On June 10, 2020, in Nelson v. Commissioner, T.C. Memo 2020-81, the Tax Court ruled in favor of the IRS and against a taxpayer who attempted to use a defined value provision to value a transfer of assets.
The taxpayer’s primary business was in heavy equipment relating to the oil and gas industry. The taxpayer created a new holding company for the business equity, and transferred interests in the holding company to a trust in a gift and sale transaction. The taxpayer used a defined value provision in valuing the gift and sale, but the defined value provision referred to an amount determined by an appraiser within 90 days or 180 days of the transfer.
The Tax Court, distinguishing the instant case from Wandry v. Commissioner, T.C. Memo 2012-88, 2012 WL 998483, determined that the value of the gift and sale would be determined by a condition subsequent (ie, the valuation by a qualified appraiser). If the taxpayer had instead included the language “as finally determined for gift tax purposes” to define the amount transferred, and removed the specific dollar amount, the outcome likely would have been different.
The Tax Court has traditionally struck down defined value provisions that are based on a condition subsequent (ie, undue a portion of the gift based on a subsequent revaluation (see Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944)), but permitted such clauses that resulted in an adjustment to the percentage of interest that is transferred based on a later revaluation (see Wandry). While the result in the Nelson case was a blow to the taxpayer, the court indirectly ratified the defined value provision that had been approved in Wandry. In addition, the court permitted multiple, layered discounts for gift tax purposes which totaled approximately sixty (60%) percent.
The case is a lesson in using defined value provisions that have been approved in prior cases.