tcmemo_2009_280 united_states tax_court estate of anne y petter deceased terrence d petter personal representative petitioner v commissioner of internal revenue respondent docket no filed date john w porter keri d brown stephanie loomis price and j graham kenney for petitioner randall e heath and sandra veliz for respondent memorandum findings_of_fact and opinion holmes judge anne petter inherited a large amount of valuable stock and set up a company to hold it she divided anne died after trial so references to her are references continued ownership of the company among herself trusts for her children’s benefit and charities she performed this division by allocating a fixed number of units in the company to herself a fixed dollar amount to the trusts and the rest to the charities her estate and the commissioner now agree that the value of the company was higher than she first reported that has triggered the obligation to reallocate more shares in the company to the charities the question is how to measure the size of the gift on which tax is owed we have to multiply the new value of the shares by the number of shares going to the charities but is it the number of shares before or after the reallocation findings_of_fact anne petter’s uncle was one of the first investors in what became united parcel service of america inc ups ups was a privately owned company for most of its existence and its stock was mostly passed within the families of its employees when anne’s uncle died in he left her his stock it was by then worth millions anne had been a schoolteacher most of her life and after her windfall she continued to teach in washington state where she resided almost all her life--including when she filed the petition in this case she also stayed in the same house and continued to her estate and her son as its personal representative she continued to stay close to her children she had three-- donna petter moreland terrence petter terry and david petter donna has little or no business experience and worked mostly inside the home rearing three young children terry owns a tow truck business and has three adult children of his own these children and grandchildren were the natural objects of anne’s affection and by she realized that her ups stock put her in need of an estate planner she first went to her lawyer jim tannesen for advice but when she told him that she thought her estate would be worth close to dollar_figure million tannesen had the professional responsibility to suggest a lawyer more experienced in handling high-value estates he referred anne to richard lemaster a lawyer with years of estate-planning experience and advanced degrees in tax law i future planning lemaster first asked anne what she wanted to do with her wealth she told him that she wanted her estate put in order so it could provide a comfortable life for her children and their children and that she wanted to give some money to charity anne also wanted donna and terry to learn how to manage the family’s assets but she felt they needed help to learn how to invest and manage money wisely this case does not involve david who is disabled anne provided separately for him and those transfers are not at issue lemaster set to work first he created a life_insurance_trust ilit in to cover any estate_taxes anne contributed enough to the ilit in date for it to buy a dollar_figure 5-million life-insurance policy with her children and grandchildren as beneficiaries the purpose of the ilit was to create a source of ready cash to pay the large estate_tax bill that would arise upon anne’s death lemaster couldn’t just put the money in a bank account in anne’s name doing that would make anne the owner of the money and it would become yet another taxable part of the estate instead he made the trust the owner and anne’s heirs the beneficiaries excluding it from the estate lemaster then put dollar_figure million of ups stock in a charitable_remainder_unitrust crut to cover anne’s day-to-day expenses for the rest of her life the crut gave anne an annual income of anne set up an irrevocable_life_insurance_trust instead of simply buying a life_insurance_policy and naming beneficiaries which may have estate or gift_tax consequences the ilit buys a life_insurance_policy on the life of the grantor and the ilit then names the beneficiaries this structure removes the insurance_policy from the grantor’s estate and can allow the proceeds to flow to the beneficiaries tax free cruts are governed by sec_664 they must pay a specified percentage of their fair_market_value to a beneficiary at least annually followed by payment of the remaining trust corpus to a charity if a crut meets all the regulatory requirements the taxpayer may take a charitable deduction equal to the value of the charitable_remainder in the year he creates the trust sec_1_170a-6 income_tax regs unless otherwise indicated all section references are to the internal_revenue_code in effect for the year at issue and rule references are to the tax_court rules_of_practice and procedure percent of its assets--dividends being sufficient to fund the payout without generating immediate capital_gains_tax after she died the remainder passed to charity ii the petter family limited_liability_company and the trusts at the heart of the plan and the center of this case were the petter family llc pfllc and the trusts lemaster designed the pfllc in to be a disregarded limited_liability company5 incorporated in washington he planned to fund it with ups stock at a later date but then in date ups announced it was going public this froze anne’s ups stock so she could not transfer it until the initial_public_offering was done after anne’s stock thawed out in date she discovered that its value had risen to dollar_figure million a limited_liability_company unless it elects to be taxed as a corporation is a passthrough_entity its profits and losses pass through the entity to the owners called members who pay individual income_tax an llc’s owners do not own shares but membership units an llc with just one owner is disregarded if it is recognized under state law for instance to limit the owner’s liability but ignored under federal tax law so that the taxable activities of the company are treated as though the owner carried out those activities himself sec_301_7701-3 and b proced admin regs companies often impose lock-up periods when they make an initial_public_offering to prevent existing shareholders from immediately selling their stock in theory this prevents a flood of stock from hitting the market and lowering its price near the start of public trading see mcintyre ipo lock-ups stop insider selling investopedia http investopedia com articles stocks ipo_lockup asp lemaster and anne began finishing their plans for the pfllc lemaster had drawn up the petter family llc operating_agreement which anne donna and terry signed anne contributed big_number shares of ups stock worth dollar_figure to the pfllc these shares formed anne’s capital_account defined in the operating_agreement as an account which will initially reflect the member’s interest in the property contributed upon formation of the company net of associated liabilities she received big_number membership units divided into three classes monogrammed with the initials of herself and her children class a class d and class t membership unit class number of units class a class d class t total big_number