Tax Court Rules for Taxpayer in Transfer of Closely-Held Business Interests

The Tax Court has just passed a new technique that closely-held businesses owners —and wealthy families — can use to pass assets to heirs with a minimal amount of taxes and complications. The ruling in the case, Wandry v. Commissioner, is stirring up excitement among experts.  The below commentary was written by a WealthCounsel associate, Lizette Sundvick, who practices throughout southern Nevada.

Just between us, isn’t it nice when the IRS loses a case to a taxpayer? For example, the little-guy victory in the landmark case of Wandry v. Commissioner affirms and simplifies a very powerful tool for passing on wealth, especially for the business owner.

While the case and the estate planning tool in the crosshairs have been the subject of previous articles, The Wall Street Journal provided a new explanation of the two in an article appropriately titled “Shielding the Family Business.”

The basic plan for wealth transfer when there is a business involved is to give it in pieces, and that’s precisely the plan that benefits from Wandry v. Commissioner. Giving away the entire business outright is a good way to take a tax hit, since it will invoke a gift tax when you cross certain thresholds during the year and in your lifetime.

There’s currently a lifetime exemption of $5.12 million and an annual exclusion of $13,000. Nevertheless, it’s easy for a business to be worth more than $5.12 M, and using that exclusion in full will drain what you have available against the estate tax later at death. However, by their very nature and structure, business interests are especially amenable to piecemeal ownership transfer. This is because ownership of the business, and therefore the underlying assets owned by the business, is an abstraction, and you can simply gift your interests in the business without a tax hit. For example, you can chip away by giving a usefully small amount, say, $13,000 per year per individual (or whatever number Congress and the IRS set for that year), without gift taxes.

Of course, gifting business ownership is not entirely ideal. Fortunately, that’s what the Wandry v. Commissioner case tries to fix. Gifting exactly $13,000 is pretty easy by simply writing out the figures and name on a check. On the other hand, with an abstraction like business ownership, the gift depends on the value of the business and, more to the point, on the value that you and the IRS agree or disagree about.

If you give $13,000 of ownership on the basis of your valuation, but the IRS adds up $15,000 based on its own valuation, then the IRS might also think you owe a tax (or, alternatively, that your gift/estate tax exemption should erode by that much). As you might have guessed, that’s exactly what happened in the Wandry case. Unfortunately for the IRS, the court held that the Wandrys had clearly intended to give their annual exemption amount and, if there is a new appraisal and higher valuation of the gift, then the excess wasn’t intended to be gifted in the first place.

As is always the case with the law, there is much more to this case and more guidance to be gleaned for the business owner. I would recommend reading the original article if you are or will be transferring interests in your business. As always, make sure you engage qualified legal counsel before taking action.  I am available to talk on the phone or meet in person.

Reference: The Wall Street Journal (April 30, 2012) “Shielding the Family Business”