The Tax Court in Brief June 8 – 12, 2020
Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.
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The Week of June 8 – 12, 2020
- Howe v. Comm’r, T.C. Memo. 2020-78 | June 8, 2020 | Kerrigan, K. | Dkt. No. 29743-14
- Johnson v. Comm’r, T.C. Memo. 2020-79 | June 8, 2020 | Pugh C. | Dkt. No. 30283-15
- Flume v. Comm’r, T.C. Memo. 2020-80 | June 9, 2020 | Ashford, J. | Dkt. No. 31162-14
- Nelson v. Comm’r, T.C. Memo. 2020-81 | June 10, 2020 | Pugh, J. | Dkt. Nos. 27313-13, 27321-13
Howe v. Comm’r, T.C. Memo. 2020-78
Short Summary: Petitioners’ 2008 Form 1040 was audited which resulted in a notice of proposed adjustments. During the appeal, the IRS and the Petitioners’ agreed to sign a Form 870-AD which reduced the Petitioners’ deficiency and accuracy-related penalty. Later the IRS determined that it had signed the Form 870-AD based on misrepresentations of material facts from Petitioners’ representative and rescinded the Form 870-AD. The IRS then reopened the audit and issued a notice of deficiency to Petitioners. At trial, Petitioners challenged the validity of the notice of deficiency and claimed that Form 870-AD was presumptively valid and that the IRS was equitably estopped from voiding it. The Tax Court ruled in favor of the IRS.
Key Issue: Whether the IRS’ conduct and actions in rescinding an executed settlement agreement can be classified as affirmative misconduct for the purposes of an equitable estoppel argument.
- The IRS rescission of the Form 870-AD was not affirmative misconduct. The IRS was within its right to void the Form 870-AD based on the misrepresentations of the Petitioner’s representative to the appeals officer.
Key Points of Law:
- A proceeding before the Tax Court to redetermine a deficiency is a proceeding de novo and the Tax Court will generally not look behind the notice of deficiency to determine it validity.
- The Tax Court will however determine the validity of a notice of deficiency in case where there is substantial evidence of unconstitutional conduct on the part of the IRS.
- Form 870-AD is not a binding settlement agreement under I.R.C. 7121.
- A party seeking equitable estoppel against the US Government has the burden to show the traditional elements of equitable estoppel ((1) the party to be estopped must know the facts; (2) he must intend that his conduct shall be acted on or must so act that the party asserting the estoppel has a right to believe it is so intended; (3) the latter must be ignorant of the true facts; and (4) he must rely on the former’s conduct to his injury) as well as the following: (1) the government engaged in affirmative misconduct going beyond mere negligence; (2) the government’s wrongful act will cause a serious injustice; and (3) the public’s interest will not suffer undue damage by imposition of estoppel.
- Affirmative misconduct on the part the part of the government requires an affirmative misrepresentation or affirmative concealment of a material fact such as a deliberate lie or pattern of false promises. However, the Tax Court noted that there is no bright-line rule and each case must be decided on its particular facts and circumstances.
- Agreeing to and making payments on a deficiency are not detrimental reliance for the purposes of equitable estoppel.
Insight: The Howe case shows the importance that a taxpayer or his representative provide accurate and consistent statements and information at both the audit and appeal level. Further, it demonstrates the ability of the IRS to void a Form 870-AD and reopen an audit. The case also illustrates the considerable burden of proof a taxpayer will have to successfully claim equitable estoppel in such a situation.
Johnson v. Comm’r, T.C. Memo. 2020-79
Short Summary: Petitioner sought review of the IRS determination that (1) deductions for travel and car and truck expenses were not properly supported pursuant to sections 162, 179, and 274; and (2) the Petitioner’s valuation of his charitable contribution deductions, which was based on the granting of an easement to a non-profit conservation group, was incorrect.
Key Issue: Whether the taxpayer could support his deduction of travel expenses related through his own testimony and calendar showing his dates of travel and (2) whether the taxpayer properly valued the conservation easement, and thereby the value of the resulting charitable deductions, that the taxpayer granted to a non-profit conservation group.
- The taxpayer’s deductions for travel and car and truck expenses were not properly substantiated pursuant to sections 162, 179, and 274.
- The taxpayer’s charitable contribution deductions were allowed, but the value of such deductions was adjusted based on the Tax Court’s own review of evidence in the record with respect to the value of the property.
Key Points of Law:
- Section 162 allows a taxpayer to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Sec. 162(a).
