Case Citation

Joanne M. Wandry, Donor v. Commissioner, T.C. Memo 2012-88

Summary of Key Issues

  1. The Court upheld a defined value formula clause utilized by a family to accomplish a gifting program involving Member Interests in a Family Limited Partnership (“FLP”).
  2. The formula clause held to be valid did not involve a charitable entity, which under prior formula clause cases operated to re-allocate any excess gift over the specified formula amount to charity, making it eligible for a gift tax charitable deduction.
  3. The Court reiterated a four-part test to determine if defined value clauses in a gifting program were valid.


In 1998, Albert and Joanne Wandry formed the Wandry Family Limited Partnership, a Colorado limited liability limited partnership (“Wandry LP”), comprised of cash and marketable securities. Their tax attorney advised them that they could institute a tax-free gifting plan by giving Wandry LP interests using their annual gift tax exclusions (then $11,000) per donee, and additional gifts in excess of their annual exclusion of up to $1 million (at that time) for each donor. The gifting program commenced on January 1, 2000. The tax attorney informed the Wandrys that:

  1. The number of partnership units equal to the desired value of their gifts could not be known until later when a valuation was made of Wandry LP.
  2. He further advised them to make gifts of a specific dollar amount, rather than a set number of Wandry LP units.
  3. All gifts should be transferred on December 31 or January 1 of a given year so that a mid-year closing of the books would not be required.

In 2001, the Wandrys started a family business with their children and formed a Colorado limited liability company, Norseman Capital, LLC (Norseman). By 2002, all of Wandry LP’s assets had been transferred to Norseman. The Wandrys continued their gifting program with Norseman just as they had with Wandry LP. They also followed the three key guidelines specified by their tax attorney.

The Adjustment Clause

On January 1, 2004, the Wandrys executed their gift documents, specifying that a “sufficient number” of Units of Norseman be transferred as gifts so that the fair market value of such Units shall equate to specific dollar amounts as indicated in the gift documents — $261,000 to each of four children, and $11,000 to each of five grandchildren. Further, the gift documents provided:

Although the number of Units gifted is fixed on the date of the gift, that number is based on the fair market value of the gifted Units, which cannot be known on the date of the gift but must be determined after such date based on all relevant information as of that date.

Furthermore, the value determined is subject to challenge by the Internal Revenue Service (IRS). I intend to have a good-faith determination of such value made by an independent third-party professional experienced in such matters and appropriately qualified to make such a determination. Nevertheless, if, after the number of gifted Units is determined based on such valuation, the IRS challenges such final valuation and a final determination of value is made by the IRS or a court of law, the number of gifted Units shall be adjusted accordingly so that the value of the number of Units gifted to each person equals the amount set forth above, in the same manner as a federal estate tax formula marital deduction amount would be adjusted for a valuation redetermination by the IRS and/or a court of law.

The Issues Before the Court

In 2006, the IRS examined the gift tax returns and determined that the value of the gifts exceeded the Wandry’s Federal gift tax exclusions. The gift tax returns had indicated percentage interests on them which the IRS took to mean fixed percentage interests. However, the percentage interests were actually derived from the dollar amounts specified in their gift documents relative to the total value of Norseman. Where the Wandry’s thought they were making gifts of $261,000 to each child and $11,000 to each grandchild, the IRS determined such amounts at $366,000 and $15,400, respectively, precipitating a deficiency notice. Prior to the trial, both sides agreed that such interests were worth $315,800 and $13,346, respectively.

Further, the IRS argued that the adjustment clause does not save the Wandrys from the tax imposed by Section 2501 because it creates a condition subsequent to completed gifts and is void for Federal tax purposes as contrary to public policy. The public policy issue derived from a transfer clause reversed in Commissioner v. Procter, 142 F.2d 524 (4th Circuit 1944), wherein a transfer clause that operated to reverse a completed transfer in excess of the gift tax was voided and deemed to be contrary to public policy since any effort by the IRS to collect the implicit tax would defeat the gift, thereby discouraging efforts to collect the tax.

