Can your gifting program benefit from defined-value gifts?

It’s no surprise that many individuals are making (or are considering making) substantial gifts to their family members to take advantage of the current federal gift and estate tax exemption. Indeed, the 2022 exemption of $12.06 million ($24.12 million for married couples) is the highest amount it’s ever been. But absent action from Congress, the amount will drop to an inflation-adjusted $5 million in 2026.

If your estate consists of hard-to-value assets, including interests in a closely held business or family limited partnership (FLP), making gifts of these assets can be risky. If the IRS later determines that the gifts were undervalued, you may be liable for gift tax (plus interest and possibly penalties). A defined-value gift may help you avoid unexpected tax liabilities.

Defining a defined-value gift

Simply put, a defined-value gift is a gift of assets that are valued at a specific dollar amount rather than a certain number of stock shares or FLP units or a specified percentage of a business entity.

Structured properly, a defined-value gift ensures that the gift won’t trigger an assessment of gift tax down the road. The key is to ensure that the defined-value language in the transfer document is drafted as a “formula” clause rather than an invalid “savings” clause.

A formula clause transfers a fixed dollar amount, subject to adjustment in the number of shares or units necessary to equal that dollar amount (based on a final determination of the value of those shares or units for federal gift and estate tax purposes). A savings clause, in contrast, provides for a portion of the gift to be returned to the donor if that portion is ultimately determined to be taxable.

Passing IRS muster

For a defined-value gift to be effective, it’s critical to use precise language in the transfer documents. In a recent case, the U.S. Tax Court rejected an intended defined-value gift of FLP interests and upheld the IRS’s assessment of gift taxes based on percentage interests. The documents called for the transfer of FLP interests with a defined fair market value “as determined by a qualified appraiser” within a specified time after the transfer.

The court found that the transfer documents failed to achieve a defined-value gift, because fair market value was determined by a qualified appraiser. The documents didn’t provide for an adjustment in the number of FLP units if their value “is finally determined for federal gift tax purposes to exceed the amount described.”

Wording the transfer documents

Making defined-value gifts may be right for you if you plan to transfer hard-to-value assets. Before taking action, contact your estate planning advisor, because this strategy requires precisely written transfer documents to be effective.