Here, Joanne and Dean Wandry had established a family LLC, which held marketable securities. In 2004, they decided to give away LLC units to family members. That year, the annual gift tax exclusion was $11,000 per recipient and the lifetime gift tax exemption was $1 million. Therefore, both spouses decided to give away $250,000 worth of LLC units to each of their four children, using up their lifetime exemptions, and to also give $11,000 of LLC units to each child and to each of five grandchildren.
Gifts of illiquid assets are often hard to value. This couple hired an appraiser to value the LLC, did the math, and each gave away about 2.5% of the LLC units. By using the gift tax breaks, the Wandrys asserted that no gift tax was due.
The IRS is known to scrutinize valuations of illiquid assets. Therefore, the Wandrys inserted “defined value” clause in the gift documents. This clause said that if the value of the gifts were determined to be higher than stated, the number of units could be reduced to stay below the gift tax ceiling. That’s what happened here–the IRS said that the gifts were undervalued.
The two sides negotiated and eventually agreed that each child’s gift of LLC units was really worth about $316,000, not $261,000. Grandchildren’s gifts also were undervalued. The Wandrys would have owed over $1.4 million in gift tax.
Anticipating the chance of such a problem, the gift documents called for an adjustment in the number of LLC units to be given away, in order to reach a certain dollar amount: $261,000 per child and $11,000 per grandchild, to conform with the agreed-upon valuation. The younger relatives would get fewer units and no gift tax would be owed.
In 2012, the U.S. Tax Court ruled for the Wandrys. Last November, the IRS issued an Action-on-Decision and “non-acquiesced” in the Tax Court’s holding. The IRS won’t appeal this decision but won’t go along in other cases. Nevertheless, as Blanche Christerson, managing director at Deutsche Bank Private Wealth Management, puts it, “We surely have not heard the last of this approach.”