Probate & Trust Law Section Conference Manual ... - Minnesota CLE

DEFINED VALUE GIFTS – MECHANICS AND ETHICAL ISSUES
1. A Short Primer on Defined Value Gifts
Grantors often intend to make gifts of a specific amount of property (e.g., an amount
equal to the annual gift tax exclusion or an amount that fully utilizes the donor’s applicable
exclusion amount). It’s not easy to make gifts of exact amounts, especially where the gifted
property consists of interests eligible for valuation discounts. If the grantor applies valuation
discounts in excess of what the Service or courts subsequently permit, the grantor accidentally
make a gift to the trust that would trigger liability for gift tax. Accordingly, some gifts include a
“formula clause” designed to discourage the Service from challenging a valuation by providing
for a gift over to charity of the value of the gifted property above a specified amount.
Presumably the Service would have little incentive to challenge the valuation of a gift if
the excess value would not be subject to gift tax. And it’s for precisely this reason that the
Service has so actively opposed the use of formula clauses in this context. But appellate
opinions from three federal circuits in the past seven years approve the use of defined value
clauses where any amounts in excess of a specified dollar figure pass to a charitable
organization.
In McCord v. Commissioner, 13 the taxpayers (a married couple) conveyed limited
partnership interests to three groups of beneficiaries: their children, certain trusts, and two
charities. The assignment agreement signed by the donors stated that the amounts passing to
the children and the trusts would be roughly $6.9 million, with any extra value passing to the
charities. Following the assignment, the beneficiaries all executed a “confirmation agreement”
that reflected the exact percentage amounts of the gifted interests received by each
beneficiary. The Tax Court refused to apply the formula clause in the assignment agreement
because the formula was based on fair market value and not “fair market value as finally
determined for Federal gift tax purposes.” Instead, it gave effect to the allocations set forth in
the confirmation agreement, ultimately causing more to pass to the children and the trusts
than the donors likely intended. On appeal, the Fifth Circuit reversed the Tax Court. As the
court stated, the “core flaw in the [Tax Court’s] inventive methodology was its violation of the
long‐prohibited practice of relying on post‐gift events. Specifically, the [Tax Court] used the
after‐the‐fact Confirmation Agreement to mutate the Assignment Agreement’s dollar‐value
gifts into percentage interests in [the partnership]. It is clear beyond cavil that the [Tax Court]
should have stopped with the Assignment Agreement's plain wording.” The court continued
that fair market value is determined on the day the donor completesthe gift, so the Tax Court’s
reference to value as of the time of the Confirmation Agreement was erroneous. The Fifth
Circuit thus respected the taxpayer’s formula clause and rejected the valuations of the Tax
Court and the Service.
13 461 F.3d 614 (5 th Cir. 2006).
14