Estate and Gift Tax Audits:
Effectively Representing Your Client
by
Carol A. Cantrell
cctaxlaw.com
1
Examination
Coverage in 2014
Forms 1041
.1%
% of Returns
Examined
With No Change
Field Corresp.
16%
42%
Forms 706:
<$5 million
2.3%
26%
N/A
$5-10 million
21.1%
22%
N/A
>$10 million
27.0%
23%
N/A
.8%
39%
N/A
Forms 709
2
% of
Returns
Examined
Gross Collections by
Type of Tax - 2014
$3.0T
$2.5T
$2.0T
$1.5T
$1.0T
$0.5T
%
Excise taxes
Business
Income Taxes
353,141,112
11.5
Estate and
gift taxes
Individual
Income Taxes
1,614,213,171
52.6
Employment
taxes
Individual,
estate, and
trust income
taxes
Business
income taxes
Estate & Trust
Income Taxes
29,410,796
1.0
Employment
Taxes
976,223,247
31.9
Estate Taxes
17,572,338
0.6
Gift Taxes
2,582,617
0.1
Excise Taxes
71,158,076
2.3
Total
0
2014
3
2014
Money amounts in 000’s
$3,064,301,358 100.0
Number of Returns Filed
Forms 1041
Forms 706
Forms 709
4
2013
3,192,000
32,000
313,000
2014
3,206,000
34,000
335,000
Organization Chart – Estate & Gift Exam
Chief of Estate and Gift Tax
Policy
Specialists
Territories
West
Central
Groups
5
East
Northeast
Campus “Classifiers”
• The territory offices send classifiers to the
Cincinnati Campus to manually inspect all 706 and
709 returns and identify significant issues.
• Significant issues are those that will impact the tax
liability, international issues, IRC §§ 2032A and
6166 elections, and valuation issues.
• Paralegals locate related Forms 706 and 709, check
the real property records, run E-Val reports, verify
charitable donees, and review the decedent’s final
income tax liability or refund.
6
Campus Classifiers (cont.)
• Classifiers either accept the returns as filed or flag
them for audit. Returns that are not selected for
audit are stamped “Accepted as Filed” and stored
in Cincinnati.
• Returns that are flagged for audit are maintained
in inventory until ordered by the territory
managers.
• Returns that are never sent to the territory
managers remain in inventory and may never be
audited.
7
Estate Tax Closing Letters
• Forms 706 filed before June 1, 2015 will
automatically receive an Estate Tax Closing
Letter 627 if they meet the filing threshold or
portability was not denied.
• Forms 706 filed on or after June 1, 2015 will
not receive a Closing Letter unless a request
is made at least four months after filing.
• This new policy is due to the sheer volume of
Forms 706 filed solely to elect portability.
8
Estate Tax Closing Letters (cont.)
• The IRS website suggests that estates obtain a
transcript through e-Services or Form 4506-T as
an “acceptable substitute” for a closing letter.
• Transaction Code 421 on the transcript
indicates that the return has been accepted as
filed.
• AICPA has asked for an option to receive an
official “closing letter” by checking a box or
making some other notation on the Form 706.
9
Early Discharge of Personal Liability
• Executors can still request an early discharge
of their personal liability for the decedent’s
estate, income, and/or gift tax by attaching
Form 5495 to the Form 706.
• On the later of nine months after the IRS
receives the Form 5495, or the executor pays
any deficiency, the executor will be discharged
from personal liability for any deficiency found
thereafter. IRC §§ 2204(a), 6905.
10
Section 2032A and 6166 Elections
• Returns with §§ 2032A or 6166 elections are
scrutinized for timeliness, eligibility, lien or bond
processing, calculating the installment
payments, figuring the appropriate installment
period, and determining whether the IRS should
order its own appraisal.
• Executors should consider alternative methods
of relief, such as a redemption to pay death
taxes under IRC § 303 or a 12-month payment
deferral under IRC § 6161.
11
“International” Returns
• “International returns” are heavily scrutinized.
That includes returns filed by non US citizens,
non-residents, and US citizens and residents who
died abroad. Form 706-NA.
• Attach Form 8833 if relying on a foreign treaty.
• A resident surviving spouse is entitled to the
DSUE.
• But non-citizen, non-resident surviving spouses
are not entitled to the DSUE, absent a treaty
provision.
12
Other Audit Flags on Form 706
•
•
•
•
Failure to properly value marketable securities;
Mathematical errors;
Large blocks of stocks or bonds;
Insurance on the decedent’s life not included on
the return;
• Any taxable estate;
• Real estate worth over $500,000. IRM 4.25.12.3.
• Artwork worth over $50,000. IRM 4.25.12.2.1.
