The gift tax has taken a few twists and turns in its lifetime. Originally, the gift tax and the estate tax were “de-coupled,” meaning that each separate tax applied independent of each other. That is, the re-valuation of gifts was solely a gift tax issue and didn’t have any bearing on any eventual estate tax payable, which had its own independent exemption amount (which couldn’t be reduced by lifetime gifting).
The Tax Reform Act of 1976 changed this and set the foundation for the coupled gift tax and estate tax that we know today, whereby the gift tax and the estate tax share a unified credit. In essence, in determining estate tax, the unified credit is reduced by lifetime gifting, which creates an unbreakable relationship between lifetime gifting and eventual estate settlement.
As became quickly evident, one major issue was that of consistency: Can the Internal Revenue Service take a second look at lifetime gifting when it comes time to review the estate tax return? After a little back and forth in the courts, the answer was determined—yes—the IRS had the ability to revalue lifetime gifting (even if disclosed on a gift tax return and for which the statute of limitations for gift tax purposes had run) for purposes of determining estate tax liability.
Estate of Smith v. Commissioner
The problems created with this system are self-evident, and practitioners weren’t shy about voicing dismay about this system. Nonetheless, the IRS enjoyed a victory on this front in Estate of Smith v. Comm’r,1 which squarely addressed the problem.
In 1997, Congress, having tired of the IRS playing Monday morning quarterback on estate tax returns, statutorily overruled Smith in enacting Internal Revenue Code Section 2001(f), which generally provided that if the statute of limitations had run on transfers adequately reported on a gift tax return, then the value provided on the gift tax return is finally determined for purposes of the estate tax. This new rule, though, applies only to gifts made after Aug. 5, 1997, and the impact on pre-Aug. 6, 1997 gifting is outside the scope of this article.
Now, let’s go back in time just a bit to 1987 when Congress enacted former IRC Section 2036(c) (now repealed) in an attempt to eliminate abusive estate freeze techniques. Section 2036(c) set the groundwork for Chapter 14 of the IRC (which contains IRC Sections 2701-2704). Chapter 14 of the IRC was enacted in 1990 and brought with it the first rendition of IRC Section 6501(c)(9) (discussed below), which provided in relevant part: “if any gift of property the value of which is determined under section 2701 or 2702 . . . is required to be shown on a return of tax imposed by chapter 12 . . .” The IRS adopted permanent regulations interpreting Section 6501(c)(9) in 1992, contained in Treasury Regulations Section 301.6501(c)-1(e) (discussed below).
Now, to bring everything full circle, in 1997, the IRS amended Section 6501(c)(9) to state that the rule contained therein applies to all transfers disclosed on a gift tax return, not just those transfers the value of which is determined under Section 2701 or 2702. The IRS issued permanent regulations a few years later in 1999, which set forth the requirements for adequate disclosure of gift transactions2 and the requirements for adequate disclosure of non-gift transactions.3
So, in summary, the requirements for adequately showing transfers of property the value of which is determined under Section 2701 or Section 2702 have taken a different historical path than adequately disclosing other transfers.
Adequately Disclosed vs. Shown
Section 6501(a) states the general foundational rule that the IRS has three years to audit a gift tax return:
Except as otherwise provided in this section, the amount of any tax imposed by [Title 26 of the United States Code, which includes income tax, estate tax, gift tax and generation-skipping transfer tax, among other items] shall be assessed within three years after the return was filed (whether or not such return was filed on or after the date prescribed) . . . and no proceeding in court without assessment for the collection of such tax shall be begun after the expiration of such period.
Importantly, Section 6501(c)(9) provides that:
If any gift of property the value of which (or any increase in taxable gifts required under section 2701(d) which) is required to be shown on a return of tax imposed by chapter 12
(without regard to section 2503(b)), and is not shown on such return, any tax imposed by chapter 12 on such gift may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time. The preceding sentence shall not apply to any item which is disclosed in such return, or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item. (Emphasis added.)
Section 6501(e)(2) also generally provides the 6-year statute of limitations for gross understatement of the value of an estate or gift.
The regulations governing adequate disclosure are found in Treas. Regs. Section 301.6501(c)-1 and provide exceptions to the general period of limitations on assessment and collection as provided in Section 6501. Let’s break the subsections into three components: (1) Treas. Regs. Section 301.6501(c)-1(e) (which deals with transfers subject to the special valuation rules of IRC Sections 2701 and 2702); (2) Treas. Regs. Section 301.6501(c)-1(f)(1)-(3) (which sets forth the requirements for adequate disclosure of gift transactions); and (3) Treas. Regs. Section 301.6501(c)-1(f)(4) (which sets forth the requirements for adequate disclosure of non-gift transactions).
