Gift tax SOL prop. regs.

Before the Taxpayer Relief Act of 1997 (TRA '97), the IRS generally could revalue a gift for gift tax purposes within three years of the date of filing the gift tax return (if tax was paid with the return). When the gift involved a transfer subject to Chapter 14's special valuation rules, the taxpayer had to make additional disclosures (set forth in Regs. Sec. 301.6501(c)-1(e)) as to the property transferred for the statute of limitations (SOL) to commence.

For estate tax purposes, gifts that could not be revalued for gift tax purposes could nevertheless be revalued to determine the appropriate estate tax bracket. To provide closure to valuation issues, the TRA '97 and the Internal Revenue Service Restructuring and Reform Act of 1998 allowed taxpayers to finalize valuation issues for gift and estate tax purposes. Now, the Service cannot revalue a gift for gift or estate tax purposes if it was adequately disclosed on a gift tax return. However, prior taxable gifts remain adjustable for purposes of subsequent gift and estate tax returns if the proposed adjustments are not related to valuation issues.

The TRA '97 amended Sec. 6501(c)(9) to require adequate disclosure of all gifts for which the taxpayer seeks SOL protection. Because Regs. Sec. 301.6501(c)-1 (e) deals with Chapter 14 gifts, it was not clear what type of disclosure was required for non-Chapter 14 gifts. The IRS proposed Regs. Sec. 301.6501(c)-1(f), providing taxpayers with disclosure requirements necessary to commence the SOL for non-Chapter 14 gifts (see News Notes, "Gift Tax SOL," T-FA, February 1999, p. 73). The proposed regulations are effective for gifts made in calendar years ending after Aug. 5,1997, if the gift tax return for such year is filed after the regulations become final. (Presumably, this would include 1998 gift tax returns extended and filed after the regulations become final.) Table 1, on p. 296, summarizes disclosure requirements and suggests possible applications.

Table 1: Proposed Disclosure Requirements for Non. Chapter 14 and Chapter 14 Transfers

     Non-Chapter 14 transfers               Chapter 14 transfers

1.   A description of the transferred       A description of the
     property and any consideration         transactions, including
     received by the transferor.            a description of
       Comment: A part sale, part gift      transferred and
     now must be disclosed under these      retained interests and
     rules. Previously, only the net        the method (or methods)
     gift would be reported.                used to value each.

2.   The identity of (and relationship      The identity of (and
     between) the transferor and the        relationship between)
     transferee.                            the transferor,
       Comment: This information            transferee, all other
     already must be submitted in           persons participating
     preparing a girl: tax return.          in the transactions and
                                            all parties related to
                                            the transfer- or holding
                                            an equity interest in an
                                            entity involved in the
                                            transaction.
3.   A detailed description of the method   A detailed description
     used to determine the fair market      (including all actuarial
     value (FMV) of property transferred,   factors and discount
     including any relevant financial       rates used) of the
     data and a description of any          method used to
     discounts (such as discounts for       determine the amount of
     blockage, minority or fractional       the girl: arising from
     interests, and lack of                 the transfer (or taxable
     marketability) claimed in valuing      event), including, for
     the property. In the case of the       an equity interest not
     transfer of an interest in an          actively traded, the
     entity (e.g., a corporation or         financial and other data
     partnership) not actively traded,      used in determining
     a description of any discount          value. Financial data
     claimed in valuing the entity or       should generally include
     any assets owned by such entity,       balance sheets and
     including a statement of the FMV       statements of net
     of 100% of the entity (determined      earnings, operating
     without regard to any discounts        results and dividends
     in valuing the entity or any assets    paid for each of the
     owned by the entity), the pro rata     five years immediately
     portion of the entity subject to       before the valuation
     the transfer and the FMV of the        date.
     transferred interest as reported
     on the return. 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), this information must
     be provided for each entity and
     the assets owned by each entity.
       Comments: Unlike Chapter 14
     rules, the proposed non-Chapter
     14 rules do not specify the type
     of financial data required.
     However, relevant financial data
     may involve appraisals and
     financial statements. In any
     event, the gift tax return
     instructions follow the Chapter
     14 rules for gifts of closely
     held or inactive stock.
       Together with the gift tax
     return instructions, the proposed
     rules require specific disclosure
     of information regarding
     valuation discounts. In contrast,
     such disclosure is not explicitly
     required by the Chapter 14 rules.
     However, it has been generally
     understood by practitioners that
     valuation discounts had to be
     disclosed as part of the method
     used to value the transferred and
     retained interests (see
     Requirement 1, above, for Chapter
     14 transfers).
4.   If the property is transferred in
     trust, the trust's tax
     identification number and a brief
     description of the trust's
     terms.
       Comments: The "brief description"
     requirement might be satisfied by a
     summary of the trust's terms. The
     gift tax return instructions
     contain the following additional
     requirement:

     If the gift was made by means of
     a trust, attach a certified or
     verified copy of the trust
     instrument to the return on which
     you report your first transfer to
     the trust. You do not need to
     attach the trust to returns on
     which you report subsequent
     transfers to the trust, unless
     the trust provisions have been
     revised.
5.   Any restrictions on the transferred
     property considered in determining
     the property's FMV.
       Comment: Such restrictions could
     include easements or retained
     life estates.
6.   A statement of relevant facts
     affecting the gift tax treatment
     of the transfer that reasonably
     may be expected to apprise the
     IRS of any potential controversy
     concerning the gift tax treatment
     of the transfer or, instead, a
     concise description of the legal
     issue presented by the  facts. In
     addition, a statement describing
     any position taken contrary to any
     temporary or final Treasury
     regulations or revenue rulings.