13
Audit Flags for Gift Tax Returns
• Returns disclosing “non-gift” transactions such
as loans and sales to related parties;
• Returns approaching or exceeding the
applicable exclusion amount;
• Large gifts of family partnership interests,
especially in light of possible new regulations
under IRC § 2704 reducing discounts.
• Gifts involving split-dollar life insurance.
14
Territory Managers
• Territory managers place orders for estate
and gift tax returns from the Cincinnati
E&G Campus based on the workload and
needs of their group managers.
• They also make the final decision on
whether the IRS will accept a settlement in
fast track settlement and mediation cases.
15
Group Managers
• Group managers place orders for 706s and
709s from the Territory Manager and review
cases before assignment to field agents.
• Group managers can use field agents in their
own group or other groups, depending on
workload and staffing needs.
• They control the scope, depth, and techniques
to be used during each examination.
• They monitor the progress of each
examination and the statute of limitations.
16
Examiners
• Examiners are always licensed attorneys. They
do not necessarily live in the same city or state
as the group manager.
• After being assigned a return, they first
“perfect” it by verifying that it contains all the
required documents and is signed by an
authorized person.
• They also verify that the return was timely filed
and the tax was timey paid.
17
Examiners (cont.)
• Examiners have discretion to determine whether
to audit a return and what to challenge. Their
personality bears heavily on this decision.
• They may request anything dealing with matters
required to be on the return.
• They may order appraisals from in-house or
outside experts, request interviews, and issue
summons.
• They may request technical advice from the
National Office in unusual or complex issues. Reg.
§
601.105(b)(5).
18
Examiners (cont.)
• Examiners may not consider hazards of litigation
or take a position contrary to that announced by
the IRS.
• They are required to follow Supreme Court cases,
but are not required to follow lower court cases
that are adverse to the IRS, unless the IRS has
acquiesced in the decision. IRM 4.10.7.2.9.8.
19
Where the Exam Takes Place
• The regulations require the examination to
take place “on the taxpayer’s premises.”
Reg. § 601.105(b)(3).
• The IRS will attempt to assign an examining
agent who lives in the taxpayer’s locality.
• However, this is not always possible due to a
shortage of examiners in the taxpayer’s
location.
• It is generally futile to object to an out of
town examiner.
20
Filing the Return
• Returns received by the IRS after the deadline for
filing are considered delinquent unless they are:
– postmarked on or before the due date and
sent to Cincinnati, OH; or
– Sent by UPS, Fed Ex, or DHL to Covington,
Kentucky.
• Returns may also be hand carried to the local IRS
office on or before the due date. IRC § 6091.
• Bind the return securely with all attachments. IRS
may not disassemble it. IRM 4.25.1.1.1.
21
Required Attachments
• Will, death certificate, and foreign probate records.
• Forms 712, 709, 706-CE, and/or 8833 (treaty based
position).
• Proof of any sales made before the alternate
valuation date.
• Trust and power of appointment instruments
• Appraisals (706s require only real estate
appraisals).
• Financial statements on non-public entities.
• Certification of payment of state of death tax.
22
Amending Form 706
• Form 706 cannot be amended after the due
date (including extensions) except for changes
in special use valuations and deferred payment
elections. Reg. § 20.2032A-8 (d); 20.6166-1
(b).
• To make changes, the executor may file
“Supplemental Information” on Form 706.
Reg. § 20.6081-1(c)
23
“Portability Returns”
• IRS field examiners have already received
many Forms 706 filed solely to elect
portability.
• Campus classifiers verify the mathematical
accuracy of the deceased spouse’s unused
exclusion (DSUE).
• If the decedent uses the DSUE of the last
deceased spouse, the examiners verify that it
was calculated correctly.
24
What IRS Does Not Generally Examine
• Related income tax returns;
• Basis of property subject to a 754 election;
• Basis of property where the discount was
disallowed during a Form 706 audit;
25
Possible New Issues in 706 and 709 Exams
• Examiners will likely ask executors to verify
that they furnished basis statements to
beneficiaries who received property reported
on the return under IRC § 1014(f) and 6035(a).
• Examiners may also flag more returns
involving transactions with grantor trusts
based on IRS’s new policy against ruling on the
basis of assets owned by those trusts. Rev.
Proc. 2015-37.
26
Expected Time Frame for an Audit
• Examiners are expected to complete the audit
18 months from the filing date. IRM
4.25.1.5.1.
• Unagreed cases may be forwarded to appeals
only if there is at least one year left on the
statute of limitations for gift tax returns (9
months for estate tax returns). IRM 8.2.1.4.
27
Statute of Limitations
• Forms 706 and 709 generally have a 3 year
statute of limitations. IRC § 6501(a).
• The IRS may request an extension of time to
examine a Form 709 using a Form 872. The
extension can be for a “fixed-date” or “openended.” IRS Pub. 1035.
• The statute of limitations on a Form 706 can
not be extended. IRC § 6501(c)(4).
28
Statute of Limitations (cont.)