- But a taxpayer may not deduct personal, living, or family expenses unless the Code expressly provides otherwise. Sec. 262(a).
- Taxpayers are required to maintain sufficient records to establish the amount of any deduction. Sec. 6001.
- Under the Cohan rule, a court may estimate the amount of an expense if the taxpayer is able to demonstrate that he has paid or incurred a deductible expense but cannot substantiate the precise amount, so long as he produces credible evidence that gives a basis for the court to do so. Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).
- But the Cohan rule does not apply to certain expenses as set forth in Sec. 274. Instead, the taxpayer must substantiate by adequate records or by sufficient evidence corroborating the taxpayer’s own statement: (1) the amount of the expense, (2) mileage for each business use of the vehicle as well as the total mileage for all purposes during the taxable period (if an automobile expense), (3) the time and place of the travel or use, and (4) the business purpose of the expense.
- To substantiate by adequate records, a taxpayer must provide an account book, a log, or similar record and documentary evidence which together are sufficient to establish each element with respect to an expenditure. Reg. § 1.274-5T(c)(2)(i).
- Without adequate records, a taxpayer may still substantiate expenses with sufficiently detailed written or oral statements and other corroborative evidence showing that he incurred the expense.
- In general, a taxpayer may not claim a deduction for a charitable contribution of property consisting of less than the taxpayer’s entire interest in the property. See sec. 170(f)(3).
- However, a taxpayer may deduct the value of a contribution of a partial interest in property if the contribution constitutes a “qualified conservation contribution.” See sec. 170(f)(3)(B)(iii).
- The amount of a charitable contribution deduction generally is the fair market value of the contributed property at the time it is contributed. Treas. Reg. § 1.170A-1(a), (c)(1).
- With respect to a conservation easement, fair market value of the deduction should be determined by calculating the difference between the property’s fair market value before and after the taxpayer grants the easement. Reg. § 1.170A-14(h)(3)(i).
- The court will consider expert reports to determine such value, and when experts offer competing estimates of fair market value, the court will determine how to weigh those estimates by examining the factors the experts considered in reaching their conclusions. But the court is not bound to an expert’s opinion and can indeed reach a determination of value based on the court’s own review of evidence in the record. Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), aff’g T.C. Memo. 1974-285.
- In deciding a property’s fair market value, the court will first take into account the property’s highest and best use. Stanley Works & Subs. v. Commissioner, 87 T.C. 389, 400 (1986).
- A property’s highest and best use also is the highest and most profitable use for which it is adaptable and needed or likely to be needed in the reasonably near future. Olson v. United States, 292 U.S. 246, 255 (1934).
Insight: The Johnson case illustrates the heightened substantiation standard for travel and car and truck expenses. Specifically, the case demonstrates the importance of maintaining travel logs and mileage logs as needed. Further, this case illustrates that the value of a charitable contribution deduction, which relates to the grant of a “charitable” easement, can be determined by the Tax Court’s own review of evidence in the record—rather than fully accepting an expert witnesses’ valuation.
Flume v. Comm’r, T.C. Memo. 2020-80
Short Summary: The IRS issued notices of deficiency to the taxpayers for tax years 2006, 2007, and 2008 related to income associated with foreign entities. The underlying case ultimately arose, in part, out of an audit prompted by the IRS’s receipt of records from Union Bank of Switzerland (UBS) pertaining to a UBS account held by a Bahamian entity owned by the taxpayers. That information was provided to the IRS in response to a request for treaty information.
This case, which will become known as “Flume II,” also arose in connection with a prior Tax Court case in which the taxpayer-petitioners were involved. In Flume v. Commissioner (Flume I), T.C. Memo. 2017-21, a collection due process case, the issue for decision was whether Mr. Flume was liable for assessed civil penalties under sections 6038 and 6679 for his failure to declare (via Forms 5471) his ownership interest in Wilshire for the 2001-09 taxable years (and his ownership interest in FFM for the 2001 and 2002 taxable years). In deciding the issue, the Court had to determine whether Wilshire was a CFC for years that included the years at issue in the instant case. The Court determined that petitioners each held 50% ownership interests in Wilshire throughout a period that included the subject years. Those determinations became important with respect to Flume II under issue preclusion principles.
