Disclosure Is Key To Discount Planning

Failure to tell the IRS enough on a Federal gift tax return (Form 709) can hamstring your clients’ efforts to minimize their taxes through FLP and FLLC transfers. How?

First, let’s look at what has to be disclosed. The IRS Regulations governing reporting of gifts require a taxpayer to disclose enough to apprise the IRS of:

The nature of the gift, and
The basis of the value being reported

At a minimum, the IRS needs to know the identities and relationship of the transferor and transferee, what property is being gifted, the method employed for valuing the property, and whether there are any restrictions imposed on the transferred property – and how those restrictions factor into the valuation of the property.

What happens in a case of inadequate disclosure? Under normal circumstances – that is, when there is adequate disclosure – there’s a three-year statute of limitations for the IRS to come back and challenge the valuation method used. Absent adequate disclosure, though, the statute of limitations never runs.

So, the IRS can come back at any point in the future and revalue the gift, applying the “appropriate” amount of tax, and also assessing interest and penalties on the unpaid tax from the time of the original gift. This is where the true damage can be done to the taxpayer; there’s the potential for the total amount of interest and penalties to exceed the amount of the tax itself many fold.

What’s the best way to avoid this situation? Carefully document the method used for valuing any gifted property and pass this information on to the IRS. This means having the property appraised by a competent and reasonable professional and attaching the appraisal report to the gift tax return. It also means fully disclosing the approach, assumptions, and conclusions involved in determining the amount of any discounts applied in the transfer of the property

Remember, in a gift or estate tax return, it is better to err on the side or providing more information than technically required rather than providing too little.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
6050 Santo Road, Suite 240
San Diego, CA 92124
(800) 846-1555
www.aaepa.com