Making transfers of interests in family limited
partnerships or shares of a family corporation are key elements in
protecting your family assets from future lawsuits. Gifts to a
charitable trust, family foundation or an irrevocable trust or even
outright gifts of property to various family members are also widely
used methods of asset protection and estate preservation for family
property.
All of these inter-family and charitable transfers have
one critical problem that is seldom discussed in articles or books on
asset protection.
There are transfer tax valuation implications.
The gifted property needs to be properly valued to avoid
future tax penalties. The estate and gift taxes are generally based on
the value of the property at the date of the transfer. With cash or
publicly traded stock or bonds, valuation is not much of a problem. With
every other asset it can become a huge problem in the future.
Contributions of property to a charity require a
"qualified appraisal" by a "qualified appraiser" as defined in tax code
section 170. Gifts of property to family members are to be valued at the
"fair market value", which is the theoretical amount at which the
property would change hands between a willing seller and a willing
buyer, where both parties have reasonable knowledge of the relevant
facts. Applying this theory to the valuation of real estate or a family
owned business is more of an art than a science.
Penalties for undervaluing any part of an estate can be
severe, but won't usually be incurred until the estate tax return is
audited by the IRS. The most significant penalty provisions are spelled
out in tax code sections 6662 through 6664, dealing with penalties
relating to accuracy or to fraud. These sections impose a 20% penalty on
any understatements of value if the value of the property claimed on
any return is 50% or less of the "correct" value (as determined by the
IRS). Where the reported value is 25% or less of the "correct" value,
the penalty is increased to 40% of the difference in the tax.
How can you avoid the penalty? The key is to show that
you relied in good faith on a well qualified expert - an appraiser. The
better qualified the expert, the less the chance of a penalty. Be sure
the appraiser is also well informed on any related tax laws.
A Tip On Choosing
An Appraiser
When you are making a transfer of property that can't be
valued by reference to an auction market, the most critical element is
the valuation appraisal. A well qualified appraisal will protect you
from substantial penalties down the road and will make it hard for the
IRS to successfully dispute the value placed on your property. On behalf
of a client, I recently spent quite a bit of time helping the client to
select an appraiser. About two months before that, I wrote an article
for a technical journal about business valuation software. As a result
of the research I did on the subject of valuations, I concluded that
the reputation of the appraiser is far more important than the
software.
With the software I still have, I could compute the value
of a business at least 20 different ways. But I won't and if I would, it
would be a mistake for anyone to hire me for that purpose. Why? Because
I have no experience or relevant credentials. Being a CPA doesn't mean
that I'm fully qualified to put a value on a business. The reason I'm
not fully qualified is because I don't choose to specialize in this
field. Anyone who doesn't devote at least 60% of their work time to
valuation issues isn't a genuine specialist - in my opinion. And anyone
who hasn't been doing business valuations almost full time for at least
three years isn't going to be presumed to be an expert.
The "secret" in getting an appraisal is to get someone
with a reputation that will make it impossible for the IRS to convince a
judge that your appraiser wasn't qualified and didn't know what he or
she was doing. You want your appraiser to be so well qualified that it
will make their appraiser look like an amateur by comparison.
How did I make the choice for my client? I called about a
dozen estate planning lawyers in the area and asked for recommendations.
Then I called the five who were mentioned the most and asked for a
professional bio and a sample appraisal report. Then we interviewed
three of the five. Then I suggested the client hire the one with the
largest firm that did the most appraisals. And, the appraiser we
selected wasn't any more expensive than the others.
How much did it cost? The fee was about $7,000 to prepare
a valuation analysis for a business (in 1998) with about ten employees
and with annual sales of about $3 million. Based on the valuation
provided by the appraiser, the taxpayer was able to immediately remove
more than $1.2 million in assets from his estate and to be able to
remove an additional $80,000 per year, thereafter. The estimated estate
tax savings will be far in excess of the appraisal fee - and I believe
that an appraisal by an experienced specialist with a good reputation is
a bargain when you are planning to make transfers of assets for asset
protection and/or estate planning.
By the way. The Taxpayer's Relief Act of 1997 included a
provision that will take much of the uncertainty out of the question of
how the IRS will value prior gifts when they do an estate tax audit.
Previously, it was their practice to not value a gift until they looked
at the estate tax return. Even though the three year statute of
limitations had run on a gift tax return, the IRS contended that they
could still value the gifted property as part of the estate tax audit.
The 1997 law put an end to this little bit of duplicity on the part of
the IRS. Now, they only get "on bite at the valuation apple". If they
don't audit the gift tax return within the three year statute of
limitations, they can't come back years (or decades) later and argue
about that value when they examine the estate tax return.
Further details about valuations of assets to protect your
assets from future lawsuits are available in our subscriber's web site.
