The Wall Street Journal just reported that “the Tax Court just blessed a technique that owners of closely held businesses-and wealthy families-can use to pass assets to heirs with a minimum of taxes and complications.” The ruling in Wandry v. Commissioner is causing waves among tax experts.
In 2004, Dean and Joanne Wandry gifted their prospective heirs membership units in a limited liability company (LLC). Pursuant to gift documents, units of the donors’ LLC were transferred to their children and grandchildren. The gift documents specified that the fair market value of the units was unknown at the time of the transfer, but to avoid tax consequences the Wandrys specified that the gifts should equal the dollar amount of their exemptions. Currently, the lifetime exemption is $5.12 million but at that time the lifetime exemption was $1 million.
Furthermore, the gift document stated that if the IRS challenged the eventual valuation of the units, the number of units transferred would be adjusted so that they still equaled the specified amounts. An independent appraiser determined the value of the LLC, and the Wandrys’ CPA used the appraisal to report the number of units transferred on the Wandrys’ gift tax returns.
The IRS, however, contested the appraisal and determined that the value of the gift was 20% higher than the Wandrys’ valuation.
Here, the tax court found that the gift tax returns were consistent with the gift documents and therefore the Wandrys’ intent to transfer a specific dollar amount was established. Additionally, there was no evidence that the LLC’s capital accounts reflected gifts of a specific percentage of ownership interests, rather than a defined dollar value. Moreover, under the terms of the gift documents, the donees were always entitled to a predefined number of units, which was expressed in terms of a specific dollar amount. When the value of the units was increased, under the adjustment clause, the number of units that the donees were entitled to decreased. The increase in value of each individual unit did not alter the transfer. Instead, the adjustment clause altered the allocation of membership units so that they accurately reflected the fair market value. Thus, the court found the Wandrys were not liable for a gift tax deficiency
The Wandry case is a boon not only for business owners but also wealthy families with “family limited partnerships” or entities holding publicly traded stocks. Even though the stocks’ value is easy to determine, submerging them in a nontraded company provides valuable discounts when units are transferred to heirs.
As a “memorandum” decision, Wandry may be cited as precedent in future cases. The IRS had no comment either on the decision or whether it will appeal the case to the 10th Circuit Court of Appeals.
The catch: The IRS has more than three months to appeal the case. Mr. Porter believes its reasoning is sound, but taxpayers who rely on it while gift-tax exemptions are high and rates are low run a risk.
Still, it may be important to act soon. The decision is so advantageous for taxpayers that it could inspire a response from Congress or the IRS.
To read the Wall Journal article in its entirety, click here.