Gift tax SOL disclosure final regs.

On Dec. 2, 1999, the IRS issued Regs. Sec. 301.6501 (c)-1(f), defining "adequate disclosure" for gifts as required under Sec. 6501 (c)(9). Adequate disclosure requires sufficient information be included on a gift tax return to apprise the Service of the nature of a gift. The statute of limitations (SOL) will not start for any gifts not adequately disclosed on a gift tax return. Obtaining the three-year SOL is important, as the SOL runs with respect to all issues, not just those for valuation. The regulations apply to all gifts made after 1996, if the return is not filed until after Dec. 3, 1999.

Previously, the regulations required special disclosures for gifts subject to Chapter 14 (dealing with certain transfers to family members when the donor has retained a certain type of interest in the property transferred) of the Code. The IRS has now issued disclosure requirements applicable to all other gifts (referred to as Chapter 12 gifts). The original disclosure requirements for Chapter 14 gifts continue to apply only to Chapter 14 gifts. The new disclosure rules apply to all non-Chapter 14 gifts. Exhibit 1 lists the disclosures under these two chapters. This will explore some differences between the proposed and final Chapter 12 regulations and highlight some differences between the final Chapter 12 and Chapter 14 disclosures.

Exhibit 1

Section A--Disclosure Required for Transfers Subject to Chapter 12 (Regs. Sec. 301.6501 (c)-1 (f))

1. A description of the transferred properly and any consideration received by the transferor.

Comment: A part-sale/part-gift transaction must now be disclosed under these rules. Previously, only the gift portion of the transaction would be reported.

2. The identity of, and relationship between, the transferor and transferee.

Comment: This information has always been required on a gift tax return.

3. If the properly is transferred in trust, the trust's tax identification number (TIN) and a brief description of its terms, or in lieu of a brief description of the trust terms, a copy of the trust instrument.

Query: For a trust that is defective for income tax purposes (which is the case with many insurance trusts), should the taxpayer use the grantor's TIN?

4. A detailed description of the method used to determine the FMV of the properly transferred, including any financial data (e.g., balance sheets, etc., with explanations of any adjustments) used in determining the value of the interest, any restrictions on the transferred properly considered in determining the property's FMV and a description of any discounts (such as discounts for blockage, minority or fractional interests and lack of marketability) claimed in valuing the properly. For a transfer of an interest actively traded on an established exchange (such as the New York Stock Exchange, the American Stock Exchange, the NASDAQ National Market, a regional exchange or recognized foreign exchange), in which quotations are published on a daily basis, recitation 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 the applicable valuation date, will satisfy all of the requirements of this paragraph.

For a transfer of an interest in an entity (e.g., a corporation or partnership) not actively traded, a description must be provided of any discount claimed in valuing the interests in the entity or any assets owned by such entity. In addition, if the value of the entity or of the interests in the entity is properly determined based on the net value of the assets held by the entity, a statement must be provided as to the FMV of 100% of the entity (determined without regard to any discounts in valuing the entity or any assets owned by the entity), the pro rata portion of the entity subject to the transfer, and the FMV of the transferred interest as reported on the return. If 100% of the value of the entity is not disclosed, the taxpayer bears the burden of demonstrating that the FMV 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. If the entity that is the subject of the transfer owns an interest in another nonactively traded entity (either directly or through ownership of an entity), the information required must be provided for each entity if the information is relevant and material in determining the value of the interest. 5. A statement describing any position taken that is contrary to any proposed, temporary or final regulation or revenue ruling published at the time of the transfer; see Regs. Sec. 601.601(d)(2).

Section B--Disclosure Required for Transfers Subject to Chapter 14 (Regs. Sec. 301.6501 (c)-1 (e))

1. A description of the transactions, including a description of transferred and retained interests and the methods used to value each.

2. The identity of (and relationship between)the transferor, transferee, all other persons participating in the transactions and all parties related to the transferor with an equity interest in any entity involved in the transactions.

3. A detailed description (including all actuarial factors and discount rates used) of the method used to determine the amount of the gift arising from the transfer (or taxable event), including, in the case of an equity interest not actively traded, the financial and other data used in determining value. Financial data should generally include balance sheets and statements of net earnings, operating results and dividends paid for each of the five years immediately before the valuation date.

Valuation Data

The final regulations describe specific disclosures for actively traded and nonactively traded interests; the proposed regulations addressed only nonactively traded interests. The requirements for actively traded interests (see Exhibit 1, Sec. A, #4) are relatively straightforward. The requirements for nonactively traded interests are less clear.

