Take that IRS: U.S. Tax Court Blesses Wealth Transfer Technique

Last month, the U.S. Tax Court ruled in favor of wealthy, closely held business owners everywhere when it gave the OK for these owners to gift shares of their business with the least amount of tax possible.  Sounds like common sense, but the IRS always wants you to pay up.  Here’s the gist of Wandry v. Commissioner:

The Wandrys each gave units of their family-owned LLC, worth over $1 million, to their heirs in 2004.  To avoid paying tax, they specified the gifts should be equal to the dollar amount of their federal tax exemptions (at the time of the gift, the lifetime exemption was $1 million, and the annual exclusion was $11,000).  The hitch in these plans is always the valuation:  taxpayers must hire professional appraisers to give these units a proper value.  Usually, these valuations are rather low in order to give the taxpayers the maximum use of their exemptions.  However, the IRS has the power to challenge these valuations, and they often appraise these family-owned businesses at a much higher dollar amount.  For the Wandrys, the value rose about 20% when the IRS challenged the appraiser’s work. 

So if the IRS determines the value to be much higher, do you have to write the IRS a big fat check for tax on the amounts over the federal exclusions? Thanks to the Wandrys, the answer is no.  Because the Wandrys explicitly stated that the gift amounts were to be equal to the applicable federal exemptions, the Court found that those excess amounts were never actually gifted to their heirs.  Because there was no gift over the exemption amount, no tax was owed.  And the excess amount of the gift remains the property of the Wandrys.  Great result for smart tax planners, especially because the unified exemption for couples is now $10 million.  

 The trick is to make sure your documentation explicitly states that the gift amount is to be equal the applicable exemption.  If this language is missing, a court very well may rule that you intended for your gift to transfer, regardless of the ultimate valuation.

But you may need to act fast:  The IRS has time to appeal this Tax Court ruling to the Court of Appeals.  Because this ruling is so great for us taxpayers, it is likely the IRS will have the 10^th Circuit take another look.  Look for updates on this blog.