Assessment Was Untimely Because Taxpayer's Disclosures Triggered Statute of Limitations

(Parker Tax Publishing June 2023)

The Tax Court held that the documents a taxpayer submitted to the IRS Offshore Voluntary Disclosure Program (OVDP) describing a gift of stock to his relatives, which the taxpayer reported as occurring in 2006, but the IRS determined did not occur until 2007, was an adequate disclosure of the gift under Reg. Sec. 301.6501(c)-1(f)(2) and therefore commenced the period of limitations to assess the gift tax. The court held that the adequate disclosure requirement may be satisfied with substantial compliance and found that the taxpayer's OVDP submissions substantially complied with the regulation by describing the gifted property, the parties to the gift, and the method used to determine the gift's fair market value. Schlapfer v. Comm'r, T.C. Memo. 2023-65.

Background

Ronald Schlapfer was born in Switzerland in 1950 and remained there until 1978. While in Switzerland, he began a career in banking and finance, working at Bank Vontobel and then Citibank. In 1979 he moved to the United States to continue his career at Citibank. After leaving Citibank in 1998, Schlapfer started his own businesses. In 2002, Schlapfer formed European Marketing Group, Inc. (EMG), a Panamanian corporation that managed investments.

In 2006, Schlapfer applied for a LifeBridge Universal Variable Life Policy (UVL Policy) offered by swisspartners Insurance Company SPC Ltd. (Swisspartners). Schlapfer wanted to create and fund a policy that his mother, aunt, and uncle could use to benefit his nephews, whose dad (Schlapfer's brother) had died in 1994. The application listed Schlapfer as the policyholder, his mother, aunt, and uncle as the insured lives, Schlapfer and his wife as the primary beneficiaries, and Schlapfer's three children and stepchild as the secondary beneficiaries. It also identified AIG Private Bank, Zurich (AIG) as the custodian.

Schlapfer funded the UVL Policy premium with $50,000 and 100 shares of EMG (i.e., all of the company's issued and outstanding stock). The initial premium payment was made on August 21, 2006, when EMG transferred $50,000 to the AIG account. The EMG shares were transferred to the AIG account on November 8, 2006. Schlapfer eventually substituted his mother, aunt, and uncle for himself as the policyholders. On January 23, 2007, Schlapfer initially requested that Swisspartners assign the policy to his mother as the policyholder with immediate effect. Then on April 23, 2007, Schlapfer and his mother jointly requested that Swisspartners assign the policy so that Schlapfer's mother, aunt, and uncle would be joint policyholders. They also requested that the beneficiary designations be made irrevocable. These changes were executed on May 31, 2007. All other terms of the policy remained the same.

In November 2013, Schlapfer, through counsel, submitted a disclosure packet to participate in the IRS Offshore Voluntary Disclosure Program (OVDP). The submission included, among other documents, (1) a gift tax return for 2006 which reported a gift stemming from Schlapfer's assignment of the UVL Policy; (2) a protective filing attachment stating that Schlapfer made a gift of controlled foreign company (CFC) stock and was not subject to U.S. gift tax; (3) Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, which described the number and type of EMG shares; and (4) an Offshore Entity Statement detailing his control over EMG. The 2006 gift tax return reported the gift as stock rather than the UVL Policy because the 2012 OVDP instructions required taxpayers to disregard certain entities that hold underlying assets, and Schlapfer believed the policy was such an entity.

In 2016, the IRS opened an examination of Schlapfer's 2006 gift tax return. The IRS concluded that there was no taxable gift in 2006 because Schlapfer failed to relinquish dominion and control of the UVL Policy as the policyholder until May 2007. In 2019, the IRS issued a notice of deficiency determining a gift tax liability of $4,429,949, plus penalties and interest. Schlapfer took his case to the Tax Court.

