What Is a Wandry Clause and How Does It Work?

A Wandry clause is a tool used in gift and estate planning to transfer a specific dollar value of an asset that is difficult to appraise, such as an interest in a family-owned business. Its primary function is to prevent unexpected gift tax liabilities if the Internal Revenue Service (IRS) later challenges the initial valuation of the gifted asset. By defining the gift as a fixed dollar amount rather than a fixed percentage of ownership, the clause provides certainty for the donor. This approach allows individuals to make significant gifts without the risk of a revaluation creating a taxable event.

The Mechanics of a Defined Value Gift

A defined value gift is described not as a set number of shares or ownership percentage, but as an interest in an asset equal to a specific dollar amount. This allows the transfer to self-adjust based on the asset’s value as “finally determined for federal gift tax purposes.” This phrase anticipates and incorporates any future valuation adjustments made by the IRS or courts.

Consider a donor who wishes to gift an interest in a family limited liability company (LLC) to her children. An independent appraiser values the entire LLC at $2 million, and the donor decides to gift an interest worth $100,000. Based on this appraisal, the gift corresponds to a 5% ownership interest, and the transfer document includes a Wandry clause stating the gift is an LLC interest with a fair market value of $100,000.

Sometime after the gift is made, the IRS audits the transaction and determines the LLC was actually worth $4 million. Without a defined value clause, the original 5% interest would now be worth $200,000. This would create an unintended taxable gift of $100,000.

Because the gift was defined by its value, the revaluation is not a tax problem. The children are only entitled to receive $100,000 worth of the LLC. At the new $4 million valuation, this equals a 2.5% ownership stake, not 5%. The ownership percentage adjusts downward, and the donor is considered to have automatically retained the excess 2.5% interest. The gift remains valued at $100,000, and no unexpected gift tax is due.

The Wandry v. Commissioner Case

The legal foundation for this clause was solidified in the U.S. Tax Court case Wandry v. Commissioner. The Wandry family gifted interests in their LLC using language that specified the transfer of units equal to a fixed dollar amount. The documents stated that if the value was later adjusted by the IRS, the number of gifted units would change to match. The IRS audited the gift, increased the LLC’s valuation, and argued that a fixed percentage was gifted, resulting in a tax deficiency.

The IRS’s primary argument was that the clause represented a “condition subsequent” that was void as against public policy. The agency contended that such clauses discourage tax audits because if the IRS challenges the valuation and wins, the clause simply reduces the size of the gift, leaving no tax deficiency to collect. This position was based on the case Commissioner v. Procter, where a clause that attempted to revoke a gift if it was found to be taxable was invalidated. The IRS argued the Wandry clause was functionally the same, attempting to undo a completed gift.

The Tax Court disagreed with the IRS and ruled in favor of the taxpayers. The court made a clear distinction between the invalid Procter clause and the valid Wandry formula clause. It reasoned that the Wandry gift documents did not try to take back property after the fact. Instead, the clause defined the extent of the gift from the very beginning. The court determined that the donors’ intent was always to give a specific dollar value, not a specific number of LLC units.

The court’s opinion emphasized that the adjustment was merely a part of the valuation process, not a reversal of the transfer. It saw the clause as a legitimate method for dealing with the inherent uncertainty of valuing non-marketable assets. The ruling concluded that the clause did not violate public policy, stating that the role of the IRS is to enforce tax laws, not just to maximize tax collection.

Key Components for Drafting the Clause

For a Wandry clause to be effective, the language in the gift transfer document must be precise. It should clearly state the donor’s intent and include several components:

• Define the Gift by Value: The document must state the intent to transfer a specific dollar amount of an asset, not a percentage of ownership. This focus on value is the central element that distinguishes it from a gift of a fixed quantity of property.
• Use “Finally Determined” Language: The clause must explicitly reference the value “as finally determined for federal gift tax purposes.” This phrasing allows it to account for a valuation determined through an IRS audit or a court decision.
• Obtain a Qualified Appraisal: Basing the transfer on a robust, contemporaneous appraisal performed by a qualified and independent appraiser demonstrates a good-faith effort to determine an accurate value. A qualified appraisal should be conducted close to the date of the gift.
• Direct the Excess Value: The document must clearly direct what happens to any value determined to be in excess of the specified gift amount. This excess value is retained by the donor, and accounting records are adjusted to reflect the final ownership allocation.