What are the potential tax implications if the IRS challenges the reported value of a 50% share transferred to a beneficiary for gift tax purposes?
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If the IRS challenges the reported value of a 50% share transferred to a beneficiary for gift tax purposes, several important tax implications may arise, particularly regarding the proper valuation of the transferred interest and the potential for additional gift tax liability. The following analysis is based on the relevant statutes, regulations, and IRS rulings:
1. Gift Tax Is Imposed on the Value of the Property Transferred
Under Internal Revenue Code (IRC) § 2501(a)(1), a tax is imposed on the transfer of property by gift during each calendar year by an individual, whether the transfer is direct or indirect, in trust or otherwise, and whether the property is real or personal, tangible or intangible.
2. Valuation of the Gift
IRC § 2512(a) provides that if a gift is made in property, the value thereof at the date of the gift is considered the amount of the gift. Treasury Regulation § 25.2512-1 states that the value of the property is the price at which it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of the relevant facts. The value is not the price that a forced sale would produce.
Restrictions and Agreements
If the value reported is based on a restriction (such as a buy-sell agreement or stipulated price), the IRS will scrutinize whether that restriction should be respected for gift tax purposes. Under IRC § 2703(a), the value of property is determined without regard to any option, agreement, or other right to acquire or use the property at a price less than its fair market value, or any restriction on the right to sell or use the property, unless certain requirements are met (see below).
3. IRS Challenge: Disregarding Stipulated or Restricted Value
If the IRS determines that the value reported for the 50% share is artificially low due to a restriction or agreement (such as a buy-sell agreement), the IRS may disregard that value for gift tax purposes unless the agreement:
- Is a bona fide business arrangement,
- Is not a device to transfer property to family members for less than full and adequate consideration, and
- Has terms comparable to similar arrangements entered into by persons in an arm’s length transaction.
If these requirements are not met, the IRS will value the transferred interest at its fair market value, ignoring the restricted or stipulated price.
Example from IRS Guidance
In TAM 9315005, the IRS disregarded the stipulated price in a stock purchase agreement for gift tax purposes because the donor had control over the setting of the price and the agreement was not a bona fide business arrangement. The IRS valued the transferred shares at their fair market value, not the restricted price, resulting in a higher gift tax liability.
4. Indirect Gifts
If a transfer is made for less than full and adequate consideration, or if a party fails to enforce a contractual right (such as the right to require a redemption at fair market value), the IRS may treat the transaction as an indirect gift. The value of the gift is the difference between the fair market value and the amount actually paid or received.
5. Potential Tax Consequences
If the IRS successfully challenges the reported value:
- Increased Gift Tax Liability: The donor may owe additional gift tax based on the higher fair market value of the transferred interest.
- Interest and Penalties: The donor may be subject to interest and possibly penalties for underpayment of gift tax.
- Reporting Requirements: The donor may be required to file an amended gift tax return reflecting the correct value.
6. Burden of Proof
The taxpayer bears the burden of proving that the value reported is correct and that any restrictions or agreements affecting value meet the requirements of IRC § 2703(b).
7. Summary of Key Points
- The IRS will disregard a restricted or stipulated value for gift tax purposes unless the restriction meets the requirements of IRC § 2703(b).
- The value for gift tax purposes is the fair market value of the property transferred, determined as if no restriction existed, unless the restriction is a bona fide business arrangement, not a device to transfer property to family members for less than full and adequate consideration, and is comparable to arm’s length arrangements.
- If the IRS challenges the value and prevails, the donor may owe additional gift tax, interest, and penalties, and may be required to amend the gift tax return.
8.Conclusion
If the IRS challenges the reported value of a 50% share transferred to a beneficiary and finds that the value is understated due to a restriction or agreement that does not meet the requirements of IRC § 2703(b), the IRS will value the gift at its fair market value, potentially resulting in additional gift tax liability, interest, and penalties for the donor.
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