big_number big_number big_number the holders of each class of units had the right to elect a manager by majority vote anne became the manager of the class a units donna managed class d and terry managed class t a majority of the managers had to approve decisions about how to manage the company with the caveat that no vote could pass although the operating_agreement for the pfllc says the initial capital_account for each member is dollar_figure per unit we find that anne’s capital_account was actually dollar_figure per unit as she gave ups stock worth dollar_figure and got big_number units in return the discrepancy is immaterial to our holding without the approval of the manager in charge of the class a units--effectively giving anne veto power over all corporate decisionmaking another potentially important provision required that when members rather than managers voted the vote carried by a majority of membership units for each class not just a majority of members this meant for instance that if members outside the family acquired a majority of any class of shares they could override the family’s votes and elect their own manager but the operating_agreement also made such a loss of control unlikely it restricted what rights could be transferred by gift or bequest so that transfers outside the petter family required manager approval and transferees took only assignees’ rights unless they were accepted as a substituted member by the managers assignees had no voting rights but got distributions of profits and losses lemaster advised anne that managers owed fiduciary duties to all members but owed no such duties to assignees substituted members had to pay transfer costs and become parties to the operating_agreement by executing instruments of joinder this was undoubtedly the most complex transaction any of the petters had been a part of donna struggled to understand it and even hired an attorney to help her that lawyer seems to have been of some help--lemaster refers to some changes in the trust structure that donna’s lawyer prompted him to make--but the record does not show specifically what they were the situation does not seem to have turned at all adversarial however and donna did not even remember any specific bits of advice her lawyer gave once anne had all the units in place and divided into classes it was time to transfer them to donna and terry in late lemaster set up two intentionally defective grantor trusts although specialists call them defective these types of trusts are widely used by sophisticated estate planners for honest purposes anne’s trusts were defective because they allowed the trustee of either trust to purchase and pay premiums on a life_insurance_policy on the life of the grantor anne in contravention of sec_677 this meant that for income- tax purposes--though not for any other purpose--anne would be treated as the owner of the assets even though they were legally owned by a trustee and she herself would remain liable for income taxes on the trust’s income for the rest of her life this arrangement did however remove those assets held in trust from anne’s estate reducing her estate-tax liability it also allowed her to make income-tax payments for the trusts without the irs’ treating those payments as additional gifts to her children donna became the trustee of the donna k moreland long term trust donna’s trust and terry became the trustee of the terrence f petter long term trust terry’s trust donna’s trust named donna and her descendants as beneficiaries terry’s named him and his descendants as beneficiaries iii funding the trusts the transfer proceeded in two parts--first a gift then a sale on date anne gave the trusts pfllc units meant to make up percent of the trusts’ assets then on march she sold them units worth percent of the trusts’ assets in return for promissory notes as part of these transfers anne also gave units to two charities--the seattle foundation and the kitsap community_foundation both are public_charities under sec_501 which means donors can deduct donations worth up to percent of their income this is an advantage that public_charities have over private_foundations whose donors can deduct contributions only up to the lesser_of percent of income or what’s left of their percent public-charity balance sec_170 b f anne chose charities that are community foundations offering donor-advised funds donor-advised funds are owned and controlled by a charity but kept separately identified donors can at their leisure later advise the charity where they lemaster said he believed there was a rule_of thumb that a_trust capitalized with a gift at least percent of its assets would be viewed by the irs as a legitimate arm’s-length purchaser in the later sale want the money to go and how it should be invested see sec_4966 community foundations accept contributions manage investments and then spread the money across a wide variety of charitable organizations easing the administrative burdens of charitable giving the seattle foundation is big enough that it has the expertise to handle large and complex gifts like anne’s which would have been too complicated for many of the smaller charities that were the ultimate recipients of her largesse the division of pfllc’s units among gifts to the trusts and community foundations and gifts and sales to the trusts meant that anne had to value what she was giving and selling lemaster used a formula_clause dividing the units between the trusts and two charities to ensure that the trusts did not get so much that anne would have to pay gift_tax there were two sets of gift documents one for donna’s trust which named it and the kitsap community_foundation as transferees and a similar set for terry’s trust which named it and the seattle foundation as transferees the formula is laid out in both sets and in several sections recital c of terry’s document for example provides although community foundations tend to be rather quiet in their fund-raising they are rapidly becoming a force in charitable giving across the country increasing dollars donated from half a billion in to an estimated dollar_figure billion in key facts on community foundations foundation center date transferor wishes to assign class t membership units in the company the units including all of the transferor’s right title and interest in the economic management and voting rights in the units as a gift to the transferees donna’s document is similar except that it conveys class d membership units sec_1 of terry’s transfer document reads transferor assigns to the trust as a gift the number of units described in recital c above that equals one-half the minimum10 dollar amount that can pass free of federal gift_tax by reason of transferor’s applicable_exclusion_amount allowed by code sec_2010 transferor currently understands her unused applicable_exclusion_amount to be dollar_figure so that the amount of this gift should be dollar_figure and assigns to the seattle foundation as a gift to the a y petter family advised fund of the seattle foundation the difference between the total number of units described in recital c above and the number of units assigned to the trust in sec_1 the gift documents also provide in sec_1 the trust agrees that if the value of the units it initially receives is finally determined for federal gift_tax purposes to exceed the amount described in sec_1 trustee will on behalf of the trust and as a