For 2022, U.S. taxpayers may transfer up to $12.06 million by gift or bequest without triggering federal transfer taxes, thanks to the highest gift and estate tax exemption in history.
However, this historically high exemption may not last forever. Unless Congress chooses to pass further legislation, the exemption amount is currently scheduled to drop to $5 million, adjusted for inflation, in 2026.
If you’re like many taxpayers, you may be thinking about making a substantial gift to take advantage of the current exemption before it expires. However, many commonly gifted assets like family limited partnerships (FLPs) and closely held businesses can be risky because they are difficult to value.
To avoid unexpected tax liabilities, you may want to consider a defined-value gift.
Defined-value gifts
To put it simply, a defined-value gift consists of assets that are valued at a specific dollar amount (as opposed to a specified percentage of a business entity, FLP units, or a certain number of stock shares).
Properly structured defined-value gifts are useful because they don’t run the risk of triggering an assessment of gift taxes. In order to properly implement this strategy, the defined-value language in the transfer document must be drafted as a “formula” clause and not as a “savings” clause.
While a savings clause provides for a portion of the gift to be returned to the donor if it is ultimately found to be taxable, a formula clause will transfer a fixed dollar amount that is subject to adjustment in the number of units or shares necessary to equal that dollar amount. This adjustment will be based on the final value determined for those units or shares for federal gift and estate tax purposes.
Using the right language
It’s vitally important to use certain specific, precise language in the transfer documents for defined-value gifts. Otherwise, the gift may be rejected as a defined-value gift by the U.S. Tax Court.
Take, for example, a recent court case involving an intended defined-value gift of FLP interests. In this case, the Tax court decided to uphold the IRS’s assessment of gift taxes based on percentage interests, despite the donor’s intent to structure the gift as defined-value.
The Court’s reasoning? The transfer documents had called for the FLP interests to be transferred with a defined fair market value “as determined by a qualified appraiser.” However, the documents made no provision to adjust the number of FLP units if their value was “finally determined for federal gift tax purposes to exceed the amount described.”
As a result, the court ruled that a defined-value gift had not been achieved.
We can help you make a defined-value gift
As you can see, an effective defined-value gift requires carefully and precisely worded transfer documents. If you plan to make a substantial gift of hard-to-value assets, contact us for assistance. We can work with you to help you avoid unexpected tax consequences from your gift.