An overview of the IRS' adequate disclosure regulations for gifting

By Harvey Gold, CPA
American Express Tax & Business Services
Member, Business Valuation and Litigation Support Services Committee

Prior to the Taxpayer Relief Act of 1997, it was possible for the IRS to successfully argue that a decedent's lifetime taxable gifts be revalued in computing adjusted taxable gifts for estate tax purposes, even if the gift tax statute of limitations had expired (3 year/6 year) and the gift had been adequately disclosed. This created administrative and record-keeping problems for estate administrators and fiduciaries.

The 1997 Act provided a relief provision for this problem, but required that the gift in question be adequately disclosed. Thus, the gift tax statute of limitations will not run with respect to a gift that is not adequately disclosed even if a gift tax return was filed for other transfers in the same year. As with other bare-bones statutes, it was left to the IRS to put the flesh on the bones through promulgation of regulations.

The final regulations on disclosure of gifts was published December 3, 1999 and a small correction made Jan. 6, 2000.

Gifts made after Dec. 31, 1997, for which the gift tax return for such calendar year is filed after Dec. 3, 1999.

Summary of disclosure requirement

To meet the disclosure requirement, the return or schedules must:

describe the transferred property and any consideration received;
identify each transferor and transferee and their relationship;
for property transferred in trust, disclose the trust's tax identification number and a brief description of the terms of the trust, or in lieu of a brief description of the trust terms, a copy of the trust instrument;
describe the method used to determine the fair market value of property transferred, including any financial data (for example, balance sheets, etc. with explanations of any adjustments) that were utilized in determining the fair market value of the interest, any restrictions on the transferred property that were considered in determining the fair market value of the property and a description of any discounts such as discounts for blockage, minority or fractional interests, and lack of marketability, claimed in valuing the property;
for publicly traded stocks, provide the name of the exchange where the interest is listed, the cusip number of the security, and the mean between the highest and lowest quoted selling prices on applicable valuation date;
for transfers of closely held entities, identify any discount claimed in valuing the interests in the entity of any assets owned by the entity. In addition, if the value of the entity or of the interests in the entity is properly determined based on the asset-based approach, the fair market value of 100 percent of the entity, the pro rata portion of the entity subject to the transfer, and the fair market value of the transferred interest as reported on the return must be provided. If 100 percent of the value of the entity is not disclosed, the taxpayer bears the burden of demonstrating that the fair market value of the entity is properly determined by a method other than a method based on the net value of the assets held by the entity;
a statement must be provided describing any position taken that is contrary to any proposed, temporary or final Treasury regulations or revenue rulings published at the time of the transfer.

The adequate disclosure requirements will be satisfied if the donor submits an appraisal of the transferred property that is prepared by an appraiser who satisfied all of the requirements listed below, and that contains all of the information listed below. Thus, an appraisal satisfying specific requirements may be submitted with the gift tax return in lieu of a detailed description of the method used to determine the fair market value and in lieu of information regarding tiered entities.

The detailed description of the method used to determine the fair market value of the property transferred must include:

any relevant financial data (for example, balance sheets, etc. with explanations of any adjustments) used in determining the value of the interest;
any restrictions on the transferred property that were considered in determining the fair market value of the property;
a description of any discounts, such as discounts for blockage, minority or fractional interest, and lack of marketability, claimed in valuing the property.

According to the IRS, the requirement that any financial data used in valuing the interest must be submitted ensures that the information requested is available and was deemed relevant by the person valuing the interest.

Tiered entities

The information required for adequate disclosure must be provided for each entity if:

the entity that is the subject of the transfer owns an interest in another non-actively-traded entity (either directly or through ownership of an entity);
the information is relevant and material in determining the value of the interest.

Example

A owns a 70 percent limited partnership interest in PS. PS owns 40 percent of the stock in X, a closely held corporation. The assets of X include a 50 percent general partnership interest in PB. PB owns an interest in commercial real property. None of the entities (PS, X or PB) is actively traded and, based on generally applicable valuation principles, the value of each entity would be determined based on the net value of the assets owned by each entity. In 2001, A transfers 25 percent limited partnership interest in PS to B, A's child.

On the gift tax return, form 709, for the 2001 calendar year, A reports the transfer of the 25 percent limited partnership to PS. The reported fair market value of 100 percent of PS is $y and the reported value of 25 percent of PS $z, is reflecting marketability and minority discounts with respect to the 25 percent interest. But A does not disclose that PS owns 40% of X, that X owns 50 percent of PB, and that, in arriving at the $y fair market value of 100 percent of PS, discounts were claimed in valuing PS' interest in X, X's interest in PB, and PB's interest in the commercial real property.

The information on the lower-tiered entities is relevant and material in determining the value of the transferred interest in PS.

Because A failed to comply with the adequate disclosure requirements regarding PS's interest in X, X's interest in PB, and PB's interest in the commercial real property, the transfer will not be considered adequately disclosed and the statute of limitations for the transfer will remain open indefinitely.

Appraisal

The adequate disclosure requirements will be satisfied if the donor submits an appraisal (containing certain information, see below) of the transferred property that is prepared by an appraiser who is an individual who:

holds himself out to the public as an appraiser or performs appraisals on a regular basis;
is qualified to make appraisals of the type of property being valued, because of the appraiser's qualifications, as described in the appraisal that details the appraiser's background, experience, education, and membership, if any, in professional appraisal associations; and
is not the donor or the donee of the property, or a member of the family (as defined in Code Sec. 2032A(e)(2) for special valuation purposes) of the donor or donee, or any member of the family of either.

The appraisal must contain all of the following information:

the date of the transfer, the date on which the transferred property was appraised, and the purpose of the appraisal;
a description of the property;
a description of the appraisal process employed;
a description of the assumptions, hypothetical conditions, and any limiting conditions and restrictions on the transferred property that affect the analyses, opinions, and conclusions;
the information considered in determining the appraised value, including in the case of an ownership interest in a business, all financial data that was used in determining the value of the interest that is sufficiently detailed so that another person can replicate the process and arrive at the appraised value;
the appraisal procedures followed, and the reasoning that supports the analyses, opinions, and conclusions;
the valuation method used, the rationale for the valuation method, and the procedure used in determining the fair market value of the asset transferred; and
the specific basis for the valuation, such as specific comparable sales or transactions, sales of similar interests, asset-based approaches, merger-acquisition transactions, etc.

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