Family or closely held businesses present unique issues in Estate Planning. Planners must be extremely careful in passing business or partnership interests to their heirs. This is true whether the gifts are made in a grantor’s lifetime, or through the estate.
Recently, the Tax Court issued a ruling concerning “Defined Value Clauses”. Wandry v. Commissioner, T.C. Memo 2012-88. Generally speaking, defined value clauses address the way a business or partnership interest is valued for the purpose of estate or gift tax. This is a muddy area that frequently causes issues. The Wandry case is a benefit to estate planners because it provides clarity as to what will be accepted, and affirms a specific technique that is useful to planners.
In making gifts that contain business or partnership interests, the IRS will not let taxpayers determine the value of the business interests on the date of the gift. This sounds bizarre, but is the way the tax law is administered. Undeniably, this creates serious planning difficulties for business owners looking to pass their interests on to the next generation.
What the Wandry case allows business owners to do is give a defined dollar amount in the business or partnership. For example, a business owner could give away interests worth $5.12 million dollars (the maximum gift tax exemption). The amount of partnership shares or ownership interest in the company would not be determined until the death of the grantor, but the dollar amount remains set. The benefit to this is it prevents the IRS from pursuing further estate taxes upon the death of the grantor. While estate planners have been doing this for some time, the Wandry case is the first to uphold a defined value clause in this scenario, and a clear case when the IRS challenged the technique and lost. Perhaps more importantly, because under Wandry the IRS will usually not gain any revenue by challenging the valuation (even if they win), it removes one incentive for an audit.
There are important qualifications to the Wandry case and the mechanics are complex. If improperly drafted the clauses can lead to IRS clawbacks and other consequences at a later date. Still, the case does provide a useful planning tool for business owners or partners looking to pass their interests on.
Nothing in this post shall constitute “advise” or create any attorney-client relationship with Pippenger Hedberg Law. Estate planning and the tax code are complex subjects and qualified attorneys, CPA’s or other professionals need to be consulted.