• A 6-year statute of limitations applies if more
than 25% of assets or gifts are omitted from
the return and not disclosed. IRC §
6501(a)(2).
• There is no statute of limitations as to a
specific gift that is omitted. IRC § 6501(c)(9).
• The taxpayer can extend all or only some of
the issues on a gift tax return. IRC §
6501(c)(4)(B).
29
Extensions for Estate Tax Returns
• Form 706 can be automatically extended for 6
months from the original due date by filing
Form 4768 with the Cincinnati Campus. IRC §
6081.
• Executors who are abroad may obtain longer
than 6 months. Reg. § 20.6081-1(c).
• If an extension request is late, the IRS can still
grant a six-month extension if the estate
exceeds the filing threshold and the executor
has good cause. Reg. § 20.6081-1(c)
30
Extension of Time to Pay Estate Tax
• Estate may request an extension of time to pay
the tax up to 12 months past the original due
date by checking the box on Form 4768. Reg. §
20.6161-1(a).
• The extension request must be timely and does
not stop interest from accruing.
• Can request successive 12 month extensions of
time to pay the tax or installments of tax. Reg. §
20.6161-1(a)(1).
31
Extension of Gift Tax Returns
• Form 709 is due April 15 unless the taxpayer lives
abroad, in which case it is due June 15. Reg. § 1.
6081-5.
• An automatic 6 month extension to file Form 709
can be obtained by filing Form 4868 or Form
8892. Reg. § 1.6081-1(a).
• No extension of time to pay gift tax is allowed.
Reg. § 25.6081-1(c).
• There is no penalty for a late Form 709 if no tax
is due. But the statute of limitations stays open.
32
Extension of Portability Returns
• The due date for a portability election by an
estate that is required to file Form 706 is the
extended due date of the return. This is fixed by
statute. No additional extensions may be granted.
IRC § 2010(c)(5)(A); Reg. § 20.2010-2(a)(2).
• Returns filed solely to elect portability that are
not otherwise required to file may obtain an
additional extension of time to file Form 706 for
reasonable cause since portability is a regulatory
election. Reg. § 20.2010-2(a)(2); § 301.9100-3; Ltr.
Rul. 201548004.
33
Taxpayer Interviews
• Never let your client talk to the IRS unless the
IRS has issued a summons. The IRS may not
require such an interview without a summons.
IRC § 7521(c).
• If there is a summons, the taxpayer must
appear for an interview.
• If the taxpayer requests that the interview be
recorded, the IRS must allow it if the taxpayer
gives 10 days advance notice. IRC § 7521(a);
Notice 89-51.
34
Taxpayer Interviews (cont.)
• The IRS will generally request that the
recording take place in their office. Notice
89-51.
• However, the representative can request
that the interview take place in his office.
• If the IRS initiates the request to record the
interview, it must give the taxpayer 10 days
advance notice and provide a copy of the
transcript to the taxpayer for a fee. Notice
89-51.
35
Freedom of Information (FOIA) Requests
• All IRS records are subject to FOIA.
• Information obtained by a FOIA request can be
invaluable.
• However, the IRS can and will redact attorneyclient privileged documents, personnel records,
information protected under IRC § 6103, law
enforcement records, and other sensitive
records.
36
FOIA (cont.)
• FOIA requests are best sent after the field
exam is complete and the file has left the
examiner’s office.
• The request must clearly state that it is being
sent pursuant to FOIA, succinctly identify the
records sought, prove the requester’s
authority to obtain any confidential
information, and agree to pay the fees.
FOIA Requests (cont.)
• The IRS must provide the reasons if it denies
the information requested and inform the
requester of the right to appeal. Reg. §
601.702(c)(10).
• Appeals must be postmarked within 35 days of
the date of the denial. Id.
• If the IRS denies the appeal or fails to act
within 20 days of the request, the requester
may sue the IRS. But such suits are rarely
successful. Kohake v. Dept. of Treas., 116 AFTR
2d 2015-6821 (6th Cir. 2015).
38
Straight “No Change” Audits
• A straight no change audit means one where
there is no change in either the items
reported or the tax liability. This generally
occurs in less than 25% of estate and gift tax
audits.
• If there are no changes to the estate or gift
tax return, the IRS issues Letter 590, No
Change Final Letter, and the audit is
concluded.
39
Agreed Cases With Tax Due
• Proposed changes to a Form 706 are presented on
a 1273, Report of Estate Tax Examination Changes
and Form 866-A, Explanation of Items.
• Proposed changes to a Form 709 are presented on
a Form 3233, Report of Gift Tax Examination and
Form 866-A, Explanation of Items.
• If the taxpayer agrees to the changes, he signs
Form 890, Waiver of Restrictions on Assessment
and Collection of Deficiency. Interest stops running
after 30 days and the audit is over.
