TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Sunday, September 18, 2011

WSJ: 9th Circuit Approves Charitable Freeze to Hedge Against IRS Valuation Fight

Wall Street Journal Tax Report, IRS Loses a Gift-Tax Battle, by Laura Saunders:

Wealthy taxpayers who want to make large gifts to family members recently got good news: A federal appeals court affirmed a popular technique to sidestep gift taxes.

The decision, Estate of Petter v. Commissioner, was published in August by the Ninth Circuit in San Francisco. It joins earlier rulings on related issues by the Eighth and Fifth circuits. All the cases originated in Tax Court, but appeals go to the federal circuit court in which the taxpayer lives.

"These decisions make it easier for senior family members to transfer hard-to-value assets to heirs and charity with reduced gift-tax risk," says John Porter of Baker Botts in Houston, who argued all the cases. These and other victories have made him a rock star in the staid trust-and-estates bar. ...

[Valuation is] always an issue with large gifts, especially with real estate or a business. What if the IRS challenges an estimate and wants more gift taxes? Many taxpayers are loath to write a check, and some don't have ready cash. Petter offers a solution. ...

Estate planners advised Ms. Petter to transfer all the [$22 million of] UPS stock to a limited-liability company. Then she both gave and sold units of the LLC to two of her children in 2002. Ms. Petter claimed that putting the stock in the LLC entitled her to a 51% discount from its market value on the transfers made to her children. The IRS challenged that, and the two parties ultimately settled on a 36% discount.

The crux of the case: Was gift tax due once the discount dropped to 36% from 51%? ... But she had specified that in such a case they would bounce to her IRS-registered charity—with no gift tax due. The IRS didn't like that one bit, because it meant the penalty for an exaggerated discount was simply a donation to a charity, not a check to Uncle Sam.

"The government said if Ms. Petter prevailed, it had no incentive to audit," says Carlyn McCaffrey, an attorney at McDermott, Will & Emery in New York. The IRS's real fear, says retired tax expert Tom Ochsenschlager, is that without audits, taxpayers could "get away with murder on valuations."

The courts sided with Ms. Petter, giving a lift to taxpayers and charities, if not the IRS.

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