Transfer tax valuation finality and prop. regs. on the "adequate disclosure" of gifts.

Certain legislative changes included in the Taxpayer Relief Act of 1997 (TRA '97) and in the Internal Revenue Service Restructuring and Reform Act of 1998 (IRSRRA '98) purported to offer greater certainty in the area of gift tax valuation. Secs. 2504(c) and 2001(f) provide that the IRS is prohibited from revaluing gifts made in prior years in calculating subsequent gift or estate tax liability. The intent of these provisions is to lend a certain finality to the values assigned to gifts made years ago.

Despite these ostensibly favorable changes to the transfer tax law, recently issued proposed regulations would make achieving this "finality" somewhat difficult. Secs. 2504(c) and 2001(f) require that, for the Service to be barred from revaluing a gift, the applicable statute of limitations (SOL) on assessment has to have expired for such gift. Sec. 6501(c)(9) (also amended by the TRA '97), in turn, provides that for the girl tax SOL to begin running on a gift, the value of such gift has to have been "adequately disclosed" to the IRS.

What constitutes adequate disclosure for Secs. 6501(c)(9), 2504(c) and 2001(f) purposes? Recently issued proposed regulations interpreting these sections contain requirements that appear to make adequate disclosure somewhat difficult. Consequently, if the proposed rules become final (without certain significant revisions), triggering the running of the gift tax SOL, achieving transfer tax valuation finality and filing a gift tax return may all become more difficult.

Sec. 6501(c)(9)

Prior to the TRA '97 and the IRSRRA '98, Sec. 6501 provided that the period of assessment of gift tax for a calendar period generally expired three years from the date a gift tax return for that period was deemed to have been filed. This SOL applied to all gifts made in a calendar period for which a return was filed. Thus, even gifts not reported on a gift tax return for that period were covered by the rule.

However, Sec. 6501 was amended in 1990 to provide an exception to the general SOL provision for gifts covered by the special valuation rules of Sees. 2701 and 2702. For these types of gifts, Sec. 6501(c)(9) extended the period of assessment of gift: tax indefinitely. This open-ended SOL prevailed unless such Secs. 2701 and 2702 gifts were disclosed on a gift tax return in a way that was "adequate to apprise" the IRS of the nature of the transfer at issue.

This requirement, known as the "adequate disclosure" rule, was recently expanded to cover all gifts (i.e., Sec. 6501(c) (9) was amended by the TRA '97 to allow assessment of gift tax at any time with respect to any gift that has not been "adequately disclosed").

Secs. 2504(c) and 2001(f): The Importance of Adequate Disclosure

This SOL issue is what makes "adequate disclosure" critical. The failure of the SOL to begin running (and to expire) will preclude a certain gift tax valuation finality otherwise available to taxpayers. Indeed, the ramifications of the failure to trigger the gift tax SOL are even more severe after changes to Secs. 2504 and 2001 made by the TRA '97 and the IRSRRA '98.

Former Sec. 2504(c) provided that, if gift tax had been paid or assessed for the calendar period in which a gift occurred and the SOL on assessment had expired, the value of any gift made in such calendar period could not later be adjusted in determining the total amount of prior taxable gifts that the individual had made. This prohibition on adjustments applied even if a particular gift was not disclosed on the gift tax return. However, this revaluation ban apparently applied only if gift tax was actually paid or assessed for the period in question. Thus, at least according to the Service (and some courts), even gifts ostensibly sheltered by the Sec. 2503(b) annual exclusion or the Sec. 2505 unified credit were forever subject to subsequent valuation readjustment. Moreover, the IRS's position was that there was no estate tax complement to Sec. 2504(c). Despite the gift tax rule of Sec. 2504(c), the Service repeatedly asserted that it did not extend to the estate tax arena, and that it was never barred from revaluing prior gifts in computing adjusted taxable gifts for estate tax purposes.

The Service's interpretations of Sec. 2504(c) were overturned legislatively by the TRA '97 and the IRSRRA '98, which enacted significant changes to that provision and also added and amended Sec. 2001(f). Under current Sec. 2504(c), if the SOL has expired under Sec. 6501 (c)(9) for assessing gift tax for a preceding calendar period, the value of a gift made in such prior calendar period cannot be adjusted (regardless of whether gift tax has been assessed or paid for such calendar period). In addition, Sec. 2001(f) currently provides that, if the gift tax SOL has expired on such a gift, the value of that gift as finally determined for gift tax purposes is also the value to be used for estate tax calculation purposes.

Adequate Disclosure and the Prop. Regs.

Transfer tax valuation finality can now be obtained for estate tax purposes (under Sec. 2001(f)) and for gift tax purposes (under Sec. 2504(c)), even if the applicable credit amount or the annual exclusion is applied to the earlier gift. This result is available for gifts made after Aug. 5, 1997. However, this result is only available if the SOL on the prior gift has closed. How, then, can a taxpayer be sure that the SOL has indeed expired on a particular gift?

As noted, Sec. 6501(c) (9) requires "adequate disclosure" before the gift tax SOL can be triggered (or expire) for a specific gift. On Dec. 22, 1998, the IRS issued proposed roles under Secs. 6501, 2504(c) and 2001(f) to clarify the meaning of "adequate disclosure" for most gifts. The proposed rules would apply to gifts made in calendar years ending after Aug. 5, 1997, if the gift tax return for such calendar year is filed after the proposed roles are published as final regulations in the Federal Register. (The new disclosure rules would not apply to gifts governed by Secs. 2701 or 2702, as special regulations already cover such Chapter 14 transactions; see Regs. Sec. 301.6501 (c)-1 (e).)

The preamble to the proposed regulations points out:

[t]he proposed regulations provide a list of information that, if applicable to a transaction, must be reported on a gift tax return, or a statement attached thereto, in order for the transaction to be considered adequately disclosed to cause the period for assessment to commence. The required information must completely and accurately describe the transaction and include: the nature of the transferred property; the parties involved; the value of the transferred property; and how the value was determined, including any discounts or adjustments used in valuing the transferred property. Specific rules are provided in the case of transfers of entities that are not actively traded that own interests in other non-actively traded entities. In addition, the return must disclose the facts affecting the gift tax treatment of the transaction in a manner that reasonably may be expected to apprise the IRS of the nature of any potential controversy regarding the gift tax treatment of the transfer. In lieu of this statement, the taxpayer may provide a statement of any legal issue presented by the facts. Finally, the taxpayer must also provide a statement of any position taken by the taxpayer that is contrary to any temporary or final Treasury regulation or any revenue ruling.

Conclusion

The specifics of these new adequate disclosure rules appear to impose broad and burdensome filing requirements that may make compliance with the new rules somewhat difficult. For example, particularly in the case of relatively complex gift transactions, how exactly would a taxpayer disclose all "relevant facts affecting the gift tax treatment of the transfer that reasonably may be expected to apprise the Internal Revenue Service of the nature of any potential controversy" surrounding the transfer?

Such speculative requirements seem susceptible to subjective interpretation, open to inconsistent enforcement and vulnerable to litigation. For these reasons, the proposed regulations may be altered before being finalized. In fact, the Service has solicited comments and testimony on the impact of these proposed rules, and is asking whether and how they should be changed. In the meantime, taxpayers and their advisers are urged to remember that while these rules are only proposed (and thus are not yet governing law), the statutory adequate disclosure requirement of Sec. 6501(c)(9) is binding and must be satisfied.

FROM DANIEL T. VAIL, J.D., LL.M., WASHINGTON, DC