Stopping a Heads-I-Win-Tails-You-Lose Tax Stratagem: Why Congress Shouldn't Let Taxpayers Use Transfer Clauses to Frustrate IRS Gift-Tax Audits

Abstract

High tax rates create an incentive for taxpayers whose estates are likely to be assessed estate tax at death to transfer as much value as possible outside of their estates through lifetime gifts. To maximize that value, taxpayers use complex transactions involving closely-held entities, valuation discounts, and transfer clauses. A recent shift in judicial decisions has led to the popularity of transfer clauses that shelter excess value from gift tax if an IRS audit results in a discrepancy in valuation between the government and the taxpayer. Transfer clauses create a heads-I-win-tails-you-lose scenario for the IRS through fruitless audits that waste agency resources without raising revenue for the government.

To alleviate this abuse, Congress should enact legislation providing for transfer clauses to be disregarded if they depend upon an IRS audit. As a result, the excess value that the taxpayer meant to reallocate in a non-taxable manner would be subject to gift tax and the appropriate amount of revenue would be collected. Further, such legislation would provide clarity for taxpayers, the courts, and the IRS. Thus, Congress would uphold the public policy of protecting government revenue while maintaining the progressivity of the tax system by ensuring that those wealthy taxpayers most capable of paying tax are paying the correct amount.