If You Plan On Making Gifts, You Better Plan on Reporting It Correctly
By: Randall A. Denha, J.D., LL.M.
Lets first begin by saying that if you gift assets, you “may” have a duty to report those gifts. That said, if you make gifts and fail to report them when they should have been reported, then the IRS can come and knock on your door many years later. No statute of limitations begins. To best protect clients (and advisors), taxpayers must file gift tax returns, adequately disclosing gifts and non-gifts.
Under IRC Section 6501(a), the IRS generally has three years after a gift tax return is filed to assess additional gift tax. If no gift tax return is filed, or if the value of the gift is not disclosed “in a manner adequate to apprise the Secretary of the nature of such item,” then the IRS can assess gift tax at any time. Conversely, the default three-year period will apply so long as the gift has been adequately disclosed on the gift tax return or in a statement attached to the return.
To start the statute of limitations, a gift must be adequately disclosed on the gift tax return. Whenever a gift is made with assets that are hard to value (e.g., a partnership interest), tax preparers need to consider the requirements of Regs. Sec. 301.6501(c)-1(e) and/or -1(f). These rules generally require that the gift be described in sufficient detail that the IRS can determine what property was given, the identity of and relationship between the transferor and transferee, details on any trusts involved, and how the value was determined. The volume of information required to be disclosed will generally mean that the transfer cannot be completely described on the face of Schedule A of Form 709. In those cases, tax preparers should consider including a disclosure for the gift so that it meets the adequate-disclosure regulations and starts the statute of limitation for the transfer.
Schlapfer v. Commissioner, T.C. Memo. 2023-65 (U.S. Tax Court May 22, 2023), is the first reported case to contain a detailed discussion of the adequate disclosure requirements under the gift tax adequate disclosure regulations that are set forth in Treas. Reg. Sec. 301.6501(c)-1(f). The IRS generally has three years from the filing of a gift tax return to assess additional gift tax. If no gift tax return is filed, or if the gift is not “adequately disclosed” on or with the gift tax return, then the IRS may assess additional gift tax at any time. However, the adequate disclosure of a completed gift on a gift tax return will commence the running of the period of limitations for assessment of gift tax on the transfer even if the transfer is ultimately determined to be an “incomplete gift” for gift tax purposes. Very significantly, the Tax Court in Schlapfer applied a lenient “substantial compliance” standard for determining whether there has been adequate disclosure (in contrast to a strict compliance standard).
In Schlapfer, the Taxpayer funded a life insurance policy with cash and stock then subsequently assigned the policy to his mother, aunt, and uncle. The assignment was initiated in 2006. However, due to a scrivener’s error, the assignment was not properly completed until 2007. The Taxpayer reported the assignment as a gift on his 2006 gift tax return. In disclosure of such gift, the Taxpayer reported a gift of stock to his mother (which stemmed from the assignment of the life insurance policy to his mother, aunt, and uncle). In 2016, the IRS opened an examination of the 2006 gift tax return and determined that the gift was not adequately disclosed. In 2019, the IRS issued a notice of deficiency. The IRS concluded following an audit that the gift was incomplete for federal gift tax purposes until 2007, and that because Ms. Schlapfer failed to file a gift tax return for 2007, he did not adequately disclose the gift to commence the running of the gift tax statute of limitations.
The Court found that the Taxpayer’s 2006 gift tax return disclosure (i) sufficiently alerted the IRS of the underlying property transferred, (ii) sufficiently alerted the IRS that the gift was to a member or members of his family, and (iii) provided additional financial documents that appraised the Commissioner of the method used to calculate the fair market value of the property transferred. Ultimately, such disclosure was found to “strictly or substantially compl[y]” with the adequate disclosure requirements even if it may not have strictly satisfied Treasury Regulations. Consequently, the court held the IRS could not assess additional gift tax as it had failed to issue its deficiency within the three-year statutory time period.
As a result of the decision in Schlapfer, it becomes clear that gifts must be adequately disclosed when filing gift tax returns. If a gift is not adequately disclosed, the statute of limitations may not begin to run, and the IRS potentially could challenge the value of the gift or other items related to the gift at any time in the future. In fact, this decision is the first time the Tax Court has addressed the adequate disclosure requirements for gift tax purposes in a comprehensive manner. In its ruling, the court distinguished between ‘strict’ and ‘substantial’ compliance with the adequate disclosure requirements of Treas. Reg. Sec. §301.6501(c)-1(f), with the latter ‘substantial’ compliance measure being viewed as a more taxpayer-friendly standard. Despite this favorable interpretation, taxpayers generally are advised to seek to meet all the adequate disclosure requirements as this case involved some unique facts that may not be present in other taxpayer situations.
