Applicable Federal Rates - July 2020

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Formula Clauses Bolstered by Case That Rules Against the Taxpayer

Formula clauses are used when property with uncertain value is transferred by gift or sale. The objective is to set the amount that is transferred for gift tax purposes, even if the IRS later is successful in asserting that what was transferred was worth more than what was reported. This can avoid gift tax by keeping the value below available exemption amounts.

The use of formula clauses received a boost in Wandry v. Commissioner, T.C. Memo. 2012-88. There, the Tax Court held that a clause which defined the amount being transferred as a portion of the property equal to a specific value as the value of the property is finally determined for gift tax purposes, would limit the transfer to such portion of the property, as finally valued for gift tax purposes after IRS review and court determination, as equal in value to the stated dollar amount.

In a recent Tax Court case, the taxpayer sought a similar result but was denied. In the case, in lieu of defining the transfer in the manner of  "$x of Property Y as its value is finally determined for gift tax purposes," the formula clause read:"[a transfer of] a limited partner interest having a fair market value of TWO MILLION NINETY-SIX THOUSAND AND NO/100THS DOLLARS ($2,096,000.00) as of December 31, 2008 . . ., as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment." That is, the value was not based on finally determined gift tax value, but on the value determined by a qualified appraiser within 90 days of the transfer.

Since the value was tied to the appraised value, the appraised value would need to be used to set how much of a limited partner interest was transferred to meet the $2,096,000.00 target.That is, the percentage share of the partnership being transferred was locked in at that point. If, as occurred here, the IRS finally determined that the value of the partnership interest, based on the size determination using the appraiser's value, was greater than $2,096,000.00, the taxpayer was not entitled to reduce the percentage partnership interest transferred to meet the $2,096,000.00 amount. The taxable gift would be increased to reflect the finally determined value.

While not good for the taxpayer, the Tax Court's decision is good for other taxpayers, by indirectly ratifying Wandry-type clauses. The Tax Court noted the success of similar clauses in limiting the size of the transfer in Succession of McCord, Estate of Petter, and Wandry. Helpful to taxpayers is that it did not dispute the effectiveness of those clauses, but instead noted that the clause used here was not properly drawn to be consistent with the terms and effect of the clauses used in those cases, and thus ruled against the taxpayer. 

James C. Nelson, TC Memo 2020-81 

Court Retains Ability to Remove Trustee Regardless of the Terms of the Trust [Florida]

An irrevocable trust included provisions for the removal of a trustee by reason of the trustee's disability. A beneficiary brought an action to remove the trustee, but not based on the specific definition and removal provisions of the trust. Could the beneficiary use Trust Code provisions to remove the trustee when the trust instrument had different provisions? In a recent case, the trial court held that the terms of the trust required that removal could be based only on the terms of the trust.

While under the Trust Code the terms of a trust may prevail over the terms of the Trust Code, an exception to this rule exists under Fla.Stats. § 736.0105(2)(e) which provides that the provisions the trust instrument cannot override "the power of the court to take such action and exercise such jurisdiction as may be necessary in the interests of justice." The Trust Code also includes other provisions specifically granting powers of removal to the court. The 3rd DCA, in reviewing the question, reversed the trial court decision based on these statutory provisions and existing case law and concluded:

. . .while the trust document may contain other and supplemental methods to remove a trustee, it cannot eliminate or curtail the probate court's power and responsibility under the Trust Code to remove a trustee when necessary in the interests of justice to protect the interests of the beneficiaries.

The 3rd DCA also noted that the standard for removal due to disability was NOT the same as the standard for imposing a guardian. The court noted:

[t]he standard for removal of a trustee under section 736.0706 of the Trust Code is less exacting than the standard for imposing a guardianship under section 744.331 of the Guardianship Code. Persons may lack the accounting, business, legal, or mental acumen to serve as trustees regarding the property of others even when their condition would not justify the imposition of a guardianship over them regarding their own property.

Wallace v. Comprehensive Personal Care Services, Inc., 45 Fla.L.Weekly D1318a, 3rd DCA (June 3, 2020)