During the years at issue and when the petition was filed petitioners were U.S. citizens residing in Mexico
Franchise Food Services de Mexico S.A. de C.V. (FFM) is a Mexican sociedad anonima, which is a limited liability stock corporation that adopted the form of a variable capital company. FFM was incorporated in Guadalajara, Jalisco, Mexico, in 1995 to operate two fast food franchises that Mr. Flume owned.
Initially there were two 50% shareholders of FFM, Mr. Flume and Norwick Adams. Mr. Flume was FFM’s president, and Mr. Adams was FFM’s secretary and treasurer. The fast food franchises were sold in 1998, but FFM remained intact, having at least one U.S. bank account.
On February 8, 2002, Mr. Flume transferred 41% of his 50% ownership interest in FFM to Victor Mendez Tornell.
During the years at issue FFM was an active corporation. On January 15, 2007, petitioners entered into a consulting and personal services contract with FFM, and FFM made payments to them for their services.
In addition, the petitioners incorporated Wilshire Holdings, Inc. (Wilshire), in the Bahamas, with each holding one bearer share of Wilshire capital stock.
During Wilshire’s February 23, 2000, organizational meeting Mr. Flume was named as Wilshire’s director and secretary. The following year petitioners changed the domicile of Wilshire, reincorporating it in Belize. At a time not established by the record petitioners amended Wilshire’s original Belizean articles of association. These amended articles of association were backdated to April 12, 2001, to reflect the date of original incorporation in Belize. As stated in these amended articles of association petitioners’ bearer shares in Wilshire were eliminated and they and their daughter each held a 9% ownership interest, and Mr. Tornell held the remaining 73% ownership interest in Wilshire. During at least the years at issue Mr. Flume was the president and a director of Wilshire, and Mrs. Flume was the vice president and a director of Wilshire.
Petitioners opened bank or brokerage accounts in Wilshire’s name with Laredo National Bank (now BBVA Compass Bank) in 2000 (BBVA Compass Bank account), United Bank of Switzerland (UBS) in 2005 (UBS account), and Fidelity Investments at a time not established by the record (Fidelity account). They had sole signature authority over each of these accounts. The BBVA Compass Bank account was opened in the United States using a U.S. identification number petitioners obtained for Wilshire. The UBS account was opened outside the United States, and in doing so petitioners provided UBS with (among other documents) Wilshire’s original memorandum and articles of association and a certificate of incumbency for Wilshire from the Corporate Services Division of the Belize Bank Limited in Belize City, Belize. The certificate of incumbency identified Mr. Flume as Wilshire’s sole director and Wilshire’s shareholders as two “[b]earers” holding one share each of its capital stock. UBS’ due diligence documents identified petitioners as the beneficial owners of the UBS account, Mr. Flume as Wilshire’s “only shareholder and owner”, and the account’s purpose as “[w]ealth [m]anagement of retirement funds; probably [a] loan for [a] flat in Paris.” It is unknown how the Fidelity account was opened.
Wilshire did not compensate petitioners by check or direct deposit for the years at issue; instead, it would transfer funds from its BBVA Compass Bank, UBS, and Fidelity accounts to petitioners’ personal accounts or directly pay some of their personal expenses. Payments made by Wilshire of petitioners’ personal expenses during the years at issue include payments of their personal credit card charges, travel expenses, household furnishings, automatic teller machine withdrawal service charges, tuition, gifts to relatives, and rent for an apartment in San Francisco, California. In addition Wilshire would transfer funds from its BBVA Compass Bank account to FFM “in lieu of salary” to petitioners.
SMA Property Development
On January 15, 2007, FFM and Wilshire entered into a five-year joint venture agreement to acquire, develop, and sell residential real property in Mexico. This joint venture of FFM and Wilshire operated under the name SMA Property Development (SMA). Petitioners managed the affairs and funds of SMA, and more specifically, Mr. Flume served as SMA’s managing partner. On January 15, 2007, petitioners were also given powers of attorney to act jointly and independently as the attorneys-in-fact of SMA. As SMA’s attorneys-in-fact they were authorized to retain any assets owned by SMA and reinvest those assets, co-own assets and commingle their funds with the funds of SMA, and personally gain from any transaction they completed on SMA’s behalf.
The IRS determined that Wilshire was a controlled foreign corporation (CFC) that was 100% owned by petitioners for the years at issue, that the investment income from Wilshire’s UBS and Fidelity accounts was foreign personal holding company income (FPHCI) under subpart F of the Code, and that as a result petitioners were required to report their pro rata share (100%) of that FPHCI as subpart F income (and taxable as additional ordinary dividend income).
