Restoration of unified tax credit previously used.

The IRS recently issued Letter Ruling 9718004, addressing the revaluation of prior-year gifts when preparing a current-year gift tax return. If a taxpayer has used his unified credit only in a prior-year property transfer, he may have an opportunity to revalue those gifts and increase the amount of the unified credit available.

Estate and gift taxes are computed under a unified transfer tax system. Gifts made in the current year are added to taxable gifts from previous years in determining the current year's gift tax rate. Upon a decedent's death, lifetime gifts are added to the taxable estate to determine the rate of tax for an estate. Any gift taxes previously paid, or unified credit previously used, are factored into the tax computation, assuring that previous gifts and transfers are not taxed twice.

In the letter ruling, T transferred undivided interests in real estate to family members in 1982 and 1989; these gifts were reported on timely filed gift tax returns. The gifts did not result in any gift tax payable, but used a portion of T's unified tax credit. In 1991, T transferred an undivided interest in other real property, resulting in gift taxes of $167,011. This liability was paid with the filing of the gift tax return. In valuing these gifts, T did not claim any discount for the fractional interest transferred, but valued the gifts at the proportionate share value of the entire property. T passed away in 1994.

On April 13, 1995, T's executor filed a claim for refund relating to the over-valuation of the 1991 gifts. This refund was based on the claim of a fractional interest discount in valuing the real property transferred in 1991. In a meeting with the Service in October 1995, the executor contended that this discount should also apply in valuing the 1982 and 1989 transfers, i.e., that in computing the gift tax liability for 1991, the value of the taxable gifts for 1982 and 1989 should be decreased. This adjustment would result in additional unified tax credit being available in 1991, reducing the 1991 gift tax liability and the overall estate tax liability.

The IRS allowed the refund on the original 1991 tax return, but disallowed the verbal request for revaluing the 1982 and 1989 gifts on the 1991 gift tax return. The Service concurred that the use of the unified credit did not result in the payment or assessment of gift taxes in 1982 and 1989; therefore, the statute of limitations (SOL) had not begun to run (Rev. Rul. 84-11). Also, Sec. 2504(c) does not preclude adjusting the value of 1982 and 1989 gifts to reflect fractional interest discounts in determining the aggregate taxable gifts for the preceding calendar year period. However, because the executor did not raise the revaluation of the 1982 and 1989 transfers until October 1995 (after the expiration of the SOL), the additional refund claim was disallowed. Thus, the IRS conceptually concluded in favor of the taxpayer, but there was no additional refund for the 1991 gift tax paid due to the expiration of the SOL.

Even though the executor was not successful in obtaining an additional refund for the 1991 gift taxes paid, an opportunity may exist to reduce estate taxes due when filing the estate tax return. For estate tax purposes, the Service can revalue a decedent's transfers reported on a gift tax return when computing adjusted taxable gifts, even though the SOL may have expired for revaluing gifts for gift tax purposes. If the IRS increases the value of prior gifts, it must also include a corresponding credit for any additional gift tax due when the gift tax return was filed; this results in the estate paying the incremental increase in the estate tax rates. Conversely, the executor should be allowed a downward adjustment in the value of a gift, even if some or all of the tax on the transfer was previously paid. While there is no statutory authority for this conclusion, similar logic supports the decedent's estate taxes being reduced.

The conclusion reached in Letter Ruling 9718004 provides a unique tax planning opportunity to minimize estate any gift taxes. Taxpayers can revalue any gifts within the three-year SOL period if gift takes have been paid. If prior-year gifts do not result in any gift tax liability but use only the unified credit, the SOL has not begun. These transfers are subject to revaluation indefinitely. Finally, even if the SOL has expired, adjustments may be available on filing the estate tax return.

The Tax Reform Act of 1997 (TRA '97) revised Secs. 2001(f) and 2504(c) for gifts made after Aug. 5, 1997. Under the new law, when computing the estate tax, the value of prior gifts made is the value of the gift as determined for gift tax purposes if the SOL has closed on the gift tax return. TRA '97 also amended Sec. 6101(c)(9), for gifts made in year ending after Aug. 5, 1997, to provide that if a gift is adequately disclosed in a gift tax return (including attachments), the value of the gift may not be redetermined after the three-year SOL period. If the gift is not adequately disclosed, the SOL does not begin to run, and the gift may be revalued by the IRS at any time. These changes should ease the recordkeeping burden associated with gifts made if the disclosure of the gifts is adequate; no longer will gift records need to be kept indefinitely.

The changes in TRA '97 confirm the notion that estate tax returns that include gifts made prior to Aug. 5, 1997 should be evaluated to determine whether the value of the gifts made in the prior years should be revalued.