condition of the gift to it transfer the excess units to the seattle foundation as soon as practicable this is a typo the intention of all the parties involved was to refer to the maximum amount that could pass free of gift_tax the commissioner did not raise any problems that this language might cause and we find it to have been a mere scrivener’s error the foundations similarly agree to return excess units to the trust if the value of the units is finally determined for federal gift_tax purposes to be less than the amount described in sec_1 donna’s documents are similar but substitute the kitsap community_foundation for the seattle foundation for the date sale both trusts split their shares with the seattle foundation recital c of the sale documents reads transferor wishes to assign big_number class t or class d membership units in the company the units including all of the transferor’s right title and interest in the economic management and voting rights in the units by sale to the trust and as a gift to the seattle foundation sec_1 reads transferor assigns and sells to the trust the number of units described in recital c above that equals a value of dollar_figure as finally determined for federal gift_tax purposes and assigns to the seattle foundation as a gift to the a y petter family advised fund of the seattle foundation the difference between the total number of units described in recital c above and the number of units assigned and sold to the trust in sec_1 sec_1 of the sale documents differs slightly from sec_1 of the gift documents in the sale documents it reads the trust agrees that if the value of the units it receives is finally determined to exceed dollar_figure trustee will on behalf of the trust and as a condition of the sale to it transfer the excess units to the seattle foundation as soon as practicable likewise the seattle foundation agrees to transfer shares to the trust if the value is found to be lower than dollar_figure in exchange for the units transferred in the sale documents donna and terry as trustees for their trusts each executed dollar_figure installment notes on date the notes have a 37-percent interest rate and require quarterly payments of dollar_figure for principal and accrued interest the notes have a 20-year term expiring on march anne and the children as trustees signed pledge agreements giving anne a security_interest in the pfllc shares transferred under the sale agreements the pledge agreements specify it is the understanding of the pledgor and the security party sic that the fair_market_value of the pledged units is equal to the amount of the loan--ie dollar_figure if this net fair_market_value has been incorrectly determined then within a reasonable period after the fair_market_value is finally determined for federal gift_tax purposes the number of pledged units will be adjusted so as to equal the value of the loan as so determined the parties agree that donna’s and terry’s trusts have made regular quarterly payments since date the trusts were able to make payments because the pfllc paid quarterly distributions to all members crafted so the amounts paid to the trusts covered their quarterly payment obligations donna’s sale documents also add initially before receives in sec_1 the transfer documents clearly indicate that anne intended donna terry and the two foundations to be substituted members rather than assignees sec_3 of each transfer document reads upon each transferee’s execution of this transfer agreement it will be admitted as a substituted member under the terms and subject_to the requirements and limitations of the operating_agreement both the gift documents and the sale documents have two signature pages the first bears the signatures of anne as transferor donna or terry as trustee of their trusts and the president of the seattle or kitsap community_foundation the second set is the consent of managers and members for the gift documents anne donna and terry each signed as both managers and members for the sale documents anne donna and terry signed as consenting managers and members but the kitsap community_foundation president also signed as a consenting member iv the charities we have no doubt that behind these complex transactions lay anne’s simple intent to pass on as much as she could to her children and grandchildren without having to pay gift_tax and to give the rest to charities in her community lemaster got the community foundations involved because he knew bill sperling who was involved in gift planning at the seattle foundation and it was this relationship that led to lemaster’s suggestion to the petters that they create a donor-advised_fund donna decided that she wanted to donate to the kitsap community_foundation because she lived in kitsap county and wanted to make a bigger difference in a smaller communitydollar_figure she also trusted the smaller organization because her father-in-law was familiar with it and her lawyer was on its board_of directors the kitsap community_foundation was tiny compared to the seattle foundation and did not have the expertise to independently vet the paperwork so it glommed onto the same agreements the petters negotiated with the seattle foundation because the petter gift consisted of units in the pfllc rather than liquid equities or cash the seattle foundation asked outside counsel to evaluate whether accepting the units would jeopardize the tax-exempt status of the donor-advised_fund michele osborne a lawyer at davis wright tremaine llp negotiated the terms of the transfer for the seattle foundation and as a practical matter for the kitsap community_foundation too she asked that the transfer documents make clear that the foundations would bear no legal costs in connection with the gift she also wanted to clarify that the foundations would be donna was right about being able to make a difference--in her donations of dollar_figure more than doubled the foundation’s total annual grantmaking in contrast the seattle foundation held more than dollar_figure million worth of assets substituted members in the pfllc rather than assignees with no voting rights osborne also recognized that the foundations might need distributions from the pfllc to cover any taxes triggered by the transaction and warned the petters that they would have to monitor the investment mix of the pfllc to ensure that the seattle foundation did not become exposed to unrelated business taxable incomedollar_figure she suggested some specific changes to the transfer documents to address her concerns and lemaster accepted them on the date of the gifts and sales to the trusts anne sent letters to the foundations describing her gift in them she requested that the foundations establish a y petter family advised funds funded by that portion of a gift of class d or class t membership units the llc units in petter family l l c that exceeds a value of dollar_figure as of the closing of the new york stock exchange on that date in similar letters describing the units that she was selling to the trusts she made a point of describing her additional gift to the foundations of that portion of a transfer of big_number class d or class t membership units the llc units in petter family l l c that exceeds a value of dollar_figure pincite am on date tax-exempt organizations have to pay taxes on income if the income comes from a trade_or_business that is unrelated to the organization’s charitable