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Contents
SC&H Business Valuation & Support Leaders 
Michael J. Young, 
Nathan E. DiNatale,
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Valuations Insights, July, 2010 Back-to-back Defined Value Cases Deliver Double Punch to IRS First came Estate of Christiansen v. Commissioner, 2009 WL 3789908 (C.A.8)(Nov.13, 2009), in which the Eighth Circuit upheld an estate's formula disclaimer of assets. Next, the Tax Court strongly affirmed the use of defined value clauses in Estate of Petter v. Commissioner, 2009 WL 4598137(U.S. Tax Ct.)(Dec. 7, 2009). This "one-two" punch may have knocked out the IRS's strong public policy arguments against these types of structured gifts, representing an important recent development in estate and tax planning. Did the Tax Court wait for the feds? The Tax Court was deciding Petter while Christiansen was still pending in the Eight Circuit. Judge Holmes—who wrote the original opinion in Christiansen and was preparing to write Petter—probably waited to see how the Eighth Circuit would rule, because he issued Petter just about three weeks later. In Christiansen, the taxpayer's daughter structured a disclaimer of her inheritance to keep part of it and give the rest to charity. The formula was complicated: the numerator was the fair market value of the gift, less $6.35 million, and the denominator was the fair market value of the gift on a certain date, "as finally determined for federal estate tax purposes." "The Commissioner quibbled with this clause because he said it worked to reallocate gifts after an audit," Judge Holmes observed, discussing the case in Petter. The IRS also invoked its standard arguments to defeat the additional charitable deduction that resulted from the daughter's disclaimer; i.e., the adjustment clause was a condition subsequent and contrary to public policy. "But we sided with the taxpayer," Holmes wrote (and so did the 8th Circuit). Specifically, the charitable transfer was not contingent because it remained constant (25% of any excess over $6.35 million) regardless of the estate's ultimate valuation. Further, public policy generally favors charitable gifts, and any public-policy exceptions to the Tax Code must "severe and immediate." Any fears that charities may be abused by tax-avoiding donors were unfounded, Holmes added. Executors, charitable foundation directors, and state attorneys general "would all have some incentive to police low-ball appraisals." Further, the court distinguished Christiansen and also Petter from precedent concerning "savings clauses"—adjustment clauses that require any gift subject to tax to revert back to the donor. "The distinction is between a donor who gives away a fixed set of rights with uncertain value—that's Christiansen," Holmes observed, "and a donor who tries to take property back." The former are fine but the latter are void, he said. "But figuring out what kind of clause is involved in this case [Petter] depends on understanding just what it was that [the taxpayer] was giving away." A complicated plan. In Petter, the taxpayer inherited UPS stock worth over $22 million. To preserve the wealth for her two children and for charity, she transferred the stock to a family limited liability company (LLC), establishing grantor trusts for the children. Over the next two years, the mother gave substantial LLC interests to the trusts by formula allocation, so that they ultimately received units worth $4.08 million "as finally determined for federal gift tax purposes," the excess to be assigned to two charitable foundations. (The charities specifically renegotiated their transfers to maintain voting, member interests.) The taxpayer obtained a reputable appraiser to value the transfers at the time of the original gift. After comparing the LLC to closed-end mutual funds and applying a 46% marketability discount, he reached a unit value of $536.20. Based on that appraisal, the taxpayer's attorney allocated the units among the donees and the taxpayer reported the transactions on her gift tax return, which attached detailed disclosures, including the appraisal. After an audit, the IRS reduced the discount to 29% and claimed the formula clauses were invalid, thus denying any larger charitable deduction triggered by their reallocation. The taxpayer died before trial. Her estate negotiated a 35% discount with the IRS. The parties disputed only the size of the charitable gift: Was it the number of shares before or after reallocation? The answer turned on whether the formula allocation cause was valid. Precedent and planning tips. The formula allocation provisions were not "void as contrary to public policy, as there was no ‘severe and immediate' frustration of public policy as a result, and indeed no overarching public policy against these types of arrangements in the first place," the Tax Court held. Further, it allowed a gift tax charitable deduction for the year of the original transfer, rather than in the year of final determination, because no matter what triggered the reallocation, subsequent events would not undo the transfer. The plain language of the documents showed that the donor transferred an ascertainable dollar amount rather than a specific number of shares. Finally, the charities were not "passively helping a putative donor to reduce her tax bill," the court said, but actively negotiated for an equal voting and oversight role in the LLC. The foundations' directors were bound by their own fiduciary duties, and could lose their tax-exempt status if they "acted in cahoots with a tax-dodging donor." In conclusion, "We have no doubt that behind these complex transactions lay [the taxpayer's] simple intent to pass on as much as she could to her children and grandchildren without having to pay gift tax, and to give the rest to charities in her community." Given this "knockout" blow to long-standing IRS policy, estate planners, financial advisors, and attorneys for all parties (including charities), should work closely to plan and implement the formula allocation process, including transfer documents that:
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