In a big win for the taxpayer—and for estate and gift lawyers—the Tax Court resoundingly rejected the IRS’s three arguments against defined value clauses, even in cases involving interfamily transfers. In this new decision, the court also provided what amounts to a four-part “blueprint” for drafting successful formula clauses in the future.
The case concerned a wealthy Colorado couple, who set up a family LLC with cash and marketable securities to continue a gift-giving plan for their children and grandchildren; specifically, they executed gift documents that transferred a “sufficient number” of LLC units to each recipient “such that the fair market value for federal tax purposes” would equal the amount of the then-current annual gift tax exclusion. If the IRS later determined a different value, then the number of gifted units would adjust accordingly. The taxpayers retained an independent appraiser to value the LLC assets, made appropriate adjustments in the LLC’s capital accounts to reflect the transfers, and then reported their value on their gift tax returns, based on the appraisal as well as the descriptions in the operative documents.
The IRS challenged the valuation of the gifts as well as the validity of the defined value clause. Importantly, the taxpayers stipulated to the IRS’s valuation, thus “closing the door” to the IRS’s first argument, that they intended to transfer fixed percentage interests rather than a specific dollar amount. This amount—and the recipients’ right to receive it—was always fixed and certain, the Tax Court held, in defeating the IRS’s second argument. Just because the precise number of LLC units necessary to fulfill the gifts might be uncertain did not create a condition subsequent to which the taxpayers could “take the property back.” Finally, that the gifts had no charitable component was “inconsequential,” the court held, in overruling the IRS’s final argument, that the formula clauses were void for public policy reasons. It then cited four provisions in the gifting documents that preserved their operation in this and possibly future cases.