Tax Court details requirements to meet adequate disclosure on gift tax returns (2024)

In brief

In Schlapfer v. Commissioner (T.C. Memo 2023-65), the US Tax Court determined that the taxpayer substantially complied with the adequate disclosure requirements when he filed his 2006 gift tax return. As a result, the three-year period to assess gift tax commenced when the return was filed, and since the IRS issued its notice of deficiency more than three years after the filing, the statute of limitations period had expired.

Generally, the IRS has three years from the filing of a gift tax return to examine the filing and assess any additional tax; however, the statute of limitations will not begin to run (and gift tax may be assessed at any time) if the value of the gifted property is not ‘adequately disclosed’ on the gift tax return. If a gift has been adequately disclosed on the gift tax return or in a statement attached to the return, then the ordinary three-year period for assessment commences upon filing. This is true even if a gift is later determined to be an incomplete transfer in the year of the filed return, so long as the transfer has been adequately disclosed as a completed gift.

In Schlapfer, the Taxpayer entered the Offshore Voluntary Disclosure Program (OVDP) in 2012 and submitted a disclosure packet to the IRS in November 2013 that included, among other items, a gift tax return for 2006. Upon examination, the IRS concluded that the Taxpayer’s gift actually was made in 2007 (not 2006), and as the Taxpayer did not disclose the transfer on a 2007 gift tax return, the statute of limitations period never began to run. In response, the Taxpayer argued that because he adequately disclosed his transfer as a completed gift on the 2006 gift tax return, the statute of limitations period had expired once the IRS issued its notice of deficiency.

Although determining that the Taxpayer did not ‘strictly’ comply with the adequate disclosure requirements on his 2006 gift tax return, the Tax Court concluded that he ‘substantially’ complied with the requirements because his disclosure was sufficiently detailed to alert the IRS to the nature of his gift. In reaching this decision, the Tax Court relied not only on the description of the gift on the 2006 gift tax return, but also on the accompanying documents included with the Taxpayer’s OVDP submission packet. Consequently, the court held the IRS could not assess additional gift tax as it had failed to issue its deficiency within the three-year statutory time period.

Observation: The outcome in Schlapfer reinforces the importance of adequate disclosure when filing gift tax returns.If a gift is not adequately disclosed,the statute of limitations may not begin to run, and the IRSpotentially could challenge the value of the gift or other items related to the gift at any time in the future.

Observation: This decision is the first time the Tax Court has addressed the adequate disclosure requirements for gift tax purposes in a comprehensive manner. In its ruling, the court distinguished between ‘strict’ and ‘substantial’ compliance with the adequate disclosure requirements of Treas. Reg. Sec.§301.6501(c)-1(f), with the latter ‘substantial’ compliance measure being viewed as a more taxpayer-friendly standard. Despite this favorable interpretation, taxpayers generally are advised to seek to meet all the adequate disclosure requirements as this case involved some unique facts that may not be present in other taxpayer situations.

In detail

Taxpayer Ronald Schlapfer, a Swiss national, moved to the United States in 1979 on a nonimmigrant visa, not intending to permanently reside in the United States at that time. He later applied for US citizenship on May 18, 2007, becoming a citizen in 2008.

In July 2006, the Taxpayer applied for a LifeBridge Universal Variable Life Policy (UVL Policy) offered by Swisspartners Insurance Company SPC Ltd. on the lives of his mother, aunt, and uncle, with Taxpayer and his wife as the primary beneficiaries. The Taxpayer funded the UVL Policy with $50,000 and 100 shares of EMG, a Panamanian corporation founded by Taxpayer in 2002 to manage investments of marketable securities and cash.

At that time, the Taxpayer instructed Swisspartners to transfer ownership of the policy to his mother, aunt, and uncle as soon as the policy was issued; however, due to a ‘scrivener’s error,’ the Taxpayer initially was named as the policyholder. This oversight was not corrected until May 2007 once the insurance company officially assigned the policy to the taxpayer’s mother, aunt, and uncle.

In 2012, Taxpayer entered into the OVDP, a compliance program designed for US taxpayers who had “undisclosed income from offshore assets” to resolve their income tax and tax information reporting obligations. By voluntarily coming forward and reporting their noncompliance, participants in the OVDP could receive protection from criminal prosecution and were subject to a standardized civil penalty structure.

To participate in the OVDP, the Taxpayer submitted a disclosure packet to the IRS in November 2013. The disclosure packet included US individual income tax returns for 2004-2009 (including Forms 5471 Information Return of U.S. Persons with Respect to Certain Foreign Corporations for 2004-2006); an Offshore Entity statement describing EMG’s ownership history, and Form 709 United States Gift (and Generation-Skipping Transfer Tax Return) for the 2006 tax year, which reported a gift of EMG stock to the Taxpayer’s mother valued at $6,056,686 (which stemmed from his assignment of the life insurance policy). Although this value exceeded the 2006 lifetime exemption amount ($1 million), the Taxpayer included a protective filing statement indicating that he was not subject to US gift tax under Reg. Sec. §25.2501-1(b) since he was not domiciled in the United States at the time of the gift.

