Tax Court Gives Defined Value Clauses A Boost - Or Does It?

The use of "defined value clauses" or "value definition formulas" in making gifts has received much attention and possibly a boost from a decision this year of the United States Tax Court in Wandry v. Commissioner, T.C. Memo 2012-88. Wandry seems to extend the effectiveness of such techniques beyond what previous case law permitted. But Wandry is not well-settled law on this subject, its reasoning is troubling, and it should not be relied on except with great care, especially since the IRS has filed a Notice of Appeal.

Background

Many assets that are the subject of gifts to family members do not trade in any market and therefore are hard to value. Examples are undivided interests in real estate and membership units in family limited partnerships or LLCs. Donors understandably want to be able to make such gifts without a risk of a gift tax audit that could be a hassle and an expense and could result in increased gift tax. Just as in the days when one could drive into a gas station and ask for "five dollars' worth of regular," without specifying the number of gallons, there is an intuitive notion that a donor ought to be able to make a gift of any stated amount expressed in words like "such interest in X Partnership, an ... limited partnership, as has a fair market value of $13,000." The value of that gift appears to be $13,000, no matter what kind of property is given. The IRS approved a gift using that very language in Technical Advice Memorandum 8611004 (Nov. 15, 1985). (The ellipsis is in the version of the TAM that was made public; the deleted word appears to have been Oklahoma.) But since 1985, the IRS has become less sympathetic and has challenged such audit-resistant formulas, often citing Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944), a case with unusual facts in which the court found a provision in a document of transfer that "the excess property hereby transferred which is deemed by [a] court to be subject to gift tax ... shall automatically be deemed not to be included in the conveyance" to be contrary to public policy because it would discourage the collection of tax, would require the courts to rule on a moot issue, and would seek to allow what in effect would be an impermissible declaratory judgment.

In Knight v. Commissioner, 115 T.C. 506 (2000), the Tax Court sided with such an IRS challenge to an attempt to transfer "that number of limited partnership units in [a partnership] which is equal in value, on the effective date of this transfer, to $600,000." As a result, the court redetermined the value subject to gift tax. It was generally believed, however, that the result in Knight could have been avoided if the taxpayers had acted more consistently and carefully. Despite the apparent attempt to make a defined-value gift, the gifts shown on the gift tax return were stated...