1. Estate and Gift Tax Audits: Effectively Representing Your Clientby
Carol A. Cantrell
cctaxlaw.com

2. Examination Coverage in 2014
% of Returns Examined
With No Change
Field
Corresp.
Forms 1041
.1%
16%
42%
Forms 706:
<$5 million
2.3%
26%
N/A
$5-10 million
21.1%
22%
>$10 million
27.0%
23%
Forms 709
.8%
39%

3. Individual Income Taxes Estate & Trust Income Taxes
Gross Collections by
Type of Tax
2014 %
Business Income Taxes
353,141,112
11.5
Individual Income Taxes
1,614,213,171
52.6
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
$3,064,301,358
100.0
Excise taxes
$3.0T
Estate and
gift taxes
$2.5T
Employment
taxes
$2.0T
Individual,
estate, and
trust income
taxes
$1.5T
$1.0T
Business
income taxes
$0.5T
2014
Money amounts in 000’s

4. Number of Returns Filed
2013
2014
Forms 1041
3,192,000
3,206,000
Forms 706
32,000
34,000
Forms 709
313,000
335,000

5. Organization Chart – Estate & Gift Exam
West
Central
East
Northeast
Policy
Specialists
Chief of Estate and Gift Tax
Territories
Groups

6. 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 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.

7. 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.

8. 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.

9. 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.

10. 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.

11. 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.

12. “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.

13. 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
Artwork worth over $50,000. IRM

14. 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.

15. 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.

16. 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.

17. 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.

18. 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. § (b)(5).

19. 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

20. Where the Exam Takes Place
The regulations require the examination to take place “on the taxpayer’s premises.” Reg. § (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.

21. 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

22. 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.

23. 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. § A-8 (d); (b).
To make changes, the executor may file “Supplemental Information” on Form Reg. § (c)

24. “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.

25. 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;

26. 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

27. Expected Time Frame for an Audit
Examiners are expected to complete the audit 18 months from the filing date. IRM
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

28. 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 “open- ended.” IRS Pub
The statute of limitations on a Form 706 can not be extended. IRC § 6501(c)(4).

29. 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).

30. 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 §
Executors who are abroad may obtain longer than 6 months. Reg. § (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. § (c)

31. 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 Reg. § (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. § (a)(1).

32. 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. §
An automatic 6 month extension to file Form 709 can be obtained by filing Form 4868 or Form Reg. § (a).
No extension of time to pay gift tax is allowed. Reg. § (c).
There is no penalty for a late Form 709 if no tax is due. But the statute of limitations stays open.

33. 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. § (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. § (a)(2); § ; Ltr. Rul

34. 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

35. Taxpayer Interviews (cont.)
The IRS will generally request that the recording take place in their office. Notice
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

36. 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 attorney- client privileged documents, personnel records, information protected under IRC § 6103, law enforcement records, and other sensitive records.

37. 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.

38. 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. § (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 (6th Cir. 2015).

39. 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.

40. 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.

41. Fast Track Settlement
If there are just one or two unresolved issues, the taxpayer can request Fast Track Settlement (FTS) by filing Form 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.

42. 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.

43. 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.

44. There Are Three Bites at the Appeals Apple
Fast Track Settlement
30-Day Letter
Appeal
Post-Appeal
Mediation
90-Day Letter

45. 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

46. 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
However, the taxpayer may raise new issues in appeals. But doing so requires appeals to send the case back to exam. IRM

47. 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

48. 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 ;
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.

49. 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 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.

50. 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).

51. 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.

52. Inexpensive Resources
Internal Revenue Manual – Section and other pertinent sections, as updated from time to time, available at
Federal Tax Procedure for Attorneys, by W. Patrick Cantrell (American Bar Assoc ed.) available at Amazon.com.