purpose sec_511 through once the transfers were completed the petters directed many gifts through both the foundations to such organizations as the downtown action to save housing the real change homeless empowerment project the girl scouts junior achievement the olympic music festival the kitsap children’s musical theatre the salvation army habitat for humanity local food pantries and many others v appraisal unit distribution and audit during the planning stages lemaster had to estimate the value of the pfllc units so he could predict how many units might go to the trusts and how many might go to the foundations his method was not sophisticated he took the market_value of the ups stock held by the pfllc and discounted it by percent such a discount is a major goal and often a major problem of contemporary estate_planning anne could of course have just transferred and sold her ups stock outright but doing so would’ve enabled the commissioner to tax her on its full value-- ups stock is publicly traded and easy to price but a gift of membership units in an llc is harder to value because provisions in the operating_agreement restrict members’ rights to sell and typically no single member is allowed to sell llc assets without approval of the managers this creates the possibility of a more taxpayer-friendly valuation see estate of erickson v commissioner tcmemo_2007_107 acknowledging the valuation benefits associated with family limited_partnerships but once the documents were signed and the deal was done lemaster’s estimates needed to be replaced with a formal appraisal he turned to the well-known firm of moss adams on date moss adams sent lemaster the 41-page petter family llc appraisal report valuing the membership units as of the march gift to the trusts moss adams’s appraisal compared the pfllc to closed-end mutual funds owning domestic stock and having little or no debt closed-end funds very often trade at a discount to net-asset value and moss adams’s survey of the range of those discounts led it to take a valuation discount of percent to value the pfllc at dollar_figure million from there it lopped off an additional percent for nonmarketability reached by averaging the marketability discounts found in two studies the result was a unit value of dollar_figure on the basis of the moss adams valuation lemaster allocated the shares transferred by anne’s gift and sale moss adams determined a general market_discount of percent for closed-end funds and added percent to the discount rate to account for the pfllc’s unique risk factors the percent represented percent of the pfllc’s discounted value unique risk factors were those for which according to moss adams the pfllc had more risk than the companies in the market study--notably lack of asset diversification recipient class of unit number of units terry’s trust donna’s trust seattle foundation seattle foundation kitsap community_foundation t d t d d anne kept the rest dollar_figure dollar_figure dollar_figure class of units number of units class a class t class d total dollar_figure dollar_figure big_number this left the parties with the following interests in the pfllc name anne terry’s trust donna’s trust seattle foundation kitsap community_foundation total number of units owned big_number big_number big_number big_number percent interest although anne now had a much smaller interest than either of the trusts she owned all the class a shares entitling her to elect a manager with veto power over any other managers and the foundations both had minority interests allowing terry’s and donna’s trusts to retain control_over votes for the managers of the class t and d units anne timely filed a gift_tax_return in date she hid nothing on that return she listed gifts worth dollar_figure to donna’s and terry’s trusts gifts worth dollar_figure dollar_figure and dollar_figure to the seattle foundation and a gift worth dollar_figure to the kitsap community_foundation for all of these gifts her return indicated that the gifts were units in the pfllc and the value of the limited_liability_company is based on the fair_market_value of the underlying assets with a non- marketability discount and a net asset value adjustment applied she also listed several cash gifts of dollar_figure or less to her children grandchildren and son-in-law she even attached to the return a disclosure statement that included the formula clauses from the transfer documents a spreadsheet of the pfllc unit allocation the organizing documents for the pfllc the trust agreements and transfer documents letters of intent to the seattle foundation and the kitsap community_foundation the moss adams appraisal report annual statements of account for her ups stock and forms noncash charitable_contributions disclosing her gifts to the seattle foundation and the kitsap community_foundation the commissioner’s audit began in date the parties agree that throughout the audit anne complied with every request for witnesses information documents meetings or interviews in a timely manner the parties were unable to resolve the issues during the examination and in date the commissioner sent anne a notice_of_deficiency in gift_tax for the commissioner had several quarrels first he believed the correct value of a single class t or d membership unit in the pfllc was much higher than reported he thought it should be dollar_figure which would balloon the total value held by the trusts and the charities owner terry’s trust donna’s trust seattle foundation kitsap community_foundation number of units big_number big_number moss adams value irs value dollar_figure dollar_figure dollar_figure dollar_figure big_number dollar_figure dollar_figure dollar_figure dollar_figure lemaster had anticipated that the final unit value might be different from his or moss adams’s and thought he had accounted for it with all the formula clauses we’ve already described under these clauses a revaluation would trigger a reallocation of shares from the trusts to the charities creating--lemaster thought--a greater charitable deduction for anne but no additional gift_tax the commissioner thinks these formula clauses are invalid if he is right the units might still be reallocated to the charities but anne would not get an additional charitable deductiondollar_figure this also would mean that the shares sold to the trusts were sold for less than full and adequate_consideration and thus were transferred partly by sale and partly by an additional dollar_figure gift to each trust computed by deducting the price of the installment notes from the fair_market_value of the shares transferred the commissioner thus concluded that anne had made gifts in the following amounts to the two trusts the commissioner did allow an additional dollar_figure deduction for the increased value of the shares already given to the foundations there appears to be a misplaced decimal in the notice_of_deficiency under explanation of adjustments issue class d units march gifts the commissioner correctly calculates the additional deduction under issue however so the typo does not affect our holding transaction gift to terry’s trust sale to terry’s trust gift to donna’s trust sale to donna’s trust total taxable gift original gift dollar_figure adjusted gift difference dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number anne filed a timely petition with us and the parties agreed on a final valuation of dollar_figure