If you transfer business interests or other assets to your loved ones, the IRS generally has three years to challenge their value for gift tax purposes or to claim that a transfer you treated as a nongift was in fact a gift or partial gift. However, the three-year statute of limitations period doesn’t begin to run until you “adequately disclose” the transfer to the IRS. Otherwise, the IRS can come after you for unpaid gift taxes, plus penalties and interest, years or even decades later.

To avoid this situation, your gift tax return must satisfy federal tax regulations’ adequate disclosure requirements. And even if you treat a transfer as a nongift (such as the transfer of an asset in exchange for full and adequate consideration), you may want to report it on a gift tax return anyway to prevent the IRS from arguing, many years later, that you made a taxable gift.

Note that if you decide not to disclose the transaction on a gift tax return, it’s crucial that the transaction is documented properly and that the documentation is retained by you and the buyer.

What are the adequate disclosure requirements?

Generally, to adequately disclose a transfer, file a gift tax return for the year in which the transfer is completed, containing the following information:

  • A description of the transferred property and any consideration received,
  • The identity of, and relationship between, the transferor and each transferee,
  • If property is transferred to a trust, the trust’s tax identification number and a brief description of its terms (or a copy of the trust instrument),
  • A detailed description of the method used to value the transferred property or a qualified appraisal, and
  • A statement describing any position taken that’s contrary to any proposed, temporary or final tax regulations or revenue rulings published at the time of the transfer.

Additional information is required for certain transactions between related parties, such as grantor retained annuity trusts, qualified personal residence trusts, and transfers of interests in corporations or partnerships.

For transfers reported on a gift tax return as nongifts, describe the methods used to value the property or furnish an appraisal. You’ll also need to explain why they’re not gifts.

Substantial compliance is sufficient

Often, strict compliance with tax regulations is required. However, in a recent U.S. Tax Court case (Schlapfer v. Commissioner), the court held that substantial compliance with the adequate disclosure regulations is sufficient. However, the disclosure must be “sufficiently detailed to alert the Commissioner and his agents as to the nature of the transaction so that the decision as to whether to select the return for audit may be a reasonably informed one.”

This decision provides some comfort to taxpay- ers who fail to cover all the bases when disclosing gifts. But to avoid an IRS challenge and potential litigation, it’s advisable to follow the regs as closely as possible.

Protect your estate plan

Does your estate plan involve gifting assets to family members or others? Or is there a risk that a nongift transfer could later be characterized as a partial gift? The best way to protect your plan is to report the gift or transfer on a timely filed gift tax return that satisfies the adequate disclosure requirements. Doing so can help minimize the chances of unwelcome tax surprises years or even decades in the future. Contact your estate planning advisor for more details.

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Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation. All THK blogs are considered advertising material by the Indiana Bar Association.