Adequately Shown
The provisions of Treas. Regs. Section 301.6501(c)-1(e) (which deal with transfers subject to the special valuation rules of IRC Sections 2701 and 2702) use the term “adequately shown” in reference to what’s sufficient to begin the general 3-year statute of limitations provided in Section 6501. In the case of transfers subject to the special valuation rules of IRC Sections 2701 and 2702, if the transfer isn’t adequately shown, any tax imposed on the transfer may be assessed at any time (that is, the statute of limitations remains open indefinitely).
There’s significant overlap between the elements for a transfer to be adequately shown and adequately disclosed, but it’s clear that the IRS, in enacting regulations concerning adequate disclosure effective Dec. 3, 1999, intended for there to be a difference between the two standards:
Some commentators argued that Congress intended that the new adequate disclosure requirements be the same as the existing disclosure requirements under prior section 6501(c)(9) for pre-August 5, 1997 gifts of property subject to the special valuation rules of sections 2701 and 2702. Therefore, the commentators suggested that the IRS adopt the disclosure requirements under §301.6501(c)-1(e)(2) for those interests. This suggestion was not adopted.4
In addition to different requirements to satisfy the applicable disclosure thresholds, the text of Treas. Regs. Section 301.6501(c)-1(e)(2) appears to create three distinct requirements for satisfying the adequately shown threshold, as opposed to essentially general guidance (which now may be the case with respect to the adequate disclosure threshold for gifting transactions). That is, the body of Treas. Regs. Section 301.6501(c)-1(e)(2) provides that the adequately shown standard will be met “only if . . . the return provides [the three requirements].” (Emphasis added). As will be discussed later, this is a major difference between the adequately shown standard and the adequately disclosed standard with respect to gift transactions.
Adequately Disclosed
Adequate disclosure of gift transactions. The provisions of Treas. Regs. Section 301.6501(c)-1(f) (which deal with transfers not subject to the special valuation rules of IRC Sections 2701 and 2702) use the term “adequately disclosed” in reference to what’s sufficient to begin the general 3-year statute of limitations provided in Section 6501. The regulations governing adequate disclosure can essentially be broken into three components: (1) items that are sufficient for purposes of adequate disclosure of gift transactions;5 (2) the appraisal safe harbor;6 and (3) items that are sufficient (or perhaps necessary) for purposes of adequate disclosure of non-gift transactions.7
Like the regulations governing the adequately shown standard, the regulations governing the adequately disclosed standard for purposes of reporting gift transactions (that is, Treas. Regs. Section 301.6501(c)-1(f)(2)) contain an “only if” statement, which reads: “a transfer will be adequately disclosed on the return only if it is reported in a manner adequate to apprise the [IRS] of the nature of the gift and the basis for the value so reported.”
Treas. Regs. Section 301.6501(c)-1(f)(2) then goes on to list five items that are sufficient (but, as discussed below, not necessary) for purposes of adequately disclosing a gift transaction. The comments to the 1999 regulations acknowledge that not every item contained in Treas. Regs Section 301.6501(c)-1(f)(2) must be met, stating:
it is not intended that the absence of any particular item or items would necessarily preclude satisfaction of the regulatory requirements, depending on the nature of the item omitted and the overall adequacy of the information provided.
Although not expressly authorizing a substantial compliance standard for meeting the requirements of adequate disclosure of gift transactions, subsequent case law (specifically, Schlapfer v. Comm’r8) has held that substantial compliance with the adequate disclosure regulations is sufficient. In the few months since Schlapfer was released, much has been written about it and its impact on the adequate disclosure regulations. This article isn’t intended to be another commentary about that case, and I’ll discuss it below only when relevant. That said, the importance of Schlapfer in this area can’t be understated.
The five items sufficient to meet the standard for adequate disclosure of gift transactions are:
- a description of the transferred property and consideration received by the transferor;
- the identity of and relationship between the transferor and transferee;
- if property is transferred in trust, the trust’s tax identification number and a description of the terms of the trust (or a copy of the trust instrument);
- a detailed description of the method used to determine the fair market value (FMV) of the property transferred; and
- a statement describing any position taken that’s contrary to any proposed, temporary or final Treasury regulations or revenue rulings published at the time of the transfer.
Appraisal safe harbor. Generally speaking, the most arduous item contained in the five items listed above is Item 4—a detailed description of the method used to determine the FMV of the property transferred. The actual text of the regulations9 is much more lengthy than as provided above and goes into substantial detail about what’s expected under this item. Treas. Regs. Section 301.6501(c)-1(f)(3) provides that an appraisal meeting certain requirements will be sufficient to satisfy Item 4 above. It should be emphasized that an appraisal isn’t required to satisfy Item 4, but often, the goal is to meet the appraisal safe harbor as provided in Treas. Regs. Section 301.6501(c)-1(f)(3) (and, in many cases, is less burdensome to satisfy than the list of documentation set forth in Item 4).
