Wandry Clause: Drafting, Disclosure, and the Petter Alternative

A Wandry clause is language in a gift document that defines the gift as a specific dollar amount of value in an asset rather than a set number of units or a fixed percentage. If the IRS later decides each unit was worth more than the donor’s appraiser said, the number of units transferred shrinks automatically so the total gift stays at the intended dollar figure. Donors use it for hard-to-value interests, like stakes in a family LLC or limited partnership, where the true fair market value is a matter of judgment and the difference between two reasonable appraisals can be worth hundreds of thousands of dollars in gift tax or lost lifetime exemption.¹

How the Defined Value Formula Works

Federal gift tax is based on fair market value on the date of the transfer, defined as the price a willing buyer and willing seller would agree on with neither under pressure and both reasonably informed.²³ For publicly traded stock that number is easy to find. For a minority stake in a family LLC, it’s a range that reasonable appraisers argue over.

A traditional gift might read “I give you 10,000 units of XYZ Holdings.” A Wandry clause instead says something like “I give you $1,000,000 worth of units in XYZ Holdings, with the number of units determined by fair market value as finally determined for federal gift tax purposes.” The donor’s appraiser estimates a per-unit value, and the parties tentatively record a percentage transfer based on that estimate. But the number isn’t locked. If the IRS audits and concludes each unit is worth twice the appraised figure, the formula halves the units transferred and the total gift stays at $1,000,000.⁴

The federal gift tax rate on amounts above the lifetime exemption reaches 40%. A clause that pins the gift to a dollar figure prevents the donor from accidentally burning through more exemption than planned, or triggering actual tax when the IRS raises the valuation.

Where the Wandry Decision Stands

The clause is named for Wandry v. Commissioner, a 2012 Tax Court memorandum decision. The Wandrys transferred membership interests in a family LLC to their children and grandchildren using gift documents that specified dollar amounts, not fixed percentages. Based on an appraisal they initially recorded a 2.39% interest for each donee, but the documents stated the units would adjust if the per-unit value changed on final determination.⁴

The Tax Court ruled for the taxpayers. It held that the gifts were of a defined dollar value rather than of fixed percentage interests, and that the adjustment formula did not allow the donors to take property back. The court said the formula simply corrected the allocation between donor and donee based on the true value, and it drew on the Ninth Circuit’s earlier reasoning in Estate of Petter v. Commissioner.⁴

Then the IRS refused to accept it. In Action on Decision 2012-04, the IRS recommended nonacquiescence, meaning it will keep challenging Wandry clauses in future audits. The IRS position is that donors relinquish control over a fixed percentage interest on the date of the gift and no formula can retroactively change that. Because Wandry was a Tax Court memorandum opinion rather than a binding appellate ruling, the IRS has room to keep fighting. Expect scrutiny.

Assets Where the Clause Actually Helps

A Wandry clause only earns its keep when fair market value is genuinely uncertain. Nobody needs one for publicly traded stock. The candidates are assets that require subjective appraisal:

Family limited partnership interests holding real estate, investment portfolios, or operating businesses.
Closely held LLC membership interests with no public market.
Private corporation stock valued through earnings multiples, comparable sales, or asset-based methods.
Fractional interests in real estate, where a co-owner can’t force a sale or control management.

What ties these together is valuation discounts. Appraisers routinely apply discounts for lack of control and lack of marketability, often in a combined range of 10% to 45% depending on governance, asset risk, and liquidity. The IRS frequently challenges those discounts as inflated. That is exactly the dispute a Wandry clause absorbs: if the IRS wins on smaller discounts and a higher per-unit value, the formula reduces the units transferred rather than increasing the size of the gift.

Drafting It So It Isn’t Struck Down

The biggest drafting risk is having the clause treated as an invalid “savings clause.” That distinction traces to a 1944 Fourth Circuit decision, Commissioner v. Procter. The donor’s document there said that if a court determined any part of the transfer was subject to gift tax, that portion would be voided. The Fourth Circuit struck the provision down on public policy grounds, reasoning that it discouraged tax collection and would require courts to issue self-defeating rulings.⁵

A savings clause tries to undo a completed transfer after the fact. A Wandry clause does something different: it defines what was transferred in the first place. The gift is complete the moment the document is signed, but what the donor gave was a dollar amount of value, not a specific number of units. No property comes back to the donor if the IRS adjusts the valuation. The donor simply never gave away as many units as the initial estimate suggested. The Tax Court in Wandry specifically held that the clause did not allow the taxpayers to take property back but corrected the allocation of the interests.⁴

To stay on the right side of that line, the transfer document should state that the gift is a defined dollar amount worth of interests, that the number of units is determined by fair market value as finally determined for federal gift tax purposes, and that the adjustment happens automatically rather than at the donor’s discretion. Language suggesting the donor retains a right to reclaim property is fatal. The IRS has also pointed to entities that treated the full tentative percentage as the donee’s ownership on the books and never documented any adjustment mechanism, using that record-keeping to argue the transfer was really a fixed percentage gift.

