Defined-value gifts: Plan carefully to avoid unpleasant tax surprises

Defined-value gifts

An increase in the federal gift and estate tax exemption for 2022 makes it at its most significant level ever. In reality, you can give or give up to $12.06 million without triggering federal transfer taxes. The exemption threshold will decline to $5 million (adjusted for inflation) in 2026, a limited-time deal. However, Congress might enact legislation to cut it quickly or extend it even longer. Many people are now considering making considerable contributions to the younger generation while the existing exemption lasts. These gifts are frequently risky assets that are difficult to evaluate. For example, stakes in a closely held corporation or a family limited liability partnership (FLP). But, the option of defined-value gifts could save you money on taxes in the future.

Defined-value gifts

A defined-value gift is a gift of assets with a value of a certain cash amount rather than a specific number of stock shares, FLP units, or a percentage of a corporate entity. When properly structured, a defined-value gift eliminates the possibility of future gift tax assessments. The key to this method is that the transfer document’s defined-value language is a “formula” clause rather than an ineffective “savings” clause. A formula clause transfers a predetermined dollar amount. The amount is subject to the number of shares or units required to match the adjusted dollar amount. It is also based on the final value of those shares or units for federal gift and estate tax purposes. A savings clause allows the donor to receive a portion of the gift if it is taxable.

Language matters

It’s crucial to utilize exact language in the transfer documents to make a defined-value gift work. The U.S. Tax Court recently rejected an intended defined-value gift of FLP interests. It affirmed the IRS’s gift tax assessment based on percentage interests. The papers required that FLP interests be transferred at a specific fair market value “as determined by a qualified appraiser” within a particular time frame after the transfer. Because a trained appraiser assessed fair market value, the court ruled that the transfer agreements failed to create a defined-value gift. Suppose the value of the FLP units “is finally determined for federal gift tax purposes to exceed the amount described.” Then, the documents do not allow for an adjustment in the number of FLP units.

Seek professional advice

A defined-value gift can assist you in avoiding unexpected gift tax penalties. Contact our RRBB accountants and advisors before taking action if you plan to make considerable gifts of interest in a closely held corporation, FLP, or other hard-to-value assets. The transfer documents must include particular language that allows for an adjustable number of shares or units to express the desired value.

© 2022


Get free tax planning and financial advice