The clock is ticking on the federal gift and estate tax exemption ($13.61 million for 2024). Unless Congress steps in, the amount will drop to an inflation-adjusted $5 million in 2026. Now’s the time to make impactful gifts to loved ones and shrink your taxable estate before the window closes.
Certain hard-to-value gifts, like interests in a closely held business or family limited partnership (FLP), can trigger IRS scrutiny. If the IRS determines that a gift was undervalued, you could face gift tax, interest, and penalties. To avoid such unexpected outcomes, consider making a defined-value gift instead.
Formula vs. savings clauses
A defined-value gift involves transferring assets valued at a set dollar amount, rather than a fixed number of stock shares, FLP units, or percentage of a business. When structured properly, defined-value gifts prevent future gift tax assessments.
The key is to draft the transfer document with a “formula” clause rather than a “savings” clause. A formula clause transfers a fixed dollar amount, adjusting the number of shares to match that amount based on a final valuation of the shares for federal gift and estate tax purposes. A savings clause, on the other hand, allows for part of the gift to be returned to the donor if it is later determined to be taxable.
Precise language matters
For a defined-value gift to be effective, they must have precise language in the transfer documents. In one case, the U.S. Tax Court rejected a defined-value gift of FLP interests, siding with the IRS’s gift tax assessment based on percentage interests. The issue was that the documents stated the transfer of FLP interests should be valued “as determined by a qualified appraiser” within a specific time after the transfer, which lacked clarity necessary for the gift to qualify as defined value.
The court ruled that the transfer documents did not meet the requirements of a defined-value gift because an appraiser determined the fair market value. The documents lacked provisions to adjust the number of FLP units if their value was ultimately determined to exceed the specified amount for federal gift tax purposes.
The bottom line: Before making a gift to a loved one, reach out to your Smolin advisor to ensure your gift’s transfer documents are properly worded to meet IRS requirements. We’re here to help!