Adequate Disclosure on Form 709

A Wandry clause protects the size of the gift, but only the statute of limitations protects the donor from an audit years later. The IRS generally has three years from the date a return is filed to assess additional tax.⁶ For gifts, that clock starts only if the gift is “adequately disclosed” on the gift tax return. A gift that isn’t adequately disclosed can be challenged at any time, even decades later during estate administration.⁷

For interests in entities that aren’t publicly traded, the return or an attached statement needs to describe the property, identify the transferor and each transferee and their relationships, provide trust information where relevant, and show how fair market value was determined, including the financial data used, the restrictions on the property, and every discount claimed. It also has to report the fair market value of 100% of the entity without discounts, the pro rata portion transferred, and the reported value of the transferred interest.⁸

Tiered structures are where this most often breaks. If the entity holds interests in other non-traded entities, the same disclosure requirements apply at each level. Skipping a layer or omitting the undiscounted entity value can leave the statute of limitations open indefinitely. For a defined-value transfer, the appraisal attached to Form 709 needs to be thorough enough to satisfy every item on the list. A bare-bones appraisal that states a conclusion without showing the financial data and discount analysis won’t start the clock.

What Happens After a Value Adjustment

When the IRS challenges a valuation and the parties settle, or a court issues a final determination, the formula produces a new number. Higher per-unit value means fewer units belong to the donee. Lower value (less common) means more transfer. Either way, the entity’s records need to catch up.

That means amending the capitalization table or membership ledger to reflect the corrected percentages. Managers should document the change through a written resolution or an amendment to the operating agreement that references the original gift instrument, the final determined value, and the recalculated ownership split. The IRS has been more willing to respect Wandry clauses when the entity’s books consistently reflect the possibility of adjustment from the start.

Distributions paid between the gift date and the final determination add a wrinkle. If the donee received distributions on the tentatively higher percentage and the final determination reduces it, the donee received more than their share. The usual fix is to offset the overpayment against future distributions rather than demand cash back, and the operating agreement should say so up front. Failing to reconcile interim distributions gives the IRS grounds to argue the parties never genuinely intended the transfer to be adjustable.

Penalty Exposure If the Clause Fails

If the IRS successfully treats the transfer as a fixed-percentage gift, the donor owes the full tax consequences of the higher valuation. On top of the additional gift tax or lost exemption, accuracy-related penalties can apply. The standard penalty for a substantial estate or gift tax valuation understatement is 20% of the underpayment. A “substantial” understatement exists when the value reported on the return is 65% or less of the correct value.⁹

The penalty doubles for a gross valuation misstatement, where the reported value is 40% or less of the correct value, reaching 40% of the underpayment.⁹ The penalty applies only when the underpayment attributable to valuation understatements exceeds $5,000, but that threshold is easily cleared in the transfers where Wandry clauses are used. Separate penalties can also be assessed against the appraiser if the IRS finds the appraisal was prepared negligently or with knowledge that the values were too low.¹⁰

The Petter Alternative for Charitable Donors

Wandry isn’t the only way to use a defined-value formula. The mechanism upheld in Estate of Petter v. Commissioner by the Ninth Circuit in 2009 sends any excess value above the defined dollar amount to one or more charitable beneficiaries. The charity acts as a backstop: if the IRS raises the per-unit value, the additional units go to the charity rather than staying with the donor.¹¹

Petter has a legal advantage. It was affirmed by a federal appellate court, which carries more weight than a Tax Court memorandum opinion, and the IRS never issued a nonacquiescence against it. When a charity absorbs the excess, the public policy concerns from Procter largely disappear. Nobody is taking property back, and the charitable deduction offsets the increased gift value.

The tradeoff is that the donor has to actually be willing to give property to charity. For donors who want every unit to stay in the family, Wandry is the only defined-value option that doesn’t involve a charitable component. That is what made the decision significant: it was the first case to uphold a formula clause where no charity was a potential recipient.

1
Internal Revenue Service. What’s New – Estate and Gift Tax
2
Office of the Law Revision Counsel. 26 USC 2512 – Valuation of Gifts
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eCFR. 26 CFR 25.2512-1 – Valuation of Property; in General
4
Internal Revenue Service. Action on Decision – Joanne Wandry v Commissioner
5
Justia Law. Commissioner of Internal Revenue v Procter, 142 F.2d 824
6
Office of the Law Revision Counsel. 26 USC 6501 – Limitations on Assessment and Collection
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Internal Revenue Service. Adequate Disclosure of Gifts
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eCFR. 26 CFR 301.6501(c)-1 – Exceptions to General Period of Limitations on Assessment and Collection
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Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
10
Internal Revenue Service. Internal Revenue Manual 20.1.12 – Penalties Applicable to Incorrect Appraisals
11
FindLaw. Estate of Petter v Commissioner Internal Revenue