As most gift tax return preparers know, the IRS generally has a three (3) year time limit to challenge the gifts reported on the return. If the property that has been transferred by the donor is comprised of interests in a closely held corporation, LLC or partnership, or a fractional interest in real estate, the value reported on the gift tax return will likely be a discounted value, reduced as a result of lack of marketability and minority interest. If the IRS decides to audit the gift tax return, it may challenge the values reported on the return, including the extent of the valuation discounts.
The Treasury Regulations provide that if a gift of property is not “adequately disclosed” on the gift tax return, then any gift tax imposed on the transfer may be assessed at any time. If a donor has died, a challenge to a gift tax return, even when there is no gift tax due, may increase the donor’s estate tax by using up more of the donor’s unified credit on the gift tax return.
The Regulations state that “adequate disclosure” generally means: (1) a description of the transferred property (along with any consideration received by the donor); (2) the identity of, and relationship between, the donor and each donee; (3) if a trust is involved, the trust’s EIN and either a brief description of the trust terms or the trust agreement; and, (4) either a copy of any qualified appraisals or a detailed description of the method used to determine the fair market value of the gifts (including financial data, restrictions on the transferred property, and a description of discounts). If no appraisal is provided for interests in an entity, and the value is determined based on the net value of the entity’s assets, the return must include a statement regarding the value of 100% of the entity.
In a partially redacted Field Attorney Advice (20152201F), the IRS analyzed the statute of limitations applicable to a deceased taxpayer’s gift tax return. The taxpayer made gifts of interests in two partnerships to his daughter. The partnerships owned farmland and the farmland had been appraised. The gift tax return, however, did not include the farmland appraisals. The only disclosure of value was a one paragraph statement indicating that the farmland “was appraised” and that discounts for lack of marketability and minority interests, “etc.” were taken in determining the value of the partnership interests. The partnerships interests themselves were not appraised and the partnership agreements were not attached to the return.
The lawyer in the IRS Chief Counsel’s office concluded that the three (3) year statute of limitations did not apply to this gift tax return because the gift tax return did not adequately disclose the transferred property nor the valuation methodology for the gifts.
With respect to the disclosure of the property, the EIN for one of the partnerships contained only eight of its nine digits. In addition, the gift tax return listed “abbreviations” rather than legal names for the partnerships and omitted “LP” and “LLP”, giving the wrong impression that the partnerships were general partnerships (rather than limited partnerships). As a result, because of a missing EIN digit, the use of abbreviations, and the omission of “LP” and “LLP”, the gifted partnership interests were not adequately described and disclosed.
With respect to the disclosure of the valuation methodology, the IRS indicated that the gift tax return did not disclose any restrictions on the partnership interests that were considered in determining the fair market value. Normally, such restrictions would be disclosed in both an attached partnership agreement and an appraisal of the partnership interests. In addition, the gift tax return did not disclose how the value was derived (i.e., how the value of the farmland was determined) and did not disclose sufficient financial information about the partnerships. The IRS lawyer pointed out that the gift tax return stated the partnerships owned “primarily farmland” and that the discounts taken included minority interests, lack of marketability, “etc.” Therefore, the fact that the partnerships owned “primarily farmland” indicated that certain undisclosed assets may have been owned by the partnerships. Further, the fact that the return used an “etc.” with reference to the discounts indicated that other undisclosed discounts may have been taken. Finally, since it appeared that the value of the partnership interests were based on the net assets of the partnership, disclosure of the 100% value of the partnerships was required to be included; it was not.
The conclusion reached in the IRS lawyer’s advice should remind gift tax return preparers that gift tax returns must be carefully reviewed and gifts must be fully disclosed in order for the three (3) year statute of limitations to apply. Appraisals, partnership agreements, operating agreements, trust agreements, and full disclosures of discounts must be included. If an interest in an entity is being determined based on the net assets of the entity, the full value of the entity must be disclosed along with appraisals for the underlying assets. The use of terms such as “primarily” without more, utilizing “etcetera” when describing details, and not accurately describing the state law characterization of an entity (such as a general versus a limited partnership) may be used by the IRS to permanently extend the statute of limitations.