Schlapfer v. Commissioner, T.C. Memo. 2023-65 (U.S. Tax Court May 22, 2023), is the first reported case to contain a detailed discussion of the adequate disclosure requirements under the gift tax adequate disclosure regulations that are set forth in Treas. Reg. Sec. 301.6501(c)-1(f). The IRS generally has three years from the filing of a gift tax return to assess additional gift tax. If no gift tax return is filed, or if the gift is not “adequately disclosed” on or with the gift tax return, then the IRS may assess additional gift tax at any time. However, the adequate disclosure of a completed gift on a gift tax return will commence the running of the period of limitations for assessment of gift tax on the transfer even if the transfer is ultimately determined to be an “incomplete gift” for gift tax purposes. Very significantly, the Tax Court in Schlapfer applied a lenient “substantial compliance” standard for determining whether there has  been adequate  disclosure (in contrast to a strict compliance standard).

Facts

Ronald Schlapfer was the policyholder of a universal variable life insurance policy issued in 2006. The policy was funded with cash and the corporate stock of European Marketing Group, Inc. (EMG), an entity solely owned by Schlapfer, who assigned ownership of the policy to his mother, aunt and uncle.

Mr. Schlapfer had significant foreign connections and income having been born abroad before later becoming a U.S. citizen. In 2013, Mr. Schlapfer submitted a disclosure packet to the IRS Offshore Voluntary Disclosure Program (OVDP). In this disclosure packet, he included a gift tax return for 2006 that informed the IRS that he had made gifts of EMG stock (as opposed to the universal variable life insurance policy that was funded with EMG stock), and that he made such gifts to his mother (but not to his aunt and uncle). The disclosure packet included the following four documents to which Mr. Schlapfer later pointed in support of his claim of adequate disclosure concerning this transfer: (1) the 2006 gift tax return; (2) a protective filing statement attached to the gift tax return; (3) Schedule F of Form 5471 to his 2006 federal income tax return reporting EMG; and (4) the “offshore entity statement” concerning EMG.

The IRS concluded following an audit that the gift was incomplete for federal gift tax purposes until 2007, and that because Ms. Schlapfer failed to file a gift tax return for 2007, he did not adequately disclose the gift to commence the running of the gift tax statute of limitations.

The Tax Court’s Analysis

In developing its analysis, the Tax Court started out by noting that the IRS generally has three years from the filing of a gift tax return to assess additional tax. If no return is filed, or if the gift is not adequately disclosed on or with the gift tax return, then the IRS may assess additional tax at any time. In contrast, the adequate disclosure of a gift on a gift tax return will commence the running of the statute of limitations on the transfer even if the transfer is ultimately determined to be an incomplete gift for federal gift tax purposes (which was the case here).

The Tax Court on cross-motions for summary judgment ultimately determined that Mr. Schlapfer sufficiently disclosed the gift on his 2006 gift tax return to commence the running of the gift tax statute of limitations because the documents he attached to, and referenced in, his gift tax return were sufficient to satisfy adequate disclosure under a substantial compliance standard (as opposed to a strict compliance standard). In this regard, the Tax Court noted that when deciding whether an item has been adequately disclosed, it may consider not only a return, but also documents attached to the return and information in documents referenced in the return.

Because a substantial compliance standard applies – as opposed to a strict compliance standard – the following technical shortcomings under Treas. Reg. Section 301.6501(c)-1(f)(2) did not preclude a finding of adequate disclosure:

• the fact that the submission referred to ownership of stock (as opposed to ownership of a universal variable life insurance policy that owned the stock),
• the fact that the asserted recipients of the gift failed to include Mr. Schlapfer’s aunt and uncle, and
• the fact that no statement was provided describing how Mr. Schlapfer determined the fair market value of the gift.

Rather, according to the Tax Court, 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 – and, per the Court, the preamble to the Treasury Decision that promulgated the gift tax adequate disclosure regulations made clear that this was the intended result. According to the Court, that was done here. 

Therefore, because the Tax Court found the gift tax adequate disclosure requirements to have been met here, IRS’s period of limitations to assess gift tax commenced when the return was filed in 2013. Because the IRS issued its notice of deficiency more than three years after the return’s filing (taking into account an extension that the taxpayer agreed to), the IRS was barred from assessing gift tax.

Kevin Matz, Esq., CPA, LLM, is a partner at the law firm of ArentFox Schiff LLP in New York City. He earned his JD from Fordham University School of Law, New York, N.Y. and his LL.M. in Taxation from New York University School of Law. He is a Fellow of the American College of Trust and Estate Counsel (ACTEC), where he chairs ACTEC’s Business Planning Committee and currently serves as chair of the Estate and Gift Taxation Committee of the New York City Bar Association.

 He also currently serves as a Director on the NYSSCPA Board of Directors, and currently chairs both the NYSSCPA’s Professional Liability Insurance Committee and the Foundation for Accounting Education (FAE) Curriculum Committee. He may be contacted at (212) 745-9576 or kevin.matz@afslaw.com.