40
Fast Track Settlement
• If there are just one or two unresolved issues,
the taxpayer can request Fast Track
Settlement (FTS) by filing Form 14017 before
the IRS issues the 30-Day Letter.
• The IRS may decline to participate in FTS.
• The goal of FTS is to settle the case in 60 days.
• An IRS appeals officer functions as an
independent mediator and the case proceeds
much like a normal mediation.
41
Benefits of Fast Track Settlement
• Unlike the examiner, the mediator has
authority to propose a settlement based on the
hazards of litigation.
• The IRS territory manager has final authority to
accept or reject the mediator’s proposal.
• Either party can withdraw from FTS at any time
before final settlement.
• The taxpayer still retains his right to a regular
appeals conference if a settlement is not
reached in Fast Track Settlement.
42
Detriments of Fast Track Settlement
• Fast Track Settlement gives the IRS a
sneak preview of its weaknesses and
allows it time to cure them before appeal
or trial of the case if FTS is unsuccessful.
• For example, FTS may uncover holes in
the IRS’s appraisal and allow it time to
revise the appraisal before appeals
and/or a Tax Court petition.
43
There Are Three Bites at the Appeals Apple
Fast Track
Settlement
44
30-Day
Letter
Appeal
PostAppeal
Mediation
90-Day
Letter
Unagreed Cases With Tax Due
• If FTS is unsuccessful , the IRS will issue Letter 950
(30-Day Letter).
• If the taxpayer files a written protest within 30
days of receipt of the 30-Day Letter, the case is
forwarded to appeals.
• Forms 709 must have at least 365 days and Forms
706 must have at least 270 days left on the
statute of limitations or else appeals will not
accept the case and the IRS will issue the 90-day
letter. IRM 8.2.1.4.
45
Appeals
• Appeals can negotiate issues and penalties based
on the hazards of litigation.
• Taxpayers should be proactive in moving the
examiner along to allow time for administrative
appeals. This also shortens the time the IRS has to
develop its case.
• The IRS may not raise new issues in appeals. IRM
8.2.1.8.3.
• However, the taxpayer may raise new issues in
appeals. But doing so requires appeals to send
the case back to exam. IRM 8.6.1.6.6.
46
Changes With No Immediate Tax Consequence
• If the IRS proposes a change to a gift tax return
with no immediate tax due (i.e. increase in value
but below the exclusion amount), it will issue a
Preliminary Determination Letter, Form 950-F or G.
• The taxpayer may protest and proceed to appeal
as a “No Immediate Tax Consequence” case.
• If appeal is unsuccessful and the change is based
on a legal or valuation issue, the taxpayer may file
a declaratory judgment action in Tax Court. IRC §
7477; IRM 4.25.10.1.1.
47
Adjustment Affecting Only the DSUE
• If an IRS audit adjustment affects only the
deceased spouse’s unused exclusion (DSUE)
amount, the taxpayer may appeal the decision,
but may not petition the Tax Court if appeal is
unsuccessful because there is no deficiency. IRM
4.25.10.1.1; 8.1.1.3.2.
• It may be possible for the taxpayer to appeal the
DSUE change on a later filed estate or gift tax
return when it does affect the tax.
48
Post Appeal Mediation
• If appeals is unsuccessful, the taxpayer or the IRS
may request post-appeals mediation. IRC §
7123(b)(1).
• Like Fast Track Settlement, the mediator is a
trained IRS appeals officer who attempts to
settle the case in 60-90 days. The taxpayer may
also engage a co-mediator who is not employed
by the IRS at his own expense.
• At the conclusion of the mediation, appeals must
issue a 90-Day Letter for any unresolved issues.
49
90 Day Letters – Notice of Deficiency
• If the case is unagreed, the IRS will issue Letter
902, Notice of Deficiency (90 Day Letter) by
certified mail.
• The taxpayer has 90 days from the date the
deficiency notice is mailed to file a Tax Court
Petition. There are no extensions. IRC § 6213(a).
• Failing that, the taxpayer must pay the full tax,
file a claim for refund on Form 843, and 6
months later sue for refund in federal district
court or claims court. IRC § 7422(a).
50
Closing Agreements
• Either the taxpayer or the IRS may request a
closing agreement at the conclusion of the audit.
IRC § 7121.
• Closing agreements are not the same as closing
letters. They are legally binding on both parties
and prevent reopening the case or taking return
positions inconsistent with the agreement.
• The IRS uses Forms 866 (Final Determination) or
Form 906 (As to Specific Matters) for closing
agreements.
51
Inexpensive Resources
• Internal Revenue Manual – Section 4.25
and other pertinent sections, as updated
from time to time, available at
www.irs.gov/irm/index.html
• Federal Tax Procedure for Attorneys, by
W. Patrick Cantrell (American Bar Assoc.
2015 ed.) available at Amazon.com.
52