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Estate Planning: Reduce Risk with Proper Reporting

In Estate of Sanders v. Commissioner, T.C. Memo 2014-100 (May 27, 2014), Tax Court Judge Kroupa denied summary judgment to the taxpayer on the issue of whether the donor's gift tax returns adequately disclosed gifts of closely held stock. In essence, the government argued that the gift tax returns filed did not meet the rules because they failed to disclose information regarding an underlying entity. Whether or not adequate disclosure is made is a question of fact and in the instant case, the facts were in dispute. The Sanders v. Commissioner case is further affirmation that the quality of adequate disclosure is of utmost significance and the lack of such quality can be successfully challenged by the IRS.


One of the most effective strategies for estate tax planning is gifting property to family members. Why? Because the fair market value of a properly reported gift – and any future appreciation – is removed from the taxable estate of the person making the gift. The donor may be able to use the lifetime federal estate tax exemption ($5,340,000 in 2014) in order for the gift to not be taxable. The gifting of minority ownership interests in closely-held businesses and commercial real estate can be an effective estate planning strategy. However, these ownership interests do not have a readily available market price and their value must be determined using generally accepted valuation methods and procedures, which require professional judgment. Additionally, the estimated value is subjective and may be challenged by the IRS.

Disclosure Requirements for Gift Tax Filings
Proper reporting of gifted property includes filing a gift tax return and a valuation of the property that meets adequate disclosure requirements to start the three-year statute of limitations running. Per IRS regulations[1], a “transfer will be adequately disclosed if it is reported in a manner adequate to apprise the IRS of the nature of the gift and the basis for the value so reported.” If the IRS does not challenge the values on a gift tax return during the three-year period following the filing of the gift tax return and there is “adequate disclosure,” then the IRS may not adjust the amount of the gift in determining future gift or estate tax liability for these gifts.

The Internal Revenue Code (IRC)[2] also states that if the value of a gift is required to be shown on a gift tax return but is not disclosed on the return, or on a statement attached to the return, in a manner adequate to apprise the IRS of the nature of the transfer, the statute of limitations for the assessment of gift tax with respect to the gift will not begin to run. The IRS often waits until the filing of the estate tax return to challenge the gift. If the gift is not properly disclosed, you can rectify the problem by filing an amended return meeting the adequate disclosure requirements.

For gift and estate tax purposes, the fair market value of property transferred to another party is measured on the date of the transfer as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.”[3]

In addition to other information, for gifts made after December 31, 1996, the final IRS regulations[4] require that the following information be provided on the gift tax return:

  • A description of the transferred property and any consideration received by the transferor;
  • The identity of and relationship between the transferor and each transferee;
  • If the property is transferred in a trust – provide the tax identification number and a brief description of the terms of the trust or a copy of the trust;
  • A description of the method used to determine the fair market value of the property transferred;
  • Any financial data that was utilized in determining the value of the interest;
  • Any restrictions on the transferred property that were considered in determining the fair market value of the property; and
  • A description of discounts for blockage, minority or fractional interests, and lack of marketability claimed in valuing the property.

Reduce Risk by Utilizing a Qualified Professional Appraiser
Treasury regulations[5] also state that in lieu of providing the valuation detail above, the donor can submit an appraisal of the property that is performed by a qualified professional appraiser who meets the following requirements:

  • The appraiser is an individual who holds himself or herself out to the public as an appraiser or performs appraisals on a regular basis.
  • Because of an appraiser’s qualifications, as described in the appraisal that details the appraiser’s background, experience, education, and membership, if any, in professional appraisal associations, the appraiser is qualified to make appraisals of the type of property being valued.
  • The appraiser is not the donor or the donee of the property or a member of the family of the donor or donee, as defined by IRC[6], or any person employed by the donor, the donee, or a member of the family of either.

Although the criteria for “qualified appraiser” as defined by the IRC[7] pertain to valuations of charitable contributions, they provide a good set of guidelines for evaluating appraisers of property for other tax purposes as well. Under such guidelines, an appraiser should hold a designation from a recognized professional appraiser organization and possess relevant and generally accepted education and experience. A further Treasury regulation[8] disqualifies appraisers who do not perform a majority of their appraisals during the tax year for persons other than the taxpayer in question.

Most estate planning professionals recommend the use of a qualified professional appraiser to reduce the risk of not meeting the adequate disclosure requirements as well as the risk of audit.

Determining Fair Market Value
The IRS regulations[9] state that if the value of the entity being valued or an interest in the entity being valued is properly determined based on the net value of the assets held by the entity, a statement must be provided that indicates what the fair market value of 100% of the entity is without regard to any discounts in valuing the entity or any assets owned by the entity. In addition, the statement would then indicate what portion of the entity is subject to the transfer and the ultimate fair market value of such interest that is reported on the gift tax return. 

The regulations go further in stating that the taxpayer is not required to submit the value of 100% of the entity, without regard to any discounts, provided the lesser interest in the entity is properly determined without using the net asset value of the entire entity. However, it is the taxpayer’s burden to demonstrate that the fair market value of the entity has been properly determined by a method other than a method based on the net value of the asset held by the entity.

Similarly, taxpayers who transfer an interest in an entity that has an ownership interest in other entities will not have to provide information with regard to these entities unless the information regarding these lower-tier entities is relevant and material in determining the value of the interest transferred.

What Does CohnReznick Think?
By properly reporting gifted property on gift tax returns and submitting a qualified professional valuation, donors can start the clock ticking on the three-year statute of limitations and reduce the risk of audit. It is important to carefully follow the reporting procedures because the three-year statute of limitations on gifts applies to both the gift tax as well as the estate tax such that at the death of the donor, as long as the regulations have been met, the IRS can only go back three years in examining any prior gifts. You should consult your tax and legal advisors prior to implementing any estate planning transactions.

For more information, please visit our Tax webpage or contact us.

[1] IRS Regulation Section 301.6501(c)-1(f)(2)

[2] Internal Revenue Code Section 6501(c)(9)

[3] Treasury Regulation Section 20.2031-1(b)

[4] IRS Regulation Section 301.6501(c)-1(f)(2)(iv)

[5] Treasury Regulation Section 301.6501(c)-1(f)(3)

[6] IRC Section 2032A(e)(2)

[7] IRC Sections 6664 and 170(f)(11)(E)

[8] Treasury Regulation Section 1.170A-13(c)(5)(iv)(F)

[9] IRS Regulation Section 301.6501(c)-1(f)(2)(iv)

Circular 230 Notice: In compliance with U.S. Treasury Regulations, the information included herein (or in any attachment) is not intended or written to be used, and it cannot be used, by any taxpayer for the purpose of i) avoiding penalties the IRS and others may impose on the taxpayer or ii) promoting, marketing, or recommending to another party any tax related matters.

This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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