Non-Chapter 14 Disclosure Requirements

Under the proposed regulations, disclosure of non-Chapter 14 transfers is adequate if the gift is reported in a manner adequate to apprise the Service of the nature of the gift and the basis for the value reported. A transfer reported as a gift on a gift tax return will be adequately disclosed only if the return provides a complete and accurate description of the transaction, including the details specified in Table 1 (which also shows the disclosure requirements for Chapter 14 transfers).

Disclosure for Nongift Transfers/Transactions

Prop. Regs. Sec. 301.6501(c)-1(f)(3) reads as follows:

Adequate disclosure of non-girl completed transfers or transactions. Completed transfers, all or a portion of which are reported as not constituting a transfer by gift (for example, a transaction in the ordinary course of business), will be considered adequately disclosed ... only if the following information is provided on or attached to the return--

(i) The information required for adequate disclosure [as discussed above and in Table 1]; and

(ii) An explanation as to why the transfer is not a transfer by gift ...

Comments: It is doubtful whether the IRS intends all transactions in the ordinary course of business to follow these disclosure requirements. Perhaps the proposed regulation is addressing transactions that involve part sales and part gifts, such as sales for less than full and adequate consideration. When a pure sales transaction would not normally be reported in a gift tax return (because there is no gift element), disclosure may now be advisable if SOL protection is desired. The scope of this particular proposal seems unreasonably broad.

Adequate Disclosure of Incomplete Transfers

Prop. Regs. Sec. 301.6501(c)-1 (f)(4) reads, in part, as follows:

Adequate disclosure of incomplete transits. Adequate disclosure of a transfer that is reported as a completed gift on the gift tax return will commence the running of the statute of limitations for assessment of gift tax on the transfer, even if the transfer is ultimately determined to be an incomplete gift for purposes of Regs. Sec. 25.2511-2 ... For example, if an incomplete gift is reported as a completed gift on the gift tax return and is adequately disclosed, the period for assessment of the gift tax will begin running when the return is filed, as determined under section 6501(b).

Regs. Sec. 25.2511-2, which addresses "Cessation of donor's dominion and control" contains the following:

A gift is incomplete in every instance in which a donor reserves the power to revest the beneficial title to the property in himself. A gift is also incomplete if and to the extent that a reserved power gives the donor the power to name new beneficiaries or to change the interests of the beneficiaries as between themselves unless the power is a fiduciary power limited by a fixed or ascertainable standard ... (Regs. Sec. 25.2511-2(c)).

A gift is not considered incomplete, however, merely because the donor reserves the power to change the manner or time of enjoyment ... (Regs. Sec. 25.2511-2(d)).

A donor is considered as himself having a power if it is exercisable by him in conjunction with any person not having a substantial adverse interest in the disposition of the transferred property or the income therefrom. A trustee, as such, is not a person having a substantial adverse interest in the disposition of the transferred property or income (Regs. Sec. 25.2511-2(e)).

The proposed regulations' preamble states that the new SOL and disclosure rules "only limits the IRS's ability to make adjustments related to the value of a gift. Thus, the IRS is not precluded from making adjustments that are not related to value, such as the erroneous inclusion or exclusion of property for gift tax purposes."

Queries: How would a taxpayer benefit from the SOL if the transaction reported on the gift tax return is ultimately found to be an incomplete gift includible in the taxpayer's gross estate? If a donor makes an incomplete transfer that he reports as complete and also makes the required disclosures, can the Service revalue the incomplete transfer on his estate tax return? In this event, do the proposed regulations suggest that the new SOL rules foreclose an examination of value in determining the donor's gross estate? The proposed regulations do not provide answers to these questions.

Prop. Regs. Sec. 301.6501(c)-1(f)(4) continues:

On the other hand, if the transfer is reported as an incomplete gift and adequately disclosed, the period for assessing a gift tax with respect to the transfer will not commence to run even if the transfer is ultimately determined to be a completed gift. In that situation, the gift tax with respect to the transfer may be assessed at any time, up until three years after the donor files a return reporting the transfer as a completed gift.

Observations: Generally, an incomplete transfer is not reported on a gift tax return. It is not clear why incomplete transfers would even be considered in the proposed regulations (which are intended to provide finality on valuation issues for completed transfers). Hopefully, the IRS will clarify the proposed regulations to offer taxpayers some assurance that they have complied with the disclosures required for the SOL to commence.

FROM BRUCE A.VANDERMEULEN, J.D., MST, GRAND RAPIDS, MI3