Adequate disclosure of non-gift transactions. The regulations concerning adequate disclosure of non-gift transactions10 provide two important components: (1) transfers to family members made in the ordinary course of operating a business, if properly reported by all parties for income tax purposes, will be deemed to be adequately disclosed, even if not reported at all on a gift tax return; and (2) to adequately disclose other non-gift transactions (that is, non-gift transactions not meeting the requirements of the first component), those transactions must be reported in their entirety as non-gift transfers, and the adequate disclosure standard for such transfers will be met “only if” five elements are met (discussed below). Like the adequately shown standard, the regulations use an only if standard when naming the requirements for adequately disclosing non-gift transactions.
The five elements to meet the standard for adequate disclosure of non-gift transactions outside of transfers to family members made in the ordinary course of operating a business are:
(1) Items 1, 2, 3 and 5 listed above (note that Item 4 isn’t required for adequate disclosure of non-gift transfers); and
(2) an explanation as to why the transfer isn’t a transfer by gift under IRC Chapter 12.
Strict Compliance
Parsing through the text of the regulations, we’re left with what appears to be two provisions setting forth regulatory requirements (that is, the adequately shown standard set forth in Treas. Regs. Section 301.6501(c)-1(e) and the adequately disclosed standard for disclosing non-gift transactions set forth in Treas. Regs. Section 301.6501(c)-1(f)(4)) and one provision setting forth more general guidance as to how to apprise the IRS of the nature of a transaction (that is, the adequately disclosed standard set forth in Treas. Regs. Section 301.6501(c)-1(f)(2)).
The text of the regulations appears to require strict compliance for the adequately shown standard set forth in Treas. Regs. Section 301.6501(c)-1(e) and the adequately disclosed standard set forth in Treas. Regs. Section 301.6501(c)-1(f)(4). Conversely, the text of the regulations and subsequent case law (specifically Schlapfer) provides a substantial compliance standard for adequately disclosing gift transactions.
The statute itself (that is, the embodiment of Congressional intent) is quite terse:
[the indefinitely open statute of limitations] shall not apply to any item which is disclosed in [a gift tax return], or in a statement attached to the return, in a manner adequate to apprise the Secretary of the nature of such item.11
Schlapfer provides a great recitation of the policy behind strict compliance versus substantial compliance but focuses its attention on adequate disclosure of gift transactions (that is, Treas. Regs. Section 301.6501(c)-1(f)(2)), as that was the focus of the case. Presumably, the policy for all three separate disclosure regulations is the same (that is, to apprise the IRS of the nature of a gift or sale), but it’s undeniable that the text of the three separate disclosure regulations varies. Given the text of Treas. Regs. Section 301.6501(c)-1(f)(2), it seems obvious (at least post-Schlapfer) that those regulations should be given a substantial compliance standard based on its plain text and the IRS’ commentary when the regulation was adopted; Schlapfer is entirely consistent with this. Previously, the IRS had tried to argue that a strict compliance standard was correct,12 but for the time being must deal with Schlapfer.
Unfortunately, though, the adequately shown regulation and adequate disclosure of non-gift transactions don’t enjoy this “obvious” comfort—after all, the regulations are written differently and purport to create requirements. Although the policy may be the same for all three requirements, the IRS has a good textual argument that the regulations not addressed in Schlapfer (that is, Treas. Regs. Section 301.6501(c)-1(e) and Treas. Regs. Section 301.6501(c)-1(f)(4)) should use a strict compliance standard; from a policy perspective it appears that this argument would make little sense. My guess is that time will tell on this front, but practitioners would be wise to assume that a strict compliance standard is applicable with respect to the adequately shown standard and the adequately disclosed standard for non-gift transactions. Additionally, notwithstanding Schlapfer, I’ll still endeavor to strictly comply with the adequate disclosure regulations for gift transactions.
Schlapfer has provided some ammunition for practitioners to fight the adequate disclosure battle, but if that can be avoided at the outset (by strictly complying with the regulations), one would be prudent to do so.
Endnotes
1. Estate of Smith v. Commissioner, 94 T.C. 872 (1990).
2. Treasury Regulations Section 301.6501(c)-1(f)(1)-(3).
3. Treas. Regs. Section 301.6501(c)-1(f)(4).
4. T.D. 8845, 64 Fed. Reg. 67,767.
5. Treas. Regs. Section 301.6501(c)-1(f)(2).
6. Treas. Regs. Section 301.6501(c)-1(f)(3).
7. See supra note 3.
8. Schlapfer v. Comm’r, T.C. Memo. 2023-65 (May 22, 2023).
9. Treas. Regs. Section 301.6501(c)-1(f)(2)(iv).
10. Supra note 3.
11. Internal Revenue Code Section 6501(c)(9).
12. See, for example, FAA 20152201F.