Under the Taxpayer Relief Act of 1997, the gift tax statute of limitations doesn’t begin to run unless and until the gift is "adequately disclosed" on a gift tax return. Adequate disclosure under the act means a detailed description of (1) the nature of the gift, (2) the relationship of the parties to the transaction, and (3) the basis for the valuation.

The peace of mind offered by the statute of limitations is important to taxpayers planning for estate and gift taxes. They can rely on the unused portion of their applicable exclusion amounts, for example, without fear that the IRS will attempt to revalue gifts made three or more years earlier.

Proposed regulations issued in late 1998 created confusion over precisely what is required to adequately disclose a gift. Recently issued final regulations respond to these concerns and provide needed guidance for attorneys, valuators, and their clients. Here are some of the highlights:

Required information. The final regulations make it clear that compliance with the checklist of information in the regulations constitutes adequate disclosure. The proposed regulations were more open-ended.

Financial data. The proposed regulations required a detailed description of the method used to determine the property’s fair market value, as well as "any relevant financial data." In response to objections that this term is too subjective, the final regulations require taxpayers to submit only the financial data that was used in valuing the property.

Value of entity. Under the proposed regulations, transfers of fractional interests in a non-actively traded entity required a statement of the fair market value of the entity as a whole, without regard to valuation discounts. The final regulations eliminate this requirement if the value of the interest is properly determined without using the net asset value of the entire entity.

Qualified appraisal. The final regulations provide that an appraisal satisfying specific requirements may be submitted in lieu of a detailed description of the method used to determine the property’s fair market value.

Gift tax controversies. One of the more controversial provisions of the proposed regulations required a "statement of the relevant facts affecting the gift tax treatment of the transfer that reasonably may be expected to apprise the Internal Revenue Service of the nature of any potential controversy . . . ." This requirement was eliminated from the final regulations.

Non-gift transactions. The treatment of non-gift transactions creates a dilemma for taxpayers. On the one hand, such a transaction need not be reported on a gift tax return. But on the other hand, if it isn’t "adequately disclosed," there’s nothing to prevent the IRS from claiming, years later, that the transaction was a gift after all, and imposing taxes and penalties.

Ironically, the proposed regulations imposed even greater reporting demands on non-gift transactions. They required the taxpayer to submit all the information otherwise required for adequate disclosure plus an explanation of why the transfer wasn’t subject to gift tax. This requirement apparently applied even to transfers to family members in the ordinary course of business (such as salaries paid to children who work in the family business).

The final regulations offer some relief by (1) limiting the information required in non-gift situations, and (2) providing that transfers to family members in the ordinary course of business are deemed to be adequately disclosed if they are properly reported by all parties for income tax purposes.

Qualified Appraisal is Critical

To avoid revaluation of a gift years or even decades after it’s made, it’s critical to comply with the adequate disclosure requirements. In most cases, the best way to do this is to obtain a contemporaneous appraisal of the property by a qualified business valuator, together with an appraisal report that provides the information required by the final regulations.