Formula Clauses Used to Avoid Gift Taxes : Where are We?

In an environment where the continued long-term existence of the federal estate tax has become uncertain, estate planners are discovering that clients are becoming hesitant to engage in transfer tax planning transactions that trigger a substantial gift tax. One of the techniques increasingly used by planners to attempt to cap gift tax exposure with respect to a gift or sale transaction involving a hard-to-value asset is a formula clause. These clauses are designed to limit the transferor's gift exposure by either adjusting the value of the interest transferred to the extent a different value is "finally determined for gift tax purposes" (a "value adjustment clause") or specifying the dollar value of the interest transferred (a "defined value clause"). In the typical valuation case, the taxpayer simply argues that the value determined by the appraiser is correct. With a formula clause, the taxpayer possesses additional arguments to avoid the imposition of transfer tax. This article will discuss the IRS's and the courts' treatment of formula clauses, as well as the arguments favoring the use of such clauses