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Financial Planning > Tax Planning

Tax Planning Advice: Avoid Inaccurate Formula Clauses—Martin Shenkman

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This is the seventh in a series of 23 tax tips that AdvisorOne will publish on each business day in March as part of our Tax Planning Special Report (see our Special Report calendar for a more complete list of topics to be covered and experts who will deliver their insights).

Today’s tax tip comes from Martin Shenkman of Shenkman Law, with offices in New Jersey and New York. Shenkman is the author of 34 books, hundreds of magazine and journal articles, and received his undergraduate education from the Wharton School of the University of Pennsylvania, his MBA from the University of Michigan, and his JD from Fordham University.

The Tip: Use Accurate Formula Clauses in Legal Agreements.

Martin ShenkmanShenkman (left) says it is unfortunately common for tax advisors to use inaccurate tax terms and definitions when creating formula clauses or definitions in a myriad of legal documents. Too often these clauses are also not updated for changes in the tax law, he points out.

For example, providing that a buyout of a business is based on tax book value could result in wide swings in economic effect given the tremendous changes in the maximum amount of equipment that could be deducted in the year of purchase under Code Section 179. Because of broad changes in Section 179 allowances, drastic differences in valuation can result depending on which year the Section 179 allowances were determined.


He cites, as an example of an inaccurate formula clause, “One we’re looking at now: an $8 million estate. The will says, ‘the maximum amount that won’t create an estate tax to kids, balance to new spouse.’ What do the kids get?” he asks. The executor, he adds, is the oldest child. Can he elect in 2010 to have the carryover basis rules apply? If they do, “the largest amount that can pass with no tax is unlimited, so the kids get everything and the new wife gets nothing.” Definitely not the benefactor’s intent. And, Shenkman points out, “the legal fees will be significant.”

Other potential problems from tying permanent valuations to changeable regulations can include everything from prenups to shareholder buy-sell agreements that have been tied to estate tax valuations—consider how that played out for 2010, with the sunset clause and the subsequent reinstatement of the estate tax retroactive to Jan. 1.

“While this is not a tax mistake,” Shenkman admits, “ it is a mistake that is taxing.”

See our Tax Planning Special Report calendar for a list of topics covered.


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