Inadequate disclosure of gifts of closely held business interests.

Recently published Chief Counsel Advice (CCA) 200221010 illustrates the importance of adequately disclosing gifts, so that the statute of limitations (SOL) begins to run on the gift date. The Taxpayer Relief Act of 1997 overrides the general three-year SOL for gift tax purposes and, under Sec. 6501(c)(9), provides that the SOL does not run unless a taxpayer discloses the gift in a manner that adequately apprises the IRS of the gift's nature and the basis for its reported value.

If the taxpayer does not adequately disclose this information on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, the IRS can make an assessment, even after death. This rule applies to all gifts, but its effect is especially severe for a non-readily marketable asset (such as a closely held business interest); years later, the IRS could increase its value, resulting in an unexpected (and unwelcome) tax bill.

Gathering information to prepare Form 709 (especially if a transfer involves a closely held business) is often difficult and expensive. Among other things, the taxpayer has to obtain an appraisal by a qualified, independent appraiser. When the taxpayer is reluctant to bear this expense and files Form 709 with only minimal information, he or she is not filing an adequate return; as a result, the SOL remains open indefinitely

Facts

In CCA 200221010, a taxpayer gifted an interest in a limited liability company (LLC) to a trust. He described the gift on Form 709 as "[c]lass B units in ABC LLC. Units acquired on 4/6/97 for $200,000 cash." The return reflected the date of the gift and a gift tax value of $200,000. The IRS later determined that the gift's value was actually $14 million, with a potential gift: tax liability in excess of $7 million. The taxpayer maintained that the SOL had expired, which barred assessment of the tax, because the IRS initiated its examination more than three years after he filed Form 709. Prior to assessing the tax, the local IRS office sought guidance from the National Office on the SOL issue.

Analysis

Although the IRS acknowledged that if the taxpayer had adequately disclosed the gift, the SOL would have expired, it continued to maintain that the taxpayer did not properly disclose the gift under Sec. 6501(c)(9), leaving the SOL open. In noting the absence of gift tax cases interpreting the "adequate disclosure" standard, the Service first looked to income tax cases. It found that to avoid an extension of the SOL, a taxpayer has to produce a "clue" as to why he or she omitted income (University Country Club, Inc., 64 TC 460 (1975)). Further, the taxpayer also has to give details sufficient to allow the IRS to make a reasonably informed decision about whether to audit the return.

Next, the IRS followed Regs. Sec. 301.6501 (c)-1(f), which details the minimum information required on Form 709 (or on an attached statement), to meet the gift tax adequate disclosure requirement. In pertinent part, the return must include a description of the property transferred and the method used to value it, including a description of any discount's claimed. The description of the valuation method must be very detailed, and is best satisfied if the return includes a qualified appraisal.

Although Regs. Sec. 301.6501(c)-1(f) broadly lists the type of information required for adequate disclosure, it does not give specific examples or guidance on most transactions, including gifts of LLC interests. Thus, the IRS looked to Regs. Sec. 25.6019-4, analogizing that provision's requirements for disclosing gifts of stock, with gifts of LLC interests. It concluded that the description of a gift of an LLC interest should include the number of LLC units, the class type and the percentage of ownership interest.

The IRS concluded that the taxpayer's gift was not adequately disclosed, and that the SOL remained open, because the taxpayer only indicated the LLC's name, the type of interest (Class B) transferred and the gift's purported value. Although CCA 200221010 does not explicitly address appraisals, the taxpayer evidently did not submit one with his return, merely relying on the price he paid for the LLC units. Thus, the IRS did not have the minimum information required to make a reasonably informed decision about whether to select the return for audit. Moreover, it rejected the taxpayer's argument that the absence of details on the return should have been a "clue" to the IRS to seek the missing information.

Conclusion

CCA 200221010 shows the importance of detailed information and qualified appraisals for reporting a gift of a closely held business interest. In providing insufficient disclosure on a return, a taxpayer is inviting the IRS to scrutinize and audit the return. Although gathering the information needed to meet the Sec. 6501(c)(9) adequate disclosure standard may be burdensome, failure to do so may compound the costs, by leaving the SOL open and the taxpayer facing uncertainty in future gift and estate planning. He or she could face an audit many years after making the gift, when it will be more difficult to gather information needed to support the gift's reported value, and might subject the taxpayer not only to gift tax, but also to interest and possible penalties.

In light of the interplay between the SOL and the adequate disclosure rules, taxpayers should submit a qualified appraisal, even if they believe that the value of the gifted interest is under the annual exclusion amount, to ensure that the SOL expires.

FROM SHARON GOODMAN, J.D., NEW YORK, NY