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