per pfllc unit after reallocation at this value the units will come to rest with the seattle foundation owning the largest overall percentage although not a majority of any single class name total units owned percent interest anne terry’s trust donna’s trust seattle foundation kitsap community_foundation big_number big_number big_number big_number we are asked to decide whether to honor the formula_clause for the gift and the sale if we honor them we must also decide when anne may take the charitable_contribution_deduction associated with the additional units going to the foundations opinion anne immediately takes the defensive denying that the clauses are void because of public policy she points to state law saying that this clause works under washington property laws to pass a particular dollar value of money to intended beneficiaries because it works under state law she says it should also be honored under federal gift_tax law as a transfer in the commissioner opens fire saying that the formula clauses are void because they are contrary to public policy which would create an increased gift_tax liability for annedollar_figure this is an old argument but before launching into our analysis we begin with some background on the gift_tax sec_2501 lays the groundwork for a tax imposed for each calendar_year on the transfer of property by gift during such calendar_year by any individual resident or nonresident sec_2502 tells us the donor pays the tax not the donee sec_2502 explains the cumulative aspects of gift_tax whereby the tax_rate for a gift is set by looking at that year’s gifts in relation to the donor’s lifetime giving gifts of dollar_figure per in the midst of this back-and-forth is an argument about who should bear the burden_of_proof under sec_7491 the issues in this case however are mostly a matter of applying law to uncontested facts so we don’t have to address who bears the burden_of_proof see 130_tc_1 n affd ___ f 3d___ 8th cir date donee per year increased for inflation are excluded from the lifetime cumulative total sec_2503 gifts for educational or medical_expenses are also excluded sec_2503 perhaps the most important section for our purposes however is sec_2505 the unified_credit against gift_tax in the year anne made her gifts the unified_credit allowed a donor to make lifetime tax-free gifts of up to dollar_figure million at the time she made the gifts anne believed she had dollar_figure remaining of her unified_credit and the commissioner nowhere disputes this i savings clauses procter and its progeny the parties’ argument in this case harks back to the old case of 142_f2d_824 4th cir revg a memorandum opinion of this court procter assigned remainder interests in two trusts to a new trust for the benefit of his children after his death the assets would go to his children if he outlived his mother and for one of the trusts if he was at least when she died the new trust would also repay a note to procter’s mother at her death if he was still alive the trust document had a clause adjusting the gift i t is agreed by all the parties hereto that in that event the excess property hereby transferred which is decreed by such court to be subject_to gift_tax shall automatically be deemed not to be included in the conveyance in trust hereunder and shall remain the sole property of the taxpayer id pincite the fourth circuit’s opinion in the case became the cornerstone of a body of law regarding savings clauses -- adjustment clauses requiring that any gift subject_to gift_tax revert back to the donordollar_figure the fourth circuit’s opinion rested on two propositions that now frequently appear in gift and estate_tax cases involving adjustment clauses the first is that the gift was a present gift of a future_interest in property and that the formula therefore created a condition_subsequent id the second proposition was that the clause was contrary to public policy for three reasons the clause had a tendency to discourage the collection of the tax since efforts to collect would simply undo the gift the effect of the clause would be to obstruct the administration of justice by requiring the courts to pass upon a moot case and a judicial proclamation on the value of the trust would be a declaratory_judgment because the condition is not to become operative until there has been a judgment but after the judgment has been rendered it cannot become operative because the matter involved is concluded by the judgment id pincite in christiansen t c pincite the daughter specified that if her disclaimer failed to be a qualified_disclaimer she would take all steps necessary to make it a qualified_disclaimer we called this a savings_clause but it is clearly not the same kind of adjustment clause at issue in this case the issue came up again when another taxpayer tried to use a similar clause this time in a sale this adjustment clause read ‘if the fair_market_value of the colorado corporation stock is ever determined by the internal_revenue_service to be greater or less than the fair_market_value determined above the purchase_price shall be adjusted to the fair_market_value determined by the internal_revenue_service ’ 545_f2d_700 10th cir the tenth circuit found this clause called a price-adjustment clause because it adjusts the consideration paid in a sale to be valid the tenth circuit based its decision on factual determinations that the stock was difficult to value and the sale occurred in the ordinary course of business with no donative_intent id pincite the tenth circuit was on its own for a long time however between and courts refused to honor either savings clauses or price-adjustment clauses 115_tc_506 n giving no effect to transfer of flp shares equal in value to dollar_figure to trusts when taxpayers instead reported on tax returns gift of 3-percent interest in flp and argued at trial that true value of shares was lower than that reported in the transfer documents 87_tc_78 relying on public-policy arguments from procter giving no effect to clause requiring donors to adjust number of shares so total value is dollar_figure 82_tc_239 giving no effect to clause requiring adjustment if in the opinion of the attorney for the trustee a lower value is not reasonably defendable affd without published opinion 786_f2d_1174 9th cir even the commissioner weighed in releasing revrul_86_41 1986_1_cb_300 which found no difference between a savings_clause like the one in procter and the price-adjustment clause like the one in king that required the donee to pay the donor an amount equal to the excess value transferred as a gift the commissioner determined that both types of clause were invalid and would be ignored during audits ii formula clauses creative tax planners found more sophisticated ways to accommodate uncertain valuations in wealth transfers in we decided a case in which transfer documents specified that the children of the taxpayer should receive a gift having a fair_market_value of dollar_figure anything in excess of that up to dollar_figure would go to a local symphony and all the rest would go the communities foundation of texas inc 120_tc_358 revd 461_f3d_614 5th cir much like anne’s gift the taxpayer’s gift was of shares in a limited_liability partnership id pincite the donees allocated the shares amongst themselves and they applied a large discount id pincite unlike the pfllc however the partnership retained the rights to buy out