The IRS opened an examination of the taxpayer’s 2006 gift tax return in June 2016. At that time, the Taxpayer signed Form 872 granting the IRS an extension for assessing gift tax until November 30, 2017. In August 2016, the IRS issued Form 3233 (known as the Report of Gift Tax Examination), which concluded that the taxpayer failed to relinquish dominion and control of the life insurance policy until 2007. As a result, the IRS said, the transfer of EMG stock took place in 2007 (not 2006), and as the Taxpayer did not file a 2007 gift tax return, his gift was not adequately disclosed, and the statute of limitations period never began to run. Based on this conclusion, the IRS issued the Taxpayer a notice of deficiency in October 2019 for $8,749,149 ($4,429,949 of gift tax liability and $4,319,200 of penalties and interest) for the unfiled 2007 gift tax return.

In response to the IRS’s assessment, the Taxpayer refused to concede that the gift was made in 2007 and voluntarily withdrew from the OVDP. The Taxpayer then filed a petition with the US Tax Court challenging the IRS’s determination, arguing that the period of limitation to assess gift tax had expired before the IRS issued its notice of deficiency since he had adequately disclosed the gift on his 2006 gift tax return.

Tax Court decision

Under IRC Section 6501(a), the IRS generally has three years after a gift tax return is filed to assess additional gift tax. If no gift tax return is filed, or if the value of the gift is not disclosed “in a manner adequate to apprise the Secretary of the nature of such item,” then the IRS can assess gift tax at any time. Conversely, the default three-year period will apply so long as the gift has been adequately disclosed on the gift tax return or in a statement attached to the return.

At issue in this case was whether the statute of limitations period had expired before the IRS issued its notice of deficiency to the Taxpayer. To answer this question, the Tax Court needed to decide whether the Taxpayer adequately disclosed the transfer of EMG stock on his 2006 gift tax return. While the IRS did not dispute that the Taxpayer filed a 2006 gift tax return reporting the transfer of EMG stock, it argued the transfer was not complete until 2007. On this basis, the IRS argued, since the Taxpayer did not file a 2007 gift tax return, the transfer of EMG stock was never adequately disclosed, and the statute never began to run.

Despite the IRS’s emphasis on the timing of the taxpayer’s gift (i.e., 2006 or 2007), the Tax Court determined that the timing of the transfer was “immaterial” to the analysis. Here, the court relied on Reg. sec. 301.6501(c)-1(f)(5), which states that so long as a transfer is adequately disclosed “as a completed gift,” the statute of limitations period will begin to run even if the transfer is “ultimately determined to be an incomplete gift.” Therefore, the focus on adequate disclosure should be on when the transfer was reported, not when the transfer was completed. For this reason, the Court focused its analysis on whether the Taxpayer adequately disclosed the transfer of EMG shares on his originally filed 2006 gift tax return.

Adequate disclosure

The IRS argued thatthe Taxpayer did not adequately disclose his transfer of EMG shares on the 2006 gift tax return because he failed to ‘strictly’ satisfy all the disclosure requirements of Reg. sec. 301.6501(c)-1(f)(2). Conversely, the taxpayer argued that he ‘substantially’ complied with the adequate disclosure requirements because the documents included with his OVDP submission packet (such as the Offshore Entity Statement and Forms 5471) were attached to his gift tax return, and these documents afforded the IRS with the ability to understand the nature of the transfer.

In reachingits decision, the Tax Court first determined that itnot only could consider the contents of the gift tax return itself, but also any documents attached to the return and informational documents referenced in the return to decide whether an item has been adequately disclosed. As a result, the Offshore Entity Statement, Forms 5471, and other documents included with the Taxpayer’s OVDP submission packet could be considered in its analysis.

Next, the Tax Court stated that disclosure will be considered adequate so long as it is “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” (Thiessen v. Commissioner, 146 T.C. 100, 114 (2016), quotingEstate of Fry v. Commissioner, 88 T.C. 1020, 1023 (1987)). In other words, the Tax Court said, the items listed in Reg. sec. 301.6501(c)-1(f)(2) merely “act as guidance” to inform taxpayers on how to satisfy adequate disclosure. A taxpayer’s transfer may be considered adequately disclosed so long as it is reported in a manner adequate to apprise the IRS of the nature of the gift.

Based on this determination, the Tax Court concludedthat the Taxpayer “strictly or substantially complied” with the adequate disclosure requirements, even if aspects of his disclosure might not “strictly” satisfy the conditions set forth in Reg. sec. 301.6501(c)-1(f)(2).

Observation:It is unclear whether the Tax Court might have reached the same conclusion absent the particular circ*mstances of the Taxpayer’s case. For example, the court relied on several documents and attachments from his OVDP submission packet (such as the Form 5471 filings and Offshore Entity Statement) to form the basis of its ruling. It is possible that the court might have reached a different conclusion had the Taxpayer filed the 2006 gift tax return in isolation and had not submitted the OVDP documents that included a gift tax return for 2006.

In any event, the outcome in this case reinforces the importance of providing full and adequate disclosure of all transfers reported on a gift tax return, which may involve attaching supplemental statements and other documents such as trust agreements, valuations, and appraisals to substantiate the value of the gift and the nature of the transfer.

Observation: The Taxpayer filed his 2006 gift tax return as a protective measure, arguing that his transfer of foreign company stock (a non-US situs asset) was not subject to gift tax under Reg. sec. 25.2501-1(b) since he was not domiciled in the United States at the time of the gift. As the Tax Court ruled that the Taxpayer had adequately disclosed the transfer of EMG stock, the statute of limitations had expired by the time the IRS issued its notice of deficiency. Therefore, the Tax Court did not address the question of Taxpayer’s domiciliary status. Individuals who do not believe they are domiciled in the United States nevertheless should consider whether protective gift tax returns would be advisable to start the statute of limitations when making gifts and other transfers of non-US situs property.

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