Defined-value gifts - Give now, value later

by Adler Pollock & Sheehan P.C.
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To make the most of the $5.12 million gift tax exemption amount while it’s available, many families are making large gifts this year. Such gifts can be a challenge, however, if they consist of illiquid, difficult-to-value assets, such as interests in a closely held business or family limited partnership (FLP). For one thing, they must be supported by a business valuation — a complex, time-consuming process that shouldn’t be rushed. For another, because valuation isn’t an exact science, there’s a risk that the IRS will claim, years later, that a gift was undervalued for tax purposes.

A defined-value gift can address both of these concerns.

Defined-value defined

A defined-value gift is a gift of assets that equal a specific dollar amount, rather than a set number of FLP units or a fixed percentage of a business. It protects you against unexpected taxes down the road in the event it’s determined that the FLP or business was undervalued. Although the IRS dislikes defined-value gifts, in recent years they’ve been upheld by several courts, including the U.S. Tax Court and the U.S. Court of Appeals for the Ninth Circuit.

For a defined-value gift to work as planned, an attorney must draft the gift language carefully to ensure that it’s interpreted as a formula clause rather than a savings clause. A savings clause, which is invalid, essentially reverses a portion of a gift and returns it to the donor in the event it turns out to be taxable. A formula clause, on the other hand, makes a gift of a specified dollar amount that’s fixed on the date the gift is made, even though the number of shares needed to produce the gift may be adjusted in the future.

Until earlier this year, all of the cases accepting defined-value gifts involved a “charitable cap.” That is, business interests or FLP units were donated to charity to the extent that their value exceeded the amount of the gift.

However, in a recent case — Wandry v. Commissioner — the U.S. Tax Court upheld a defined-value gift that lacked this charitable element. In this case, once the value of the entity was determined, the percentage interests in the entity were reallocated among the donor and donees in accordance with the specified dollar amounts.

Planning opportunities

If you wish to make substantial gifts of closely held business interests, FLP units or other difficult-to-value assets before year end, consider defined-value gifts. This strategy allows you to take advantage of the record-high exemption amount — which, as of this writing, is scheduled to expire at the end of the year — without the need for rushed valuations and without the fear of unintended tax consequences should the IRS challenge your gift tax values down the road.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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