Accordingly, the issues for decision before the Court were:

  1. Whether the Wandry’s transferred gifts of a specified dollar value of membership units or fixed percentage units in Norseman.
  2. Whether the gift transfer documents were void for Federal tax purposes as against public policy.

The Court’s Application of the Adjustment Clause

This case highlights the conundrum faced by wealthy clients seeking to accomplish a gifting program while minimizing gift taxes in the process. Since the gift takes place on a specific date, it is typically impossible to have a firm value of an intangible asset holding as of the valuation date. The valuation of intangible asset holdings, such as Member Interests in Norseman, can be determined by qualified business appraisers. Such appraisals require substantial documentation and time to accomplish. If the gift is made on say, December 31st, based on reasonable but undocumented expectations, how does the donor deal with the implicit gift tax when the appraised value, determined later, comes in higher than expected? Further, the donor’s appraisal expert may have such appraisal challenged by the IRS, resulting in another perspective on value and additional tax liability.

The Court drew a distinction between a “savings clause,” which a taxpayer may not use to avoid the tax imposed by Section 2501, and a “formula clause,” which is valid. A savings clause is void because it creates a donor that tries “to take property back.” On the other hand, a “formula clause” is valid because it merely transfers a “fixed set of rights with uncertain value.”

The Court determined that, under the terms of the gift documents, the donees were always entitled to receive predefined Norseman percentage interests, which the gift documents expressed as a mathematical formula. The numerator of the formula was the stated dollar amount of the gift, while the denominator was the fair market value of Norseman, the only unknown. The value was a constant.

From this perspective, with specified dollar amounts of the gifts, there could be no excess gift and accordingly no gift tax. The formula did not require that the donors “take back” the excess amount; rather, there was no excess amount ever given, and the formula simply adjusted the relative ownership percentages when the denominator amount, the fair market value of Norseman was known.

The Court applied the four-part benchmarks from Estate of Petter v. Commissioner, T.C. Memo 2009-280 to the Wandry case to ascertain the validity of the transfer clause:

  1. The donees were always entitled to receive a predefined number of Units, which the documents essentially expressed as a mathematical formula.
  2. The formula had one unknown: the value of an LLC Unit at the time the transfer documents were executed. But though unknown, that value was a constant.
  3. Before and after the IRS audit, the donees were entitled to receive the same number of Units.
  4. Absent the audit, the donees may never have received all the Units they were entitled to, but that does not mean that part of the Taxpayer’s transfer was dependent upon the IRS audit. Rather, the Audit merely ensured the donees would receive those Units they were always entitled to receive.

With regard to the public policy issue, the Court recounted that the Supreme Court has warned against invoking public policy exceptio to the IRS Code too freely, holding that the frustration caused must be severe and immediate. The Court held that there is no well-established policy against formula clauses. Prior cases confirming formula clauses included charities which re-allocated gift amounts to charity, which is favorable to public policy. In this case, the re-allocated amounts were adjusted among the donors and the donees, based on specified dollar amounts of the gifts, so no unintended gift tax was incurred, and there was no charitable entity involved.

Here’s What’s Important

  • The Court confirmed the validity of a defined value formula clause based on specified dollar amounts, which allowed for the re-allocation of percentage interests gifted, once the fair market value of the underlying entity was determined.
  • Prior cases upheld defined value formula clauses that resulted in excess transfer amounts, upon challenge by the IRS, being allocated to charity thereby avoiding unintended gift tax consequences. However, the Wandry case did not involve a charitable entity.
  • This decision allows for the gifting of specific dollar amounts when the donor does not know the exact value of the Member Units, Partnership Interests, or Shares. Such value can be determined later by a qualified business appraiser. This flexibility should enhance the often rushed year-end experience of estate planning gifts intended to take advantage of annual or lifetime exclusions in a given year.