There is some uncertainty as to the scope of valuation data required for nonactively traded interests; not so much as to the type of information but, rather, the extent or degree of the information required. For example, how much information must be included in the "detailed description of the method" used to determine the fair market value (FMV)? Likewise, what must be included in the "description of the restrictions" considered in valuing the interest? How much information is the IRS looking for? Neither the regulations nor examples provide any guidance. The preamble to the regulations notes that commentators to the proposed regulations suggested that a "substantial compliance" clause be included in the final regulations. However, the Service did not adopt this view, stating that it would be difficult to define and illustrate what would constitute substantial compliance. If the information supplied is later determined to be inadequate, the IRS may examine the gift at any time.

Taxpayers have another option for satisfying the valuation requirement. The taxpayer, in lieu of supplying the information in Exhibit 1, Sec. A, #4, may submit an appraisal meeting all of the requirements listed in Exhibit 2. Either alternative, if properly done, should commence the running of the SOL. The added benefit of the appraisal described in Exhibit 2 is the improved chances of defending the reported value against a Service valuation challenge during the audit exposure period.

Exhibit 2

Regs. Sec. 301.6501(c)-1(f)(3) provides for an appraisal in lieu of the information required in Exhibit 1, Sec. A, #4. The requirements will be satisfied if the donor submits an appraisal of the transferred property that meets the following requirements:

1. The appraisal is prepared by an appraiser who satisfies all of the following requirements:

* The appraiser is an individual who holds himself out to the public as an appraiser or performs appraisals on a regular basis;

* 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), the appraiser is qualified to make appraisals of the type of property being valued; and

* The appraiser is not the donor or the donee of the property or a member of the family of the donor or donee, as defined in Sec. 2032A(e)(2), or any person employed by the donor, the donee or a member of the family of either; and

2. The appraisal contains all of the following information:

* The transfer date, 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 (for ownership interest in a business) all financial data 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 transferred assets' FMV; 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.

Disclosures for Nongift Transfers

The proposed regulations introduced the concept of disclosure for nongift transfers. The proposed regulations did not clearly identify which types of transactions were included in the definition of nongift transfers. For example, the proposed regulations did not address whether a transaction in the ordinary course of business would be included in the definition of nongift transfers. The IRS has addressed this issue in the final regulations, stating that a transaction made between family members (as defined in Sec. 2032A(e)(2)), in the ordinary course of operating a business, would be deemed to be adequately disclosed if the transaction were properly reported by all of the parties for income tax purposes. All other nongift transfers must be adequately disclosed on a gift tax return. Adequate disclosure for nongift transfers includes all the disclosures found in Exhibit 1, Sec. A, with the exception of #4. In addition, the taxpayer must explain why the transfer is not subject to Chapter 12.

It is conceivable that a taxpayer could arrange a nongift transfer as a transaction in the ordinary course of operating a business and, therefore, not be required to disclose the transaction on the gift tax return. While the definition the Service intends to use for "ordinary course of business" is not clear from the final regulations, the preamble to the regulations states that such transactions do not include a sale of property (including a business) by a parent to a child. One might ask why this example is not included in the final regulations?

The first sentence in Regs. Sec. 301.6501 (c)-1(f) states that it applies to all transfers other than transfers described in Regs. Sec. 301.6501(c)-1(e), which applies to Chapter 14 transfers. This sentence could be understood to indicate that the disclosures applicable to Chapter 12 gifts are not applicable to Chapter 14 gifts, because Chapter 14 gifts have been provided for separately. However, taxpayers should be cautious in taking that approach. Because Chapter 14 gifts appear to be a special type (or subset) of Chapter 12 gifts, it would seem that, in the case of a Chapter 14 gift, taxpayers must comply with the disclosures under Chapter 12, plus anything in Chapter 14 not found in Chapter 12.

Incomplete Gifts

The SOL will also commence for a transfer reported as a completed gift, even if the transfer is ultimately determined to be an incomplete gift for purposes of Regs. Sec. 25.2511-2 (i.e., cessation of donor's dominion and control). Under the proposed regulations, there was no provision that applied the SOL to collateral issues, such as whether a gift was complete. For example, under the proposed regulations, a taxpayer who made an incomplete transfer, but reported it as a completed gift, would not be afforded the protection of the SOL for that gift. However, the final regulations make it clear that the SOL will start for all issues of law, not just issues of valuation. Therefore, if a taxpayer reports a transfer on a gift tax return that he believes to be a completed gift but later turns out to be an incomplete gift, and he discloses the transfer as required under the regulation, the transfer would be included in the donor's gross estate, only to the extent that a completed gift would be so included.

FROM BRUCE A. VANDERMEULEN, J.D., MST, GRAND RAPIDS, MI