Archive for the ‘Business Planning’ category

Wandry v. Commissioner: Defined Formula Transfers Provide Significant Planning Opportunity in 2012

May 1, 2012

 By Ashley Alderman

As we continue to emphasize, 2012 is the year to make transfers to family members.  The current gift tax exclusion amount is $5.12 million, which will be reduced to only $1 million as of January 1, 2013, unless Congress acts.  Therefore, most wealthy clients should use their $5.12  million exclusion amount to the greatest extent possible by the end of the year.

Many clients, however, may not have the liquidity to make transfers of $5.12 million in cash.   Instead, these clients may have family-held business interests or other business interests that could be transferred to younger generations.  The inherent problem with the transfer of business interests is the valuation of those interests.  If the IRS audits the gift tax return and adjusts the valuation of the business interests, the client may have created an unintended gift tax liability.  For example, suppose that the client transfers 500 membership units in the family LLC worth $5.12 million therefore fully utilizing the exclusion amount.  Following the IRS audit, however, the value of each membership unit is increased.  Now, the client has transferred 500 units worth $6 million and caused an unintended gift tax liability because the gift now exceeds the client’s available exclusion amount.

Fortunately, on March 26, 2012, the Tax Court issued an opinion in the case Wandry v. Commissioner, T.C. Memo 2012-88 that may provide significant assistance to taxpayers interested in these types of transfers.  In Wandry, the taxpayers made gifts of “a sufficient number of [membership units of the LLC] so that the fair market value of such Units for federal gift tax purposes” was a stated amount to their children and grandchildren.  In the assignment documents, the taxpayers acknowledged that the gift could be “subject to challenge by the Internal Revenue Service,” and that if a final determination was made by the IRS or a court of law that was different from the taxpayer’s appraisal, “the number of gifted Units shall be adjusted accordingly so that the value of the number of Units gifted to each person” equaled the stated amounts.   By making this defined value formula gift, the taxpayers intended to limit the value of the property transferred, thus eliminating the possibility of incurring unintended gift tax liability.   The Tax Court rejected several objections by the IRS to this type of formula gift and upheld the transfer.

Prior cases have upheld similar formula clauses when the excess value (if determined by audit or court) was transferred to a charity.  In those cases, no additional gift tax was incurred because the excess value received a charitable deduction.

Wandry, however, is the first case to address this formula transfer when a charity was not available as a back-stop.   Therefore, Wandry provides a significant planning opportunity for clients who have not fully utilized their $5.12 million exclusion amount.   Now, pursuant to Wandry,  using the example above, a client could make a gift of the number of units in the family LLC worth $5.12 million.  At the time of the gift, pursuant to an independent appraisal, the client may anticipate that this gift will equal 500 units, but if the IRS audits the return and a final determination results in the increase in the value of each unit, it might actually be that only 425 Units are transferred by the client, pursuant to the gift worth $5.12 million.   Rather than transferring a set number of membership units and adjusting the value later, Wandry allows the client to transfer a set value and adjust the number of units transferred later.

Because of the nuances in the Wandry case, a client should seek professional assistance before making these types of transfers to ensure that the transfer complies with the Tax Court’s opinion in Wandry.  If done correctly, however, the client will now be able to fully utilize his $5.12 million exclusion amount in 2012 without incurring any gift tax liability.

Tax Court Approves Georgia-Grown FLPs

April 13, 2012

 By Rose Drupiewski

In a recent decision involving a Georgia family and Georgia family limited partnerships, the U.S. Tax Court upheld estate tax benefits claimed by the family.

A family limited partnership (“FLP”) is a form of business created by family members that, in addition to providing important business, asset protection and other non-tax benefits, may reduce a family’s total estate tax liability.  The estate tax benefit arises from the recognition that a partnership interest is less valuable than direct ownership of the partnership’s assets.  Thus, for estate tax purposes, certain valuation discounts may be available when determining the value of a partnership interest.

In attempting to defeat the tax benefits of FLPs, the IRS often relies on section 2036.  If successfully applied, section 2036 ignores the transfer of assets to a partnership, and therefore the decedent’s estate is taxed on the value of the partnership assets as if the decedent had never transferred such assets to the partnership.  In effect, all valuation discounts are ignored that would otherwise be available by virtue of the partnership structure.  Generally, section 2036 will not apply if a partner transfers assets to the partnership in a “bona fide sale for full and adequate consideration.”  A decedent’s estate may demonstrate that a transfer is bona fide if the decedent had valid nontax reasons for forming the partnership.

In Estate of Beatrice Kelly v. Commissioner, T.C. Memo 2012-73, the decedent was an elderly woman from Rabun County, Georgia.  The decedent was diagnosed with Alzheimer’s disease, and her four children were appointed to act as her co-guardians by reason of her mental disability.  Subsequent to their appointment as her co-guardians, the children discovered that the decedent’s will did not divide her estate equally among them, and they sought a way to provide for an equal division of the decedent’s assets.  The decedent owned 27 parcels of real estate, including two rock quarries, a subdivision with rental homes, a post office, and a rural property with public access.  The Tax Court found that the real estate properties raised liability concerns for the decedent, as evidenced by a previous accident occurring at one of the quarries that resulted in personal injuries, and public traffic through the post office, subdivision and rural property.

The children, as co-guardians, sought the advice of an attorney on how to achieve an equal division of the decedent’s assets.  The attorney advised the children that they could achieve this goal by acting on behalf of the decedent to create four separate FLPs, transferring the decedent’s assets to such FLPs, and transferring the partnership interests to themselves prior to the decedent’s death, such that the decedent’s will would not control the division of such assets.

The Tax Court found that there were valid nontax reasons for formation of the FLPs.  These nontax reasons included effective management of the decedent’s real estate and equal distribution of assets among the children.  As a result, the Tax Court held that the transfer of assets to the FLPs was bona fide and section 2036 did not apply.  The holding of this case is an important reminder that FLPs can provide significant estate tax benefits to families when there are legitimate nontax reasons for forming them.