Under Code Sec. 6501(a) the IRS generally has three years after a gift tax return is filed to assess any gift tax. However, Code Sec. 6501(c)(9) provides that gift tax may be assessed at any time for any gift if the value of the gift was required to be shown on a gift tax return and was not shown on such a return. Under Reg. Sec. 301.6501(c)-1(f)(1), this exception applies unless the gift has been disclosed in a manner adequate to apprise the IRS of the nature of the gift. Reg. Sec. 301.6501(c)-1(f)(2) provides that if a gift has been adequately disclosed, the ordinary three-year period for assessment commences upon filing. The regulation provides that a transfer will be considered adequately disclosed if the taxpayer provides the following information on a gift tax return or statement attached to it: (1) a description of the gift and consideration received for the gift; (2) the identities of and relationship between the transferor and transferee; (3) if the gift is transferred in trust, certain information regarding the trust; (4) a detailed description of the method used to determine the fair market value (FMV) of the gift; and (5) a statement describing any position taken that is contrary to regulations or revenue rulings published at the time of the transfer. In this case, only the requirements in (1), (2), and (4) applied.

Schlapfer argued that the notice was barred by the statute of limitations because his OVDP submissions adequately disclosed the gift. The IRS contended Schlapfer's gift was not adequately disclosed because (1) the Offshore Entity Statement was not part of the 2006 gift tax return and should not be considered; and (2) even if the Offshore Entity Statement was considered, Schlapfer failed to satisfy all applicable requirements of Reg. Sec. 301.6501(c)-1(f)(2).

Analysis

The Tax Court held that Schlapfer strictly or substantially complied with Reg. Sec. 301.6501(c)-1(f)(2) by way of his gift tax return, protective filing, Offshore Entity Statement, and Forms 5471. As a result, he adequately disclosed the gift on his 2006 gift tax return, causing the three-year assessment period to commence in November 2013 when he submitted his disclosure package to the OVDP. The court therefore concluded that the statute of limitations expired in November 2017, before the IRS issued its notice of deficiency.

The court disagreed with the IRS's assertion that the Offshore Entity Statement should not be considered. The court noted that under Code Sec. 6501(c)(9), gift tax can be assessed at any time unless the gift is adequately disclosed on a return "or in a statement attached to the return." The court also found that in prior cases it has frequently looked beyond a taxpayer's return for purposes of determining adequate disclosure, especially where the return references a separate document. In the court's view, the Offshore Entity Statement had to be considered because it was submitted to the OVDP in a disclosure packet that included the gift tax return, and furthermore, the protective filing attached to the gift tax return referenced controlled foreign company stock, which alerted the IRS to look to the Offshore Entity Statement for information on the gift referred to in the gift tax return.

Next, the Tax Court determined that strict compliance with the adequate disclosure requirement in Reg. Sec. 301.6501(c)-1(f) is not required but rather can be satisfied with substantial compliance. The court found that in T.D. 8845, which promulgated Reg. Sec. 301.6501(c)-1(f), the IRS specifically addressed substantial compliance. It rejected a recommendation that the regulation should expressly allow substantial compliance because of "the difficulty in defining and illustrating what would constitute substantial compliance." It went on to note, however, that its rejection of the suggestion did not mean "that the absence of any particular item or items would necessarily preclude satisfaction of the regulatory requirements, depending on the nature of the item omitted and the overall adequacy of the information provided." In the court's view, that statement describes, and accepts, the very essence of substantial compliance.

The court went on to find that Schlapfer substantially complied with the requirements of Reg. Sec. 301.6501(c)-1(f)(2). The court found that, if Schlapfer's gift was the EMG stock rather than the UVL Policy, Schlapfer strictly complied with the requirement to describe the property or consideration received. If the gift was the UVL Policy, the court found substantial compliance with the description requirement because Schlapfer provided enough information to describe the underlying property that was transferred. The court reasoned that the UVL Policy's value came primarily from EMG stock, so Schlapfer's describing the transferred property as EMG stock went to the nature of the gift.

As for the requirement to identify the parties to the gift, the court found that Schlapfer substantially complied because this requirement is procedural and a failure to list the identity and relationship of each transferee was not essential to the overall purpose of the requirement, which was to give the IRS enough information to understand the nature of the transfer. In the court's view, Schlapfer's statement on the Offshore Entity Statement listing his mother as the transferee provided the IRS with enough to understand the relationship between Schlapfer and the transferee, a member of his family. The court said that his failure to provide the names of his aunt and uncle did not make a meaningful difference in understanding the nature of the transfer. Schlapfer also substantially complied, in the court's view, with the requirement to describe his method for determining the FMV of the gift, because he provided enough documentation to show how he determined the FMV of the EMG stock.

For a discussion of the statute of limitations for filing a gift tax return, see Parker Tax ¶222,940.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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