In the alternative, the IRS determined that petitioners were required to report as ordinary income: (1) interest income attributable to Wilshire’s UBS and Fidelity accounts; (2) ordinary dividend income attributable to Wilshire’s UBS and Fidelity accounts ; and (3) capital gains attributable to Wilshire’s UBS and Fidelity accounts.
The case involved three substantive issues: whether petitioners (1) had additional wage income, (2) had reportable subpart F income, and (3) are liable for accuracy-related penalties
A subsidiary issue bearing on whether the taxpayers had additional subpart F income was whether Wilshire was a CFC on any day during each of the years at issue with the result that if Wilshire was such a CFC then petitioners have reportable subpart F income for those years.
- The conditions for issue preclusion are satisfied (as a result of the prior proceedings in Flume I), rendering Wilshire a CFC during the years at issue.
- Given that the taxpayers were 100% shareholders of Wilshire for the years at issue, their pro-rata share of Wilshire’s subpart F income for those years was 100%.
- The penalties here were approved in writing before the first formal communication to petitioners of those penalties.
- Held that Petitioners did not rely on their tax-return preparer’s “judgment” (let alone reasonably rely on her “judgment”), nor did they act in good faith. Petitioners have failed to prove that they had reasonable cause within the meaning of section 6664(c).
Key Points of Law:
- In general, the IRS’s determinations set forth in a notice of deficiency are presumed correct and, except for the burden of production in any court proceeding with respect to a taxpayer’s liability for any “penalty, addition to tax, or additional amount”, see sec. 7491(c), the taxpayer bears the burden of proving otherwise.
- However, for this presumption to adhere in cases (such as this one) involving unreported income, the Commissioner must provide some reasonable foundation connecting the taxpayer with the income-producing activity.
- A taxpayer’s gross income includes “all income from whatever source derived,” including “[c]ompensation for services”, e.g., wages and salaries. Sec. 61(a)(1); sec. 1.61-2(a)(1), Income Tax Regs.
- A taxpayer is required to maintain books or records sufficient to establish the amount of his or her gross income required to be shown by such person on any return. See sec. 6001; sec. 1.6001-1, Income Tax Regs.
- If the taxpayer’s books or records do not clearly reflect income, then the Commissioner is authorized “to reconstruct income in accordance with a method which clearly reflects the full amount of income received.”
- The specific item method is a Court-approved “method of income reconstruction that consists of evidence of specific amounts of income received by a taxpayer and not reported on the taxpayer’s return.”
- Under the Controlled Foreign Corporation (CFC) statutory scheme, a U.S. shareholder of a CFC must generally include in his gross income his pro rata share of the CFC’s “subpart F income” for such year. see sec. 951(a)(1).
- Section 951(b) defines a U.S. shareholder, with respect to any foreign corporation, as a U.S. person “who owns (within the meaning of section 958(a)), or is considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote” of the foreign corporation. Section 957(a) generally defines a CFC as “any foreign corporation if more than 50 percent of–(1) the total combined voting power of all classes of stock of such corporation entitled to vote, or (2) the total value of the stock of such corporation, is [directly or constructively] owned * * * by United States shareholders on any day during the taxable year of such foreign corporation.”
- Section 952(a)(2) defines subpart F income as including foreign base company income as determined under section 954. Under section 954(a)(1) and (c)(1), foreign base company income includes “foreign personal holding company income”, which in turn includes dividends, interest, and the excess of gains over losses from the sale or exchange of certain property.
- Issue preclusion “recognizes that suits addressed to particular claims may present issues relevant to suits on other claims.”
- Issue preclusion applies when suits involve separate claims, but present some of the same issues, and ‘bars the relitigation of issues actually adjudicated, and essential to the judgment, in a prior litigation between the same parties.
- Issue preclusion focuses on whether (1) the issue in the second suit is identical in all respects with the one actually litigated, decided, and essential to the judgment in the first suit, (2) a court of competent jurisdiction rendered a final judgment in the first suit, (3) the controlling facts and applicable legal principles in the second suit have changed significantly since the judgment in the first suit, and (4) there are special circumstances, such as fairness concerns, that warrant an exception to preclusion in the second suit.
- The pro rata amount that a U.S. shareholder of a CFC reports as subpart F income of the CFC for any taxable year cannot exceed the CFC’s current earnings and profits. Sec. 952(c)(1)(A)
- A CFC’s current earnings and profits are generally “determined according to rules substantially similar to those applicable to domestic corporations”.