the charitable interests once the charities had been cashed out the partnership no longer owed the charities fiduciary duties and the charities lost their rights to demand a reallocation id pincite in a divided opinion we found that the value_of_the_gift was higher than the original appraisal id pincite we also held that the formula did not reallocate the shares later but worked only to allocate shares on the basis of the parties’ estimate of their value at the time of the gift rather than later on id pincite we did not find it necessary to consider procter the fifth circuit reversed because it held we had impermissibly looked at events occurring after the sale date mccord v commissioner f 3d pincite the court pointed to our reliance on a later agreement between mccord’s children and the charities that translated the dollar formula in the transfer documents into percentage interests in the partnership when we should have relied only on the initial transfer documents id the fifth circuit also noted with approval judge foley’s finding in his dissent that the commissioner had not met his burden_of_proof id pincite the commissioner had dropped the procter- like arguments on appeal id pincite we have since looked at adjustment clauses in estate of christiansen v commissioner affd ___ f 3d ___ 8th cir date there the taxpayer’s daughter structured a disclaimer of her inheritance to keep part of it and give the rest to charity the formula was quite complicated christine christiansen hamilton hereby disclaims that portion of the gift determined by reference to a fraction the numerator of which is the fair_market_value of the gift before payment of debts expenses and taxes on date less six million three hundred fifty thousand and no dollars dollar_figure and the denominator of which is the fair_market_value of the gift before payment of debts expenses and taxes on date the disclaimed portion for purposes of this paragraph the fair_market_value of the gift before payment of debts expenses and taxes on date shall be the price at which the gift before payment of debts expenses and taxes would have changed hands on date between a hypothetical willing buyer and a hypothetical willing seller neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts for purposes of chapter of the internal_revenue_code as such value is finally determined for federal estate_tax purposes id pincite the commissioner quibbled with this clause because he said it worked to reallocate gifts after an audit the commissioner invoked the standard procter arguments to try to defeat the additional charitable deduction claimed by the estate viz that the adjustment clause was a condition_subsequent and that it was void as contrary to public policy id pincite but we sided with the taxpayer we held that the transfer to charity was not contingent because it remained percent of the total estate in excess of dollar_figure regardless of the estate’s ultimate valuation id pincite we also found that the public-policy arguments were undermined by 383_us_687 where the supreme court warned against invoking public-policy exceptions to the code too freely the frustration of public policy that would be caused by allowing the contested deduction must be severe and immediate christiansen t c pincite in christiansen we not only held the clause not to be void as against public policy but concluded instead that public policy weighed in favor of giving gifts to charities we also thought the commissioner’s fears that charities would be abused by low-ball estate appraisals were exaggerated executors directors of charitable foundations who owe fiduciary duties to protect charitable interests and state attorneys general would all have some incentive to police low- ball appraisals id pincite although christiansen was a split decision on other issues we were unanimous in concluding that this case is not procter id pincite iii drawing the line to reach a reasonable conclusion in this case we start with two maxims of gift-tax law a gift is valued as of the time it is completed and later events are off limits 279_us_151 and gift_tax is computed at the value of what the donor gives not what the donee receives id the fifth circuit held in mccord that what the taxpayer had given was a certain amount of property and that the appraisal and subsequent translation of dollar values what the donor gave each donee into fractional interests in the gift what the donees got was a later event that a court should not consider f 3d pincite in christiansen we also found that the later audit did not change what the donor had given but instead triggered final allocation of the shares that the donees received t c pincite the distinction is between a donor who gives away a fixed set of rights with uncertain value--that’s christiansen--and a donor who tries to take property back--that’s procter the christiansen formula was sufficiently different from the procter formula that we held it did not raise the same policy problems a shorthand for this distinction is that savings clauses are void but formula clauses are fine but figuring out what kind of clause is involved in this case depends on understanding just what it was that anne was giving away she claims that she gave stock to her children equal in value to her unified_credit and gave all the rest to charity the commissioner claims that she actually gave a particular number of shares to her children and should be taxed on the basis of their now-agreed value recital c of the gift transfer documents specifies that anne wanted to transfer class t or class d membership units in the aggregate she would not transfer more or fewer regardless of the appraisal valuedollar_figure the gift documents specify that the trusts will take the number of units described in recital c above that equals one-half the applicable_exclusion_amount allowed by code sec_2010 the sale documents are more succinct stating the trusts would take the number of units described in recital c above that equals a value of dollar_figure the plain language of the documents shows that anne was giving gifts of an ascertainable dollar value of stock she did not give a specific number of shares or a specific percentage interest in the pfllc much as in christiansen the number of shares given to the trusts was set by an appraisal occurring after the date of the gift this makes the petter gift more like a christiansen formula_clause than a procter savings_clause iv public policy again because this formula_clause is not sufficiently similar to that in procter we must first ask whether to apply policy the contract includes a choice-of-law provision specifying use of washington law under washington contract law courts should not rely on contract recitals absent ambiguity in the operative clauses of the contract brackett v schafer p 2d wash however the operative provisions of this contract refer to recital c and would be ambiguous if we did not give consideration to the recital we therefore hold that the recital c clauses in both the gift and sale documents should be given effect arguments at all as we noted in christiansen there is a general_public policy in favor of encouraging gifts to charities see 338_us_692 and the facts in this case show charities sticking up for their interests and not just passively helping a putative donor reduce her tax bill the foundations here conducted arm’s-length negotiations retained their own counsel