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George F. Bearup, J.D. Senior Legal Trust Advisor

4-Mar-20

Date of Gift Valuation

Take-Away: For transfer tax purposes, the value of the transferred asset is normally determined on the date of the gift or transfer. However, that ‘date of transfer’ is not a fixed rule. Sometimes post-transfer events can affect the value of the transferred asset for transfer tax reporting purposes.

Background: To determine the value of a transferred asset (lifetime gift or at death) the Tax Code applies what it is called the willing buyer, willing seller standard to determine the fair market value an asset. This standard is explained in great detail in the Regulations. [Treas. Regulation 25.2512-1.] However, there is more to this valuation methodology than applying the simple willing buyer, willing seller standard.

  • Presumed to Know All Facts: A willing buyer and seller are presumed to have reasonable knowledge of relevant facts affecting the value of the property at issue, even if the facts are unknown to the actual owner of the property.
  • Presumed to Make Reasonable Investigation: Both the seller and the buyer are presumed to have made a reasonable investigation of the relevant facts. In addition to facts that are publically available, reasonable knowledge includes those facts that a reasonable buyer or seller would uncover during the course of negotiations over the purchase prices of the property. Restated, a hypothetical willing buyer is presumed to be (i) ‘reasonably informed’ and (ii) prudent to have asked the hypothetical willing seller for information that is not publically available. This is akin to conducting ‘due diligence’ prior to making a purchase decision.
  • Publically Traded Stock: Publically traded stock is generally valued based on the average of the highest and lowest selling price on the day of the transfer. However, if the publically traded stock prices do not represent the fair market value, then a modification and adjustment to the stock’s value is required. [Treas. Regulation 25.2512-2(e).]

Post-Transfer Events: Occasions exist when the IRS will look at post-transfer events to determine the date-of-transfer value of an asset. An example of this application of using hindsight is a recent IRS Chief Counsel Advice memorandum.

Chief Counsel Advice (CCA) 201939002 (September 27, 2019)

Facts: The taxpayer was a co-founder and Chairman of the Board of a publically traded corporation. He transferred stock in that corporation to a newly formed grantor retained annuity trust (GRAT) in an effort to shift post-transfer growth in the value of the stock to his heirs (the remainder beneficiaries of the GRAT), gift tax-free. After the stock was transferred to the GRAT, the corporation formally announced a merger with another corporation. Before the stock was transferred to the GRAT, the corporation had gone through negotiations with multiple parties, and by the time of the transfer of the Chairman’s stock to the GRAT, the corporation had engaged in exclusive negotiations with the corporation that was the subject of a subsequent merger announcement. However, the merger had not been agreed to at the time the stock was transferred to the GRAT. The IRS’s Chief Counsel determined that the pending corporate merger should have been considered in arriving at the value of the stock that was transferred by the Chairman to the GRAT.

The ‘Challenges’ of Hindsight: Various times and rules of time are used by taxpayers, as well as the IRS, when it comes to determining how to apply post-transfer events to the value of a transferred asset.

One obvious factor is the time between the two events, i.e. the passage of time between the transfer of property and the post-transfer event that possibly affects its earlier value. The longer the time that passes the less that the event was foreseeable and not considered in the determination of value.

Yet another factor the IRS looks at is whether the subsequent event was subject to a binding contractual commitment, i.e. if the event was contractually enforceable, and thus bound to occur, its impact on the asset’s value must be considered.

These elusive factors result in a facts and circumstances test, which is hard to apply with any certainty by any appraiser, especially when reporting the value of an asset that is transferred as a lifetime gift.

Examples: A couple of Tax Court examples follow:

‘Plans’ Count: Taxpayers gifted shares of preferred stock in their corporation while the corporation was in the process of a reorganization with the intent to subsequently go public. The Tax Court rejected the taxpayer’s valuation expert opinion of value of the preferred shares of stock because the expert had failed to take into account the circumstances of the planned future public offering.  In short, an indefinite plan was supposed to have been taken into consideration in determining the value of the gifted stock. Silverman v. Commissioner, T.C. Memo, 1974-285, aff’d 538 F.2d 927 (2d Cir 1976);

“Practically Certain to Go Through:” Transfers of stock occurred after an investment firm had located a purchaser for the corporation. A tentative merger agreement had been entered into and a tender offer for the outstanding issued stock was under way at the time of the stock transfer. The Tax Court concluded that the stock was transferred after the shares had ‘ripened’ from an interest in a viable corporation into a fixed right to receive cash. The Court observed that the merger was ‘practically certain to go through.’ Consequently, the Tax Court applied the assignment of taxable income doctrine in order to impose an income tax on transferor on the gain from the tender offer of the stock. Ferguson v. Commissioner, 174 F.3d 997 (9th 1999) aff’g 108 Tax Court 244 (1997)

Conclusion: While a subsequent event should be considered when an asset is gifted, that does not automatically mean that a future purchase price for the asset should be fully substituted for other reliable measures of the asset’s value on the date of the gift. However, the donor’s obligation to be reasonably informed ought not to cause the donor to be charged with clairvoyance. The ultimate challenge is what weight has to be given to the future events when the IRS’ facts and circumstances test is applied, especially when there is no guidance from the IRS on what, or how long after, events needs to be weighed. In the end, the donor and his or her valuation expert is left to guess as to what events are predictable and which are not, standing in the shoes of the donor.