McCord: defined-value gifts at the crossroads.

• Author: Satchit, Vinu

It is well-established gift tax law that a "condition subsequent" is void for gift tax purposes as contrary to public policy. This is defined as a condition that essentially operates to eliminate gift tax by adjusting the value or amount of transferred property if the IRS acts after the transfer has occurred (as opposed to applying regardless of the Service's action).

In the seminal case in this area, Procter, (1) the taxpayer transferred property to a trust for his children's benefit; the trust agreement provided that the transfer, or a portion of it, would be nullified if a Federal court found any portion subject to gift tax. Although the provision was not included to save taxes, the Fourth Circuit, clearly troubled by the implications of approving such a proviso, held it to be against public policy, because (1) public officials would be discouraged from attempting to collect the tax, as the effect of such an attempt would be to defeat the gift; (2) it would tend to obstruct the administration of justice, by requiring the courts to address a moot case; and (3) it would defeat a judgment rendered by the court.

In recent years, taxpayers have tried to distinguish a prohibited value-adjustment clause from a value-definition clause. The latter does not call for adjustment of values based on IRS audit results or court decisions, but simply defines a gift via formula (e.g., the gift is expressed as $x of the value of an interest to one beneficiary, with the remainder of the value to a charity). The differences, according to the proponents, include the fact that the transfer is unconditional and irrevocable as of the transfer date and no portion of the property reverts back to the donor under any circumstances. They also point out that such provisions are no different from the typical credit shelter/marital formulas commonly used in estate planning.

Despite the differences, the Service has argued vehemently for disregarding defined-value gift formulas on multiple fronts, including the substance-over-form and violation-of-public-policy doctrines. (2) The Fifth Circuit's recent pro-taxpayer decision in McCord (3) provides an excellent analysis of the issues involved, but leaves many unanswered questions.

Facts

On June 30, 2005, Charles T. McCord, Jr. and Mary S. McCord contributed equal and identical interests in assets valued at $12,294,384 ($6,147,192 each) to a Texas limited partnership (LP), McCord Interests, Ltd., L.L.P. (MIL); in exchange, each received roughly 41.17% of the class B LP interests? The taxpayers subsequently gifted all of their MIL interests irrevocably and unconditionally to several nonexempt and exempt donees via an assignment agreement (AA), on Jan. 12, 1996.

The gifts were not listed in the AA in terms of percentages of MIL interests, but defined in terms of dollar amounts of MILs net fair market value (FMV). Specifically, the nonexempt donees (the taxpayers' four sons and four generation-skipping transfer (GST) tax trusts established for their benefit) were to receive LP interests with an aggregate FMV of up to $6,910,933. (5) If the net FMV of the gifted LP interests exceeded that amount, the first exempt donee, Shreveport Symphony, Inc. (Symphony), was to receive a...