and won changes to the transfer documents to protect their interests perhaps the most important of these was their successful insistence on becoming substituted members in the pfllc with the same voting rights as all the other members by ensuring that they became substituted members rather than mere assignees the charities made sure that the pfllc managers owed them fiduciary dutiesdollar_figure in mccord the taxpayers built into the partnership_agreement restrictions on charitable interests in the partnership ie limited voting the operating_agreement specifies that managers are to have the same fiduciary responsibilities to the company and its members as a partner has to a partnership and its partners the operating_agreement specifies the use of washington law under washington law partners owe the partnership and the partners the duty_of loyalty and the duty_of care and can be sued for breach of either wash rev code ann sec_25 west the duty_of loyalty prevents partners from coopting partnership business opportunities transacting business with the partnership as an adverse_party and competing with the partnership id sec_25 the duty_of care prevents a partner from engaging in grossly negligent or reckless conduct intentional misconduct or knowing violations of the law id sec_25 partners also have a duty_of good_faith and fair dealing id sec_25 rights and the right of other partners to buy out the charitable interests at any time t c pincite in contrast anne’s gift made the charities equal members in the pfllc giving the charities power to protect their interests through suits for breach of the operating_agreement or breach of a manager’s fiduciary duties as well as through the right to vote on questions such as amending the operating_agreement and adding new members these features leave us confident that this gift was made in good_faith and in keeping with congress’s overall policy of encouraging gifts to charities as in christiansen we find that this gift is not as susceptible to abuse as the commissioner would have us believe although unlike christiansen there is no executor to act as a fiduciary the terms of this gift made the pfllc managers themselves fiduciaries for the foundations meaning that they could effectively police the trusts for shady dealing such as purposely low-ball appraisals leading to misallocated gifts see wash rev code ann sec_25 west the directors of the seattle foundation and the kitsap community_foundation owed fiduciary duties to their organizations to make sure that the appraisal was acceptable before signing off on the gift--they also had a duty to bring a lawsuit if they later found that the appraisal was wrong see id sec_24 west we could envision a situation in which a charity would hesitate to sue a living donor and thus risk losing future donations or the donor’s goodwill however gifts are irrevocable once completed and the charities’ cause of action most likely would have been against the trusts rather than against anne since the trusts held the additional shares to which the charities laid claim the commissioner himself could revoke the foundations’ c exemptions if he found they were acting in cahoots with a tax-dodging donor see eg sec_503 and washington’s attorney_general is also charged with enforcing charities’ rights see wash rev code ann sec_11 west we simply don’t share the commissioner’s fear in gifts structured like this one that taxpayers are using charities just to avoid taxdollar_figure we certainly don’t find that these kinds of formulas would cause severe and immediate frustration of the public policy in favor of promoting tax audits see tellier u s pincite applying the supreme court’s admonition to the second and third policy concerns in procter we find a similar lack of severe and immediate threat to public policy we do not fear although we don’t look at subsequent events when evaluating the bona fides of a gift we note favorably that at the time of trial the taxpayer was in the process of reallocating these shares in conformance with the adjusted appraisal that we are passing on a moot case because of the potential sources of enforcement we have little doubt that a judgment adjusting the value of each unit will actually trigger a reallocation of the number of units between the trusts and the foundation under the formula_clause so we are not issuing a merely declaratory_judgment anne also points out several other instances in which the irs and congress specifically allow formula clauses like this one she argues that if congress allows these clauses in other contexts there can’t be a general_public policy against using formula provisions for instance the following sections specifically sanction formula clauses sec_1_664-2 income_tax regs provides the stated dollar amount of a payment to the recipient of a charitable_remainder_annuity_trust may be expressed as a fraction or a percentage of the initial net fair_market_value of the property irrevocably passing in trust as finally determined for federal tax purposes see also revrul_72_395 sec_5 1972_2_cb_340 including acceptable sample formula_clause revproc_64_19 c b part sanctions the use of formula clauses in marital_deduction bequests the commissioner’s generation-skipping_transfer regulations provide that executors may allocate the decedent’s gst_exemption by use of a formula sec_26_2632-1 gst regs the gift-tax qualified-disclaimer regulations include an example of an allowable fractional formula where the numerator is the smallest amount which will allow a’s estate to pass free of federal estate_tax and the denominator is the value of the residuary_estate sec_25_2518-3 example gift_tax regs finally the gift-tax regulations’ definition of qualified annuity interests says that the fixed amount to be given to the beneficiary can include a fixed fraction or percentage of the initial fair_market_value of the property transferred to the trust as finally determined for federal tax purposes sec_25_2702-3 gift_tax regs the commissioner argues that the validity of these other types of formula clauses tells us nothing about the validity of the formula_clause at issue here he says the absence of an authorization of the formula_clause under the instant situation is intentional as the use of formula clauses in this situation is contrary to public policy and frustrates enforcement of the internal revenue laws he seems to be saying that congress and the treasury know how to allow such gifts and their failure to explicitly allow formula clauses under the code and regulations governing gift_tax means that they have implicitly banned them but the commissioner does not point us to any code section or regulation generally prohibiting formula clauses in gift transfers or denying charitable deductions for donors who use these formula clauses in transfers to charities the commissioner also fails to address the argument that anne is actually making the mere existence of these allowed formula clauses which would tend to discourage audit and affect litigation outcomes the same way as anne’s formula_clause belies the commissioner’s assertion that there is some well-established public policy against the formula transfer anne used the commissioner does distinguish all the similar clauses used elsewhere in the tax regulations as involving situations where money passing under those formulas will not escape taxation money passing through a gift tax-free by reason