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Defined Valued Transfer - How the Taxpayers Got it Wrong

By Eric D. Marchand on November 9, 2021
On November 3, 2021, the Fifth Circuit issued its opinion in Nelson v. Commissioner and unanimously affirmed the opinion of the Tax Court in favor of the IRS. On December 31, 2008, Taxpayers attempted to make a defined value gift of limited partnership interests, the memorandum of gift and assignment of limited partner interest (“Gift Document”), providing as follows:

[Mrs. Nelson] desires to make a gift and to assign to *** [the Trust] her right, title, and interest in a limited partner interest having a fair market value of TWO MILLION NINETY-SIX THOUSAND AND NO/100THS DOLLARS ($2,096,000.00) as of December 31, 2008 ***, as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.”
 
A few days later, on January 2, 2009, Taxpayer entered into a second transaction with the Trust, this time, executing a memorandum of sale and assignment of limited partner interest (“Sale Document”), providing as follows:

[Mrs. Nelson desires to sell and assign to *** [the Trust] her right, title and interest in a limited partner interest having a fair market value of TWENTY MILLION AND NO/100THS DOLLARS ($20,000,000.00) As of January 2, 2009 ***, as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment.”
 
Neither the Gift Document nor the Sale Document (i) defined fair market value, or (ii) provided for a reallocation of limited partner interests after the valuation date. The qualified appraiser determined and Taxpayer reported on a federal gift tax return a gift to the Trust “having a fair market value of $2,096,000 as determined by independent appraisal to be a 6.1466275% limited partner interest”. Mrs. Nelson elected to split this gift with her husband and each reported one-half of the gift (or $1,048,000).

The IRS argued that Taxpayers did not make a Wandry type transfer but instead actually gave and sold percentage interests in the partnership. The IRS issued a notice of deficiency, determining the interests gifted in 2008 were worth $1,761,009 and that Taxpayers undervalued the amount sold in 2009 by $13,607,038, resulting in each spouse making a gift in 2009 of $6,803,519.

The Tax Court determined that Taxpayers were bound by the express provisions of the Gift Document and the Sale Document and that both transferred limited partner interests on the basis of the fair market value as determined by a qualified appraiser and not as determined for federal gift and estate tax purposes. The Tax Court refused to ignore the express terms of the transfer documents and determined that the value of amount gifted was $2,524,983 and the amount sold $24,118,933.

The Fifth Circuit unanimously affirmed the Tax Court stating:

By its plain meaning, the language of this gift document and the nearly identical sales document transfers those interests that the qualified appraiser determined to have the stated fair market value – no more and no less.
 
As such, once the appraiser determined the percentages based on the stated dollar values, those percentages were locked and remained so even after the valuation changed.

The Fifth Circuit also noted that the Gift Document and the Sale Document did not contain any language that reallocated interests to ensure the recipient received only those interests [he or she] was entitled to receive. The Fifth Circuit stated “[s]imply put, while the Nelsons may have been attempting to draft a formula clause, they did not do so.”

Score one for the Service on valuation adjustment clauses, but put an asterisk by it. In Nelson, the Fifth Circuit gave the Taxpayer almost exactly what they asked for. The Nelson case illustrates the importance of attention to detail when attempting to utilize defined value gifts because Taxpayers are bound by the express language in the governing documents.

For questions regarding this blog post or any other estate planning matter, please feel free to contact Eric Marchand at (214)744-3700 or by email at emarchand@meadowscollier.com.