As the IRS endeavors to maximize results from deploying its collection resources, auditing of high-income taxpayers is rising even as the number of overall audits is falling. About 4 percent of individual returns for 2011 reporting $200,000 or more of income were audited. This represents thousands more audits compared to the 3 percent of 2010 audited returns from that income group. The IRS audited 12.5 percent of individuals with more than $1 million of income for 2011. That compares to 8 percent one year earlier. An Enrolled Agent career] focused on representing people with IRS difficulty has likely encountered more instances of high earners needing help.
Recently, gift tax and estate tax matters are drawing greater IRS scrutiny. As usual, the IRS is focusing on taxpayers that deliver the greatest opportunities for collecting substantial tax dollars. One of these situations is the estate of Bill Davidson, which the IRS is battling for an enormous tax liability. Facts in the case suggest that tax experts with Enrolled Agent training are more valuable than ever when gift tax conditions arise. A major component of the case against the Davidson estate surrounds gifts to family during the man’s life.
Davidson was one of the wealthiest people in the United States, with an estimated net worth in 2008 of $5.5 billion. He was a native of Detroit, where he built his company Guardian Industries into an international leader in manufacturing of glass, auto, and building products. Davidson also owned sports franchises in the NBA, NHL, and WNBA.
When Davidson died in early 2009 at age 86, his net worth was estimated at $3 billion. Market conditions in the period leading up to his death certainly contributed to the declining value of his holdings. However, another factor that’s relevant to Enrolled Agent education is how Davidson reduced the size of his estate with gifts made in the months preceding his death. These transfers were made to trusts established for his wife, two grown children from a previous marriage, his wife’s daughter, and six grandchildren of Davidson or his wife. One grandchild was not even born when the trusts were created.
Shares of Guardian stock were placed in the trusts. Transfers of securities are easily understood as gifts during exercises for an Enrolled Agent exam prep course. However, these arrangements are tricky in actual practice when the corporate stock is privately held. Lack of a public market for the shares makes identification of value quite difficult. The IRS contends that Davidson undervalued the privately held Guardian stock by as much as $1,500 per share at the time of his gifts.
In a 113-page court filing, the IRS alleges deficiencies as far back as 2005 of more than $900 million in gift tax that was not paid. The IRS contends that Davidson’s taxable estate and gifts total $4.6 billion. An estate tax liability alone of $1.9 billion is claimed by the government. That compares to total estate tax collected nationally of $13 billion for people who died in 2009. The unusual estate planning techniques used by Davidson’s attorneys are not commonly addressed during Enrolled Agent courses. However, comprehending the concepts embodied in these methods is a useful addition to EA study.
For example, discord between representatives of Davidson’s estate and the IRS encompasses so-called self-canceling installment notes – known as SCINs. These instruments are legal. They allow a recipient of property to make payments to the transferor while he is living. The debt is cancelled when the transferor dies and the recipient then own the property outright. What makes SCINs problematic is that the lawyers who create them for taxpayers must set the payments based upon life expectancy. In Davidson’s case, the IRS contends the payments were too low. An EA who stumbles upon a client with SCINs should mention that insufficient payment amounts will trigger gift tax on some part of the transferred property value.
Enrolled Agents with time to read the court filing of the IRS will find other interesting allegations of gift tax avoidance by Davidson. This includes money he transferred to his wife, which she then used to cover home construction costs for her daughter and son-in-law.
Lawyers for the estate have commented that the IRS is wrong and that these misunderstandings will be rectified in court. Nevertheless, the IRS accusations certainly suggest that Davidson was attempting to transfer large amounts of property without incurring any tax. The key message for Enrolled Agents is that wealthy people – particularly those who execute uncommon gifting procedures – are a main target of the IRS.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.