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IRS Validly Examined Predeceased Spouse's Return to Determine DSUE

(Parker Tax Publishing September 2017)

The Tax Court held that during the audit of an estate, the IRS validly examined a predeceased spouse's estate tax return in order to adjust the amount of the deceased spousal unused exclusion (DSUE). A Letter 627, Estate Tax Closing Document, notifying the predeceased spouse's estate that its return had been accepted as filed did not constitute a closing agreement or estop the IRS from examining the predeceased spouse's return, and the examination was not an impermissible second examination. Estate of Sower v. Comm'r, 149 T.C. No. 11 (2017).

Minnie Sower was the surviving spouse of Frank Sower, who died in 2012. From 2003 to 2005, Mr. and Mrs. Sower each gave approximately $997,000 in taxable gifts, which they reported on gift tax returns. When Mr. Sower died, his estate filed a return reporting no estate tax liability and zero in taxable gifts. Mr. Sower's estate reported a deceased spousal unused exclusion (DSUE) of approximately $1.2 million and elected portability of the DSUE to allow Mrs. Sower to use it. In 2013, the IRS issued an initial Letter 627, Estate Tax Closing Document (ETCD), to Mr. Sower's estate showing no tax liability. It stated that the return had been accepted as filed and that the IRS would not reopen or examine the return unless it was notified of changes or there was evidence of wrongdoing or error.

Mrs. Sower died