Two important cases have recently brought additional comfort to those who wish to use valuation clauses. In the McCord case, a Fifth Circuit decision, the taxpayers transferred limited partnership interests and stated that $6,910,933 worth of these interests should be divided between their children and trusts they had created for their children; $134,000 worth should go to one charity; and any remaining interests should go to a second charity. It was left to those parties to negotiate the value of the limited partnership interests being allocated among themselves. The case worked its way through the tax court and eventually to the Fifth Circuit, which ruled in the taxpayer's favor. Unfortunately, while including a great deal of language that suggested its approval of the DVC used by the taxpayer, the Fifth Circuit did not directly address the critical public policy arguments.

More recently in Christiansen, the tax court unanimously approved the use of a DVC. In that case, Helen Christiansen left everything to her only child and directed that if her daughter disclaimed any part of the property, 75% would pass to a charitable lead annuity trust and 25% to a foundation Mrs. Christiansen had established. Her daughter ultimately accepted an inheritance of $6,350,000 and disclaimed any property with a fair market value in excess of that amount. The IRS sought to deny the estate tax charitable deduction for the property passing to the foundation, in part by arguing that the using of a disclaimer in this way violated public policy for the reasons discussed above. The tax court found in favor of the taxpayer. "This case is not Procter. The contested phrase [i.e the DVC] would not undo a transfer, but only reallocate the value of the property transferred among Hamilton [the daughter], the Trust, and the Foundation. If the fair market value of the estate assets is increased for tax purposes, then property must actually be reallocated among the three beneficiaries. That would not make us opine on a moot issue, and wouldn't in any way upset the finality of our decision in this case."

Estate planners have been waiting for such a clear statement from the courts for a very long time. In one brief and simple paragraph, the tax court judges unanimously brushed aside two of the three pillars supporting the public policy argument that was the basis for Procter. The tax court recognized that in making a final determination of value it would determine the economic rights of various parties, so its decision was far from being moot or a waste of judicial resources.

This left Procter teetering on one leg, the argument that valuation clauses are invalid because they encourage taxpayers to obtain the lowest valuations possible with little concern about the tax consequences of being wrong. Here, unfortunately, the tax court could not offer such clear guidance. The court noted the strong public policy in favor of charitable giving and listed a long series of people with fiduciary duties in this case, each of whom could have and should have questioned a "low-ball" appraisal in order to ensure the foundation received a proper share of estate assets.  Executors are fiduciaries who owe a duty to all heirs, including the foundation. The foundation directors must ensure that their organization receive its fair share of the estate. State attorneys general also monitor charitable organizations. Indeed, the IRS itself can impose excise taxes or revoke the tax-exempt status of charities that permit private inurement, so if the IRS believes a charity is not adequately policing these valuation issues, it can take appropriate action.

This is all well and good, but it leaves unclear whether such factors are necessary for valuation clauses to be respected. After all, despite all these layers of fiduciary supervision so carefully listed by the tax court, the estate in Christiansen was initially reported to be slightly more than $6.5 million, but was eventually found to be $9.58 million once the audit and tax court litigation were complete, substantially increasing what the foundation was entitled to receive.

Should valuation clauses now be incorporated into every future estate planning transaction, given the outcomes of McCord and Christiansen? For now, the answer has to be no, since it remains possible for a taxpayer to get whipsawed by the IRS. Christiansen left the door open for what may be the IRS' strongest argument-that the free use of valuation clauses will so discourage gift-tax audits that abuse would be inevitable, and it remains possible that in a different situation the tax court would still find a valuation clause to be invalid for public policy reasons. If that happened to the client I first mentioned, he would have made a $1.4 million gift of stock, not the $1 million gift he intended. That is no worse than what would have happened without the valuation clause; however, the clause would still be effective for state contract law purposes. That leaves two possibilities: (1) The taxpayer will enforce his rights under the clause and $400,000 of stock will still be owned by the taxpayer and included in his estate, even though he already paid gift tax on it; or (2) If the taxpayer chooses not to enforce his rights, he may be deemed to have made another gift of property to the trust, paying a second gift tax on the same property. It may be possible to draft a valuation clause so that if it is not respected for gift and estate tax purposes, then it will be disregarded for all purposes. Whether such a clause weakens the initial argument in favor of the valuation clause is unclear.

When you combine the strong arguments in favor of respecting both PACs and DVCs with the recent favorable court decisions, it seems clear that valuation clauses should be used far more often than they are to help transfer hard-to-value assets. Properly drafted, these clauses allow taxpayers to arrange their affairs with far more predictable gift-tax consequences than were previously possible. As the remaining ambiguities in this area are clarified by future cases, these clauses will become an increasingly important weapon in the estate planner's arsenal.     

Stephen Liss is a partner at the law firm Withers Bergman LLP with a private client practice that includes domestic and international estate planning, planned charitable giving and tax-exempt organizations.