Estate Planning Pitfalls

Estate planning can be a risky business. Some of those risks were on full display in a recent tax case, Nelson v. Comm'r, 2021 U.S. App. LEXIS 32741 (Nov. 3, 2021). This case, on appeal from the Tax Court to the 5th Circuit Court of Appeals, dealt with a defective clause regarding an attempted formula gift and sale of limited partnership interests.  The intent of the parties, clearly outlined in the opinion of the court, was to have the percentages of limited partnership interests sold and gifted be adjusted in case the IRS challenged the value of the interests. That is exactly what happened in this case. The IRS challenged the value of the interests sold and gifted, and the Tax Court sided with the IRS on the “new” values.

Had the formula clause worked properly, there would not have been any gift or transaction tax because the percentages gifted would have been adjusted upward (i.e., increasing the percentage of the limited partnership gifted and sold) instead.  But the drafters of the formula clause did not follow the case law on how to properly draft such a clause. As a result, a substantial amount of gift tax was assessed by the IRS and upheld by both the Tax Court and the Appellate Court. Oops! The drafters of the transfer documents at a minimum have some very upset clients and perhaps could be subject to a claim against them for the poor draftsmanship. It is a warning to estate planners to be especially cautious when drafting estate planning documents.

Surprisingly, another warning was buried in the opinion. One of the arguments taxpayers made was that the appraisal was not completed within the time allotted in the agreements with the appraiser. The Appellate Court, while saying that the late appraisals do not change the outcome of the case, says that the trust and beneficiaries might have a claim against the appraiser. It is unclear what that claim might be, since the court admits that does not change the tax outcome, but it is, nevertheless, a curious comment. It does emphasize, if you are an appraiser, that you should stick to the terms of your agreement or make certain that you get the approval of the client in writing to amend that agreement. This is especially true if your deviation from the agreement might in some manner harm your client.

Obviously, you cannot structure your practice to be risk free. That isn’t possible. Nor would you likely have a very vibrant practice if you are too risk averse. Having said that, it is always wise that you do your best to avoid unforced errors.

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