of the marital_deduction for instance will probably be taxed when the surviving_spouse dies but this is not always true consider sec_664 governing charitable_remainder trusts in which the remaining corpus of the trust will pass to charity tax-free as it does in the gift here sec_664 we are therefore not persuaded that this distinction works to separate valid from invalid formula clauses another difference the commissioner cites is that the sanctioned clauses involve the assignment of a fixed percentage or fraction of a certain value not an open ended amount exceeding a certain dollar value again we fail to see how anne’s gift to the trusts was not an assignment of a fraction of a certain value anne’s initial gift to her children could have been expressed as a gift of the number of units equal to the lesser_of or the fraction with the numerator of dollar_figure and the denominator of the value of a unit as finally determined for federal tax purposes her gift to the foundations would then be expressed as less the fraction where the numerator is dollar_figure and the denominator is the value of a unit as finally determined for federal tax purposes or big_number ___________ value of a unit for tax purposes charitable gift the sales could be expressed in a similar mathematical formula in fact only the charities could take a gift of an open ended amount the children’s gifts and sales were capped at the dollar amounts set in the transfer documents we are again unpersuaded we refuse to hold against anne simply because she chose to express her intended allocation of the gift in plain english rather than the kind of mathematical formula outlined in regulations for other types of transfers in summary anne’s transfers when evaluated at the time she made them amounted to gifts of an aggregate and set number of units to be divided at a later date based on appraised values the formulas used to effect these transfers were not void as contrary to public policy as there was no severe and immediate frustration of public policy as a result and indeed no overarching public policy against these types of arrangements in the first place v timing we finally face the difficult question of evaluating when anne may claim a deduction for her gift of the additional units to the foundations the amount of a charitable deduction is the fair_market_value of the property donated at the time of the contribution sec_1_170a-1 income_tax regs but the regulations also specify that absent the delivery of an endorsed stock certificate directly to the donee or its agent the date of a gift of stock is the date the stock is transferred on the books of the issuing_corporation sec_1_170a-1 income_tax regs we don’t know when exactly the pfllc transferred the shares on its books here we have a conundrum for the events of the gift happened as follows date--gift of shares split between trusts and foundations letters of intent to foundations date--sale to trusts date--moss adams appraisal report later in 2002--the seattle foundation books the value of the allocated shares on the basis of the moss adams appraisal the kitsap community foundation’s records recognize the a y petter family advised fund as of date in date richard tizzano president of the kitsap community_foundation signed anne’s form_8283 for acknowledging receipt of pfllc units on date fall 2007--bill sperling notified of new appraisal for pfllc units and beginning of reallocation date--tax court trial reallocation ongoing anne says she should be able to take the entire charitable deduction at the time of the gift in the commissioner says that only some of the stock went to the charities in which means anne or her estate should take a deduction for the gift of the rest of the stock in some later year not before us sec_25_2511-2 gift_tax regs provides the gift_tax is not imposed upon the receipt of the property by the donee nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer nor is it conditioned upon ability to identify the donee at the time of the transfer anne made a gift_for which at the time of transfer the beneficiaries could be named but the measure of their enrichment could not yet be ascertained the commissioner is comfortable with this ambiguity when considering whether the gift is completed or not and states that tax treatment should not change simply because a donee’s identity becomes known at a date later than the date of the transfer by analogy we see no reason a donor’s tax treatment should change based on the later discovery of the true measure of enrichment by each of two named parties one of whom is a charity in the end we find it relevant only that the shares were transferred out of anne’s name and into the names of the intended beneficiaries even though the initial allocation of a particular number of shares between those beneficiaries later turned out to be incorrect and needed to be fixed the commissioner bases his argument partly on procter in which a later audit acted as a condition_subsequent to undo part of the gift f 2d pincite although he does distinguish the two by saying that the reallocation provisions in anne’s transfer documents were conditions precedent anne disputes this saying the rights mrs petter transferred to the charities were fixed and determinable on the valuation_date there were no conditions precedent that increased decreased terminated or modified those rights this must be true anne transferred a set number of shares to be divided according to valuations set at a later date regardless of what might trigger a reallocation anne’s transfer could not be undone by any subsequent events washington state law confirms this--under washington law courts are ‘ keen-sighted to discover an intention to make an unconditional and immediate gift to a charity ’ and will find a condition_precedent only when the gift document expresses a clear intention to do so sisters of charity of the house of providence v columbia county hosp distr in re trust of booker p 2d wash ct app quoting garland v seattle trust co p wash see also richardson v danson p 2d wash ‘it has been said that a condition which would ordinarily be considered precedent may be construed as a condition_subsequent where the gift is to a charity’ quoting butts v seattle-first natl bank in re quick’s estate p 2d wash we are also not convinced that the reallocation was a condition_precedent based on washington law holding that conditions precedent require the donee to perform some action before the property will become vested and because anne never expressed an intention to create anything but an immediately vested gift see richardson p 2d pincite the allocation of units based on the moss adams appraisal as an event occurring after the date of the gift is outside the relevant date of the transfer so anything that worked to change that allocation after the fact is not relevant to our current inquiry we also don’t consider dispositive the date when the charities booked the value of the units or the amounts the charities booked at the time of the initial transfer both because those actions also occurred after the transfer and because anne had no control_over the foundations’ internal accounting practices we therefore agree with anne that the appropriate date of the gift_for tax purposes is date the parties will submit calculations reflecting the amount_of_the_gift and corresponding charitable deduction decision will be entered under rule