With the current low asset values and the estate/ gift- tax exemption slated to be reduced to $1 million in 2013 (from its current $5 million level), many are considering sheltering their assets by making large gifts. A prevalent concern is the valuation of these large gifts. What if the IRS challenges your estimate and wants more gift taxes? In Estate of Petter vs Commisioner, a popular technique to sidestep gift taxes was affirmed.
In 1982, Ann Petter inherited United Parcel Service stock from an uncle who was among the company’s first investors. In May 2001, when the gift and estate tax rate was 55%, she held $22 million of stock. Estate planners advised Ms. Petter to transfer all of the stock into an LLC. This lowers the value of the stock shares when they are sold or given away, because no one member of the LLC has controlling interest. Ms. Petter subsequently transferred all the stock from the LLC to her two children, claiming that the transfer to the LLC entitled her to a 51% discount on the gifted stock’s value.
The IRS challenged Ms. Petter’s estimate, and the two parties ultimately settled on a 36% discount. When the IRS demanded the gift tax on the shares above the gift tax exemption, however, Ms. Petter exposed a major loophole in the current gift tax regulations. She demonstrated to the IRS that she had specified that should the shares exceed the gift tax threshold, any shares above that threshold would bounce to her IRS-registered charity, resulting in no gift tax due. The court sided with Ms. Petter, allowing the shares to go to her charities.
In addition to sidestepping the gift tax, Ms. Petters’s victory creates a dilemma for the IRS, as it minimizes its incentive to audit. “The IRS’s real fear,” says retired tax expert Tom Ochsenschlager, “is that without audits, taxpayers could get away with murder on valuations.” Some are warning that the IRS may invalidate the use of Ms. Petter’s strategy by amending its regulations accordingly. They advise those taxpayers interested in taking advantage of this loophole to act soon.
To read the entire case click here Petter v Commissioner