SOL for assessing gift tax extended.

In light of Kirkman O'Neal II, 102 TC No. 28 (1994), practitioners who advise clients on gifting programs of highly appreciated property (e.g., stock of a closely held family business) that also involve the valuation of such property must go one step further in advising both the donor and the donee of the time period in which the IRS has to issue a deficiency notice for a gift tax or generation-skipping transfer tax.

Sec. 6501(a), which applies only to the donor, sets a three-year limitation period from the time the return is filed for the Service to assess additional tax. Secs. 6324(b) and 6901(c) make the donee personally liable, up to the amount of the gift, for any additional tax assessed and add a one-year limitation period from the expiration of the donor's three-year period of limitation within which the IRS may assess additional tax to the donee.

In O'Neal, the key issue centered on when the Sec. 6901(c) one-year limitation period was in force. In 1987, Mr. and Mrs. O'Neal gave large amounts of highly appreciated stock in the family-owned business to their children and grandchildren. The O'Neals filed timely gift tax returns, paying all tax due. The valuation of the stock was based on a buy/sell agreement that contained a right of first refusal clause; the stock was valued at a price determined by this clause. Mr. O'Neal died shortly after the returns were filed. The Service audited both the Federal estate tax return and the gift tax return. The IRS did not assert any deficiency against the donor's gift tax return prior to the running of the statute of limitations (SOL) (although the opportunity to do so was there). However, just before the SOL would have run under Sec. 6901(c), the Service assessed a deficiency against the donee. The donee contended that the Service must first assert a deficiency against the donor before it can extend the liability to the transferee/donee.

Sec. 6324(b) reads, "If the tax is not paid when due, the donee of any gift shall be personally liable for such tax to the extent of the value of such gift." The Tax Court looked at this language and decided that there is no requirement that the IRS first assess the donor before personal liability runs to the transferee/donee. Therefore, because the donees were personally liable for the tax and they received notice of the deficiency within the one-year SOL under Sec. 6901(c), the notices issued by the IRS were valid.

The donees also contended that because the limitations period had run against the donors and the donors had paid the tax due, pursuant to Sec. 2504(c) the gifts could not be revalued. The court quickly dispatched with this issue. Prior to 1954, there was a lot of uncertainty concerning the valuation of gifts; the Service could revalue gifts from preceding years and assess the resulting tax due on the current year gift tax return. Sec. 2504(c) was enacted to remove this uncertainty. Two requirements must now be met for the value of a preceding year's gift to be accepted by the IRS on the current year's return. First, the statutory period for assessment of the gift tax on the prior gift must have expired. Second, the gift tax must have been assessed or paid for the prior gift. The court stated that Sec. 2504(c) applies only to prevent revaluation of a gift made in a prior closed year for purposes of calculating the tax in the current year. Since the statutory period for assessing the tax was still open, Sec. 2504(c) did not apply.

For practitioners, the outcome of this case essentially gives the Service an extra year in which to assess a deficiency against a taxpayer. It is unlikely the IRS will be concerned with who the assessment is against, as long as the tax can be collected. If not made aware of this possibility, a donee could be quite surprised on receipt of a deficiency notice. It may also put the donee in an unexpected position of owing extra tax without having the cash to pay it. This might force the donee to sell all or part of the gifted property, which could be particularly disastrous if the property is closely held stock.

From Scott P. Murphy, CPA, Cohen & Company, Akron, Ohio