KPMG sees 2022 as being bigger than the banner year of 2021 for mergers and acquisitions. The easy access to capital, lower interest rates and a recovering global economy should send deal-makers looking for lucrative targets.¹ This current economic environment makes Chief Counsel Advice 202152018 very timely. It addresses whether a pending merger should be considered for purposes of valuing the stock for gift tax purposes. Although the context involves the funding of a short-term grantor retained annuity trust (GRAT), the Advice has implications not only for outright charitable giving but also charitable remainder trusts.

The donor was a co-founder of an extremely successful company. While entertaining five offers, the donor funded a two-year GRAT with company shares as well as funding other company shares to a separate charitable remainder annuity trust.

The GRAT’s payment was based on a fixed percentage of the initial fair market value of the shares as of Dec. 31, Year 1, a date approximately seven months prior to the transfer to the GRAT. The shares funding the charitable remainder trusts were valued pursuant to a tender offer made in Year 2. The prevailing bid for the company was at a share price three times the appraised value of the GRAT-bound shares and was reflected in the qualified appraisal of the shares to the CRT.

The company justified using an outdated appraisal for the GRAT’s shares because business operations had not materially changed during the six-month period.

The Office of Chief Counsel saw the current case as similar to Silverman² and Ferguson.³ In those cases, there were searches for a merger candidate, exclusive negotiations with what turned out to be the prevailing bidder and agreements practically certain to be concluded. All of these factors were reflected in the valuations.

Thus, the fair market value of the stock should take into consideration the likelihood of the merger as of the transfer date of the shares to the GRAT. The Office of Chief Counsel thought Date 2 was more reflective of what the hypothetical willing buyer and seller would exchange.

The undervaluation caused the retained income interest of the GRAT to fail to function exclusively as a qualified interest from its creation. The trustee failed the fixed amount requirement under sec. 2702 of the Internal Revenue Code, as the amount paid from the GRAT bore no relation to the initial fair market value of the shares transferred to it. Specifically, the artificially low annuity payment was less than 34% on the dollar of the required amount. This resulted in a windfall to the noncharitable remaindermen of the GRAT.

Being prepared to quickly give stock facing a taxable takeover is critical, especially if the outcome of the takeover attempt is uncertain. Delaying a gift until the transaction has become finalized will cause gain to be taxed to the donor.

By Professor Christopher P. Woehrle, JD, LLM

Endnotes

1. https://advisory.kpmg.us/articles/2021/blowout-year-global-ma.html.
2. Silverman v. Commissioner, T.C. Memo. 1974-285, aff’d, 538 F. 2d 927 (2 Cir. 1976), cert. denied, 431 U.S. 938 (1977).
3. Ferguson v. Commissioner, 174 F.3d 997 (9^th 1999), aff’g 108 T.C. 244 (1977).