Taxpayer Victory in Petter Case Provides a Clear Path for Advisors to Follow when Planning Large Est Hot

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Much like McCord v. Commissioner which was argued, and won a few years ago, the methodology utilizes what is know as a “defined value clause” to mitigate against the risk that the appraised value of a transferred asset will be challenged by the IRS and that a re-valuation will cause gift tax or estate tax to be due because the transfer was undervalued.


In both the Petter and McCord cases, the use of Family Limited Partnerships (FLP) was a main component of the transaction. In both case the IRS challenged the appraiser’s methodology of valuing the partnership interests that were transferred and in both cases the service prevailed. Normally, this would cause additional tax and possibly penalties to be due.


For example, if a taxpayer transfers $5 million to an FLP and receives a valuation discount of 50% from his appraiser and then transfers these FLP units to his heirs, the taxpayer would report a $2.5 million gift ($5 million x 50%). If the service argues the discount should only be 30% and wins, the gift is now $3.5 million and there has been a $1 million un-reported gift made.


The manner by which Petter and McCord prevented this outcome was to make concurrent gifts of FLP units to qualified charities and to utilize very clear language that indicated that if they had valued their FLP units improperly that they simply wanted any additional value that would cause unwanted gift or estate tax to be transferred to the charities instead. In both cases, the methodology worked to perfection and the IRS was prevented from collecting additional tax.


Affluent clients who are often asked to undertake complex plans such as these fear nothing more than the IRS coming in and unraveling their whole structure. Both McCord, and now the Petter case, provide an unbelievable opportunity to mitigate that risk. While somewhat complex to get right, it is certainly worth it.

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