public policy.
One of the great challenges in planning intra-family transfers is determining the value of the assets to be transferred. While taxpayers generally obtain independent appraisals, the IRS is not bound by the appraisal and frequently does challenge them; particularly the amount determined by the appraiser for minority interest and other discounts. Thus, it is nearly impossible to insure that you are not making some taxable gift. Even where an asset is sold to children or trusts for their benefit, if the value ultimately determined is higher than the purchase price, a gift results.
These recent cases may provide a means of protecting against the risk of making an unintended gift. By providing that a charity will receive any portion of the transfer above a fixed value, it appears that a taxpayer can insure that he has not made an unintended gift. It remains to be seen whether the IRS appeals the Petter case and the result of any such appeal.