Tax Court Upholds Defined Value Gift Formula Clause

The Tax Court in Wandry v. Commissioner (T.C. Memo 2012-88) has upheld a formula clause used by a couple for a program of gifting the interests in a family limited partnership (FLP).

Formula clauses are used by taxpayers to avoid unintended gift, estate and generation-skipping transfer (GST) tax consequences when transferring property. There are two general types of formula clauses: A definition clause defines a transfer by reference to the value of a possibly larger, identified property interest; and a savings clause retroactively adjusts the value of a transfer due to a subsequent valuation determination.

The IRS has been successful challenging savings clauses for gift, estate and GST tax purposes, arguing that they are against public policy because they prevent the IRS from properly administering the Code. The definition clause is a relatively new type of clause that has generally been respected by courts for gift, estate and GST tax purposes.

In Wandry, a couple established an FLP and embarked on a gift-giving program of gifting interests in the FLP annually. Their estate planning attorney advised them that (1) the number of FLP units equal to the desired value of their gifts on any given date could not be known until a later date when a valuation of the FLP's assets could be made, (2) all gifts should be given as specific dollar amounts rather than specific numbers of membership units, and (3) all gifts should be given on Dec. 31 or Jan. 1 of a given year, so that a midyear closing of the books would not be required. Based on this advice, the following formula clause was used to set the amount of the annual transfers:

I hereby assign and transfer as gifts, effective as of [Date], a sufficient number of my Units as a Member of Norseman Capital, LLC, a Colorado limited liability company, so that the fair market value of such Units for federal gift tax purposes shall be as follows: [Name of Donee – Specified Dollar Amount]. Although the number of Units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted Units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date. Furthermore, the value determined is subject to challenge by the Internal Revenue Service (IRS). I intend to have a good-faith determination of such value made by an independent third-party professional experienced in such matters and appropriately qualified to...