In May 2023, the U.S. Tax Court handed down its decision in the case of Schlapfer v. Commissioner. According to the court, the taxpayer properly disclosed a gift of controlled foreign corporation (CFC) stock to the Internal Revenue Service (IRS) when he included a gift tax return reporting the stock transfer with his Offshore Voluntary Disclosure Program (OVDP) packet.

The details of the case set forth important lessons for those who might make and disclose gifts under similar circumstances.

Gifts Given

The taxpayer was the policyholder of a life insurance policy issued in 2006. The policy owned all the stock in European Marketing Group, Inc. (EMG), an entity previously owned by the taxpayer. He assigned ownership of the policy to his mother, aunt and uncle as gifts to each.

The taxpayer submitted a disclosure packet to the IRS OVDP in 2013. In the packet, he included Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for 2006. This return informed the IRS the taxpayer had made gifts of EMG stock to his mother, aunt and uncle.

Attached to Form 709 was a protective filing notice stating the taxpayer made a gift of CFC stock in 2006, but that he was not subject to U.S. gift tax because he did not intend to reside permanently in the United States until he obtained his U.S. citizenship in 2008.

The taxpayer reported the transfer as a gift of CFC stock rather than as a gift of the insurance policy because the 2012 OVDP instructions required taxpayers to disregard certain entities that hold underlying assets, and he believed the policy to be such an entity.

The IRS conducted an examination, during which the taxpayer agreed to extend the limitations period to November 2017. After the taxpayer’s gift tax return was examined, the IRS concluded he had made the gifts in 2007, not 2006, and prepared a substitute gift tax return for 2007. In October 2019, the IRS issued a deficiency notice based on the substitute return. The taxpayer promptly filed a petition for review in the Tax Court.

Issues in Play

In that petition, the taxpayer argued the limitations period for assessing the gift tax expired in 2017 before the deficiency notice was issued because he had adequately disclosed the gift on the 2006 gift tax return.

Generally, the IRS has three years from the filing of a gift tax return to assess additional tax. If a return is not filed, or if the gift is not adequately disclosed on or with the gift tax return, then the IRS may assess gift tax at any time.

Notably, the IRS did not dispute that the petitioner had filed a gift tax return for 2006 when he submitted the disclosure packet to the OVDP. As a result, the court did not have to consider whether the gift tax return was properly filed when it was submitted to the OVDP rather than the designated IRS service center.

However, if the gift is adequately disclosed on a gift tax return, the assessment limitations period will begin to run – even if the transfer is ultimately determined to be an incomplete gift. Citing previous decisions, the court stated: “A disclosure is ‘adequate’ if 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.”

The Court’s Decision

The Tax Court found the taxpayer had adequately disclosed the transfer on his 2006 gift tax return because the documents he attached to, and referenced in, his gift tax return provided the IRS with enough information to satisfy the adequate disclosure requirements. In addition, the protective filing notice attached to the gift tax return referred to the CFC stock, which alerted the IRS to look to the Offshore Entity Statement also included in the OVDP disclosure packet for information about the stock transfer reported in the gift tax return.

Taken together, the court said the OVDP disclosure documents substantially complied with the adequate disclosure requirements. Although the taxpayer may have failed to describe the gift correctly, he provided enough information to identify the underlying property that was transferred.

Furthermore, according to the court, the taxpayer substantially complied with the disclosure requirements, even if the gift was the insurance policy and not the EMG stock. The policy’s principal asset is the EMG stock, and the documents the court considered were enough to apprise the IRS of the method used to determine the fair market value of that stock. Because the policy’s value stems primarily from the EMG stock, the court stated those same documents can be used to illustrate the method used to determine the fair market value of the insurance policy.

Further Insights

Because the taxpayer in this case substantially complied with the adequate disclosure requirements, the period to assess the gift tax began when the return was filed with the OVDP. Therefore, the IRS was barred from assessing gift tax because the deficiency notice was issued more than three years after the gift tax return was filed.

For more information about how long the statute of limitations on gift tax assessments remains open, as well as other insights into estate planning and gifting, contact a Moore Doeren Mayhew tax advisor.