Family Business Breakthrough: Wandry v. Commissioner a “Landmark Decision” That Allows Tax-Free Ownership Transfers Over Generations —WSJ

Shielding the Family Business

The best part for valuators is that all of this requires a professional appraisal (detail below). The Wall Street Journal Tax Report‘s Laura Sanders reports  that:

Small-business owners often complain of feeling caught in the cross hairs of the tax code. For a change, here’s good news.

The Tax Court has just blessed a new technique that owners of closely held businesses—and wealthy families—can use to pass assets to heirs with a minimum of taxes and complications. The ruling in the case, Wandry v. Commissioner,[T.C. Memo. 2012-88 (Mar. 26, 2012)], is stirring up excitement among experts.

David Kautter, a director of American University’s Kogod Tax Center, calls the ruling a “landmark decision, because it allows tax-free ownership transfers from one generation to another with certainty and in an orderly manner.”

$5.12M Lifetime Exemption Given Away in $13,000 Per Year Increments

Here is why Wandry matters. Our current system imposes a gift tax of up to 35% when taxpayers give assets away, with exceptions. Individuals now get one $5.12 million lifetime exemption, and they can also give up to $13,000 of assets a year to an unlimited number of recipients. (Next year the lifetime break is scheduled to drop to $1 million and the top rate to rise to 55%.) This means an owner who wants to give a business to children or others, such as employees, can use these exemptions to transfer ownership tax-free. He can even use the $13,000 annual exclusion to transfer value bit by bit.

That is what happened in the Wandry case. Dean and Joanne Wandry, a Colorado couple, each gave units in a family-owned limited-liability company worth $1,099,000 to their heirs in 2004. To avoid paying tax, they specified the gifts should equal the dollar amount of their exemptions — a key point. (At the time, the lifetime exemption was $1 million and the annual exclusion $11,000.)

The hitch in Wandry and other cases is that the givers have to get a professional appraisal if — as is common — the company is hard to value. Often values are lowballed a bit in order to maximize the gift. But the IRS can contest the appraisal after the gift — and often does. In Wandry, the value rose about 20%.

That brings up an important issue: If values rise after an IRS challenge, must the giver write a big check for tax on the amounts above the exemption? According to the Wandry decision, no. The judge held the couple intended to make a gift equal to their exemptions, so the excess was never actually given by them. No tax was due. …

The Wandry case is a boon not only for business owners but also wealthy families with “family limited partnerships” or entities holding publicly traded stocks. Even though the stocks’ value is easy to determine, submerging them in a nontraded company provides valuable discounts when units are transferred to heirs.

. . . The decision is so advantageous for taxpayers that it could inspire a response from Congress or the IRS.

Generational Transfers—Tax Free!

TaxProf Blog notes this as related to last month’s Gerzog decision on Defined Value Clauses and Fair Market Value:

Wendy C. Gerzog (Baltimore), Defined Value Clauses and Fair Market Value, 134 Tax Notes 1685 (Mar. 26, 2012):

In [Hendrix v. Commissioner, T.C. Memo. 2011-133], the Tax Court considered the issues of whether defined value clauses were the result of arm’s-length transactions and whether they were void as against public policy. The underlying dispute was whether the taxpayers’ transfers of the John H. Hendrix Co. stock were valued at fair market value. With a decision favoring the taxpayers, the defined value clauses in both [Succession of McCord v. Commissioner, 461 F.3d 614 (5th Cir. 2006)] and Hendrix impede the accurate valuation of taxable gifts to family members and of deductible charitable gifts.

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In Wandry v. Commissioner, T.C. Memo. 2012-88 (Mar. 26, 2012), Judge Haines upheld a defined value clause.