In the March 22, 2013, Wall Street Journal, an article captioned "Gift Taxes: What Your CPA Doesn’t Know," described the necessity of filing a gift tax return for taxpayers who made gifts in 2012. 2012 gift tax returns apply to gifts exceeding $13,000. Many taxpayers transferred assets worth much more than $13,000 to take advantage of a $5 million exemption amount. The Wall Street Journal Article explains why it is important to have a qualified CPA prepare the return. What the Article did not discuss, was the importance of satisfying "adequate disclosure," if the gift included non-marketable assets, such as closely held stock or real estate. Absent adequate disclosure, the gift tax return does not start the three year statute of limitations.
As background, if the gift tax return is not filed or if the gift is not properly reported, the IRS can adjust the gift value, even upon the taxpayer’s death on the estate tax return. On the other hand, if the gift tax return is filed properly, then the statute of limitations starts to run. The IRS would only have three years from the later of the gift tax return filing date or return due date to question the value. If the IRS does not audit the return within this three year period, then the gift value cannot subsequently be challenged.
The statute of limitations commences only if the gift tax return is filed reporting the gift, and the gift is reported with adequate disclosure. The heart of the issue is what constitutes adequate disclosure? The applicable Internal Revenue Code section is 6501(c)(9), and Treasury Regulation section 301.6501(c)-1(f). The law applies to all gift tax returns filed after December 3, 1999. The "adequate disclosure" standard is satisfied if the gift is reported in a manner that adequately apprises the IRS of the gift and how the gift value was determined.
There are two primary methods described in the IRS regulations that taxpayers can utilize to meet this standard. The preferred method, and the method recommended by virtually all advisors, is to obtain a "qualified appraisal." A qualified appraisal would include the following:
1. The appraiser's qualifications to make appraisals of the type of property involved, the date on which the property was appraised, and the purpose of the appraisal. The appraiser must hold himself out to the public or perform appraisals on a regular basis and must not be the donor, the donee, a member of the family of either, or an employee of any of such persons.
2. A description of the property and the date of the gift.
3. A description of the appraisal process employed.
4. A description of the assumptions, conditions, etc. that affect the analyses, opinions, and conclusions.
5. The information considered (and if a business is involved, all financial data used sufficiently detailed so another can replicate the process).
6. The appraisal procedures followed and the reasoning supporting the analyses, opinions, and conclusions.
7. The valuation method used, the rationale for the valuation method, and the procedure for determining the fair market value of the property.
8. The specific basis for the valuation, such as comparable sales, asset-based approaches, and merger-acquisition transactions, etc.
The second method does not involve a qualified appraisal. Often taxpayers balk at the cost of an appraisal, particularly for operating businesses or several properties. In lieu of an appraisal, this second method requires a detailed description of the manner used to determine the gifted property’s value. This detailed description method would include:
1. The financial data (for example, balance sheets) used.
2. Any restrictions on stock transfers that were considered, such as would be found in a shareholders agreement.
3. A description of any discounts claimed, such as discounts for lack of a market or control.
4. Assuming there were discounts claimed, a statement regarding the fair market value of 100 percent of the entity.
5. If the entity being valued owns an interest in a nonactively traded entity, all information regarding that other entity must also be provided if that information is relevant and material in determining the value of the interest in that other entity.
Thus, with or without an appraisal, much information is necessary. With the 2012 gift tax return due April 15th, or with extension October 15th, time is running out to prepare the gift tax return and, if necessary, to satisfy the adequate disclosure requirement.