Taxpayers Win Another Victory for Defined Value Clauses

by Daniel Glassman - Posted In: Tax

In Hendrix v. Commissioner, T.C. Memo 2011-133 (06/15/2011), the United States Tax Court ruled in favor of taxpayers and against the IRS determination of a $14 million gift tax deficiency relating to transfers of stock in a closely held corporation.  The taxpayers used a defined value formula clause which allowed them to transfer shares with a certain value to trusts for their descendants and any excess to a charity.  After the transfer, the trust and the charity independently determine how to divide the total shares transferred according to the defined value formula clause.  The use of such a clause is a method to limit risk of making a larger than anticipated taxable gift when transferring hard to value assets.

Notably, in Hendrix, the taxpayer and the IRS stipulated that if the defined value clause was not respected, the fair market value of the stock was significantly greater than the value used by the trust and charity to divide the shares (which would have resulted in a significant gift tax liability for the taxpayers).  The Tax Court held that the defined value formula clause should be respected for federal tax purposes as the result of bona fide arm’s length negotiations.  The taxpayer’s victory in Hendrix shows that properly structured defined value formula clauses can mitigate valuation risk in estate planning transactions.

Tags: Daniel J. Glassman