- The Code does not define the term “earnings and profits” for domestic corporations. A domestic corporation’s earnings and profits “is generally understood to equal the corporation’s taxable income for the taxable year with certain modifications.”
- Section 6751(b)(1) requires that the initial determination of certain penalties be “personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.”
- Reasonable cause may exist where the taxpayer relies on professional advice if the taxpayer proves by a preponderance of evidence that: (1) the adviser was a competent professional who had sufficient expertise to justify the taxpayer’s reliance on him or her; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment.
Insight: Taxpayers with interests in foreign entities are often subject to complex reporting regimes, such as the CFC reporting regime, which taxes a U.S. shareholder’s allocable share of “subpart F” income earned by a CFC, whether or not the CFC actually repatriates/distributes that income to the U.S. shareholder. The case is also yet another reminder of the significant increase in the IRS’s focus on international tax reporting deficiencies, and its continuing ability to obtain information from foreign jurisdictions and sources.
Nelson v. Comm’r, T.C. Memo. 2020-81
Short Summary: Mrs. Nelson’s father cofounded Compressor Systems, Inc. (CSI). CSI sells and rents gas compression equipment to the oil and gas industry and provides financing and maintenance services in connection with that equipment. Mrs. Nelson’s father continued to expand his family businesses throughout his life, operating in Texas as a Caterpillar-approved dealer in certain territories.
As part of this expansion, Mrs. Nelson’s father organized Warren Equipment Co. (WEC), which was a holding company that owned 100% of seven other operating subsidiaries, including CSI. After his death, Mrs. Nelson indirectly through Longspar held most of the common and preferred stock in WEC. Longspar was formed as a Texas limited partnership to: (1) consolidate and protect assets; (2) establish a mechanism to make gifts without fractionalizing interests; and (3) to ensure that WEC remained in business and under family control.
On December 23, 2008, the taxpayers (Mr. and Mrs. Nelson) formed the Nelson 2008 Descendants Trust (Trust). Mr. Nelson is a beneficiary of the Trust, along with their four daughters. Thereafter, Mrs. Nelson made two transfers of limited partnership interests in Longspar to the Trust. The first transfer occurred on December 31, 2008, and was done via a Memorandum of Gift and Assignment of Limited Partner Interest for $2,096,000 “as determined by a qualified appraiser within ninety (90) days of the effective date of this Assignment.” The second transfer occurred on January 2, 2009, and was done via a Memorandum of Sale and Assignment of Limited Partner Interest for $20,000,000 “as determined by a qualified appraiser within one hundred eighty (180) days of the effective date of this Assignment.” In connection with the second assignment, the Trust executed a promissory note for $20 million.
After the assignments, the taxpayers hired an appraiser to value the limited partnership interests in Longspar. The appraiser concluded that, as of the valuation date, the fair market value of a 1% limited partnership interest in Longspar was $341,000. In arriving at this conclusion, the appraiser relied on a fair market valuation of WEC’s common stock completed by Ernst & Young. Thus, on the basis of his valuation, the appraiser determined that Mrs. Nelson’s December 31, 2008, and January 2, 2009, transfers equated to the rounded amounts of 6.14% and 58.65% limited partnership interests in Longspar, respectively.
The taxpayers filed separate Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Returns for 2008 and 2009. On their 2008 Forms 709 they each reported the gift to the Trust “having a fair market value of $2,096,000 as determined by independent appraisal to be 6.1466275% limited partner interest” in Longspar. They did not report the January 2, 2009, transfer.
The 2008 and 2009 gift tax years were audited by the IRS. Later, the IRS issued notices of deficiency determining that the taxpayers had undervalued the December 31, 2008, gift and that their halves of the gift were each worth $1,761,009 rather than $1,048,00 as of the valuation date. The IRS also determined that the taxpayers had undervalued the January 2, 2009, transfer by $13,607,038 and therefore concluded that each had made a split gift in 2009 of $6,803,519.
Key Issue: Whether the interests in Longspar Partners, Ltd. (Longspar), transferred on December 31, 2008, and January 2, 2009, were fixed dollar amounts or percentage interests; and (2) the fair market value of those interests.
- Nelson transferred 6.14% and 58.65% Longspar limited partnership interest to the Trust.
- The WEC common stock should be discounted 15% for lack of control and 30% for lack of marketability, resulting in a fair market value of $912 per share. Therefore, the controlling, marketable value of Longspar is $60,729,361.
- Discounts of 5% for lack of control and 28% for lack of marketability should apply to calculate the fair market value of a Longspar limited partnership interest. As a result, a 1% Longspar limited partnership interest has a fair market value of $411,235 and the 6.14% and 58.65% interests Mrs. Nelson transferred to the Trust have fair market values of $2,524,983 and $24,118,933, respectively.
Key Points of Law:
- Section 2501(a) imposes a tax on the transfer of property by gift. When property is transferred for less than an adequate and full consideration, then the amount by which the value of the property exceed the value of the consideration shall be deemed a gift. 2512(b). Generally, the valuation of property for federal tax purposes is a question of fact. Adams v. U.S., 218 F.3d 383, 385-86 (5th Cir. 2000).
- The fair market value of property transferred is the price at which it would change hands between a willing buyer and a willing seller, neither under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. S. v. Cartwright, 411 U.S. 546, 551 (1973). The willing buyer and willing seller are purely hypothetical figures and valuation does not take into account the personal characteristics of the actual recipients of the property being valued. Estate of Newhouse v. Comm’r, 94 T.C. 193, 218 (1990).
- With respect to a closely held entity, a determination of its fair market value for federal gift tax purposes depends upon all of the relevant facts and circumstances. Estate of Smith v. Comm’r, 198 F.3d 515, 526 (5th 1999). These relevant facts and circumstances include whether discounts for lack of control and lack of marketability factor into the fair market value of a closely held entity’s stock. Estate of Newhouse, 94 T.C. at 249; Estate of Magnin v. Comm’r, T.C. Memo. 2001-31.
- To resolve valuation issues, the Tax Court may consider expert witness opinions properly admitted into evidence. Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938). In doing so, the Tax Court will weigh each expert’s opinion in the light of the expert’s qualifications and other credible evidence. Estate of Newhouse, 94 T.C. at 217. The Tax Court has “broad discretion to evaluate the cogency of . . . [the] expert’s analysis.” Davis v. Comm’r, T.C. Memo. 2015-88. If the Tax Court finds one expert’s opinion persuasive, it may accept that opinion in whole or in part over that of the opposing expert. Estate of Davis v. Comm’r, 110 T.C. 530, 538 (1998). Alternatively, it may reach an intermediate conclusion as to value by drawing selectively from the testimony of various experts. Parker v. Comm’r, 86 T.C. 547, 562 (1986). For a value or discount it is not necessary that the value arrived at by the trial court be a figure as to which there is specific testimony, if it is within the range of figures that may properly be deduced from the evidence. Anderson v. Comm’r, 250 F.2d 242, 249 (5th 1957).
- But, property exchanged for “adequate and full consideration” does not constitute a gift for Federal gift tax purposes.Indeed, the regulations confirm that “the gift tax is not applicable to a transfer for full and adequate consideration in money or money’s worth, or to ordinary business transactions.” Reg. § 25.2511-1(g)(1). For these purposes, the regulations define a transfer in the ordinary course of business as “a transaction which is bona fide, at arm’s length, and free from any donative intent.” Treas. Reg. § 25.2512-8; Weller v. Comm’r, 38 T.C. 790, 805-06 (1962). A transaction meeting this standard will be considered as made for an adequate and full consideration in money or money’s worth. Treas. Reg. § 25.2512-8. However, a transaction between family members is subject to special scrutiny, and the presumption is that a transfer between family members is a gift. Frazee v. Comm’r, 98 T.C. 554, 561 (1992).
- The Tax Court looks to the transfer documents rather than subsequent events to decide the amount of property given away by a taxpayer in a completed gift. Estate of Petter v. Comm’r, T.C. Memo. 2009-280. And courts have rejected saving clauses because they relied on conditions subsequent to adjust gifts or transfers so the size of the transfer (as measured either in dollar amount or percentage) could not be known.
- The Tax Court has applied minority interest discounts for holding companies. See Estate of Litchfield v. Comm’r, T.C. Memo. 2009-21; Lappo v. Comm’r, T.C. Memo. 2003-258; Hess v. Comm’r, T.C. Memo. 2003-251.
Insight: As with many valuation issues in tax litigation, the Nelson case involved a battle of expert opinions. When large gifts are made, taxpayers are well-advised to seek qualified appraisals of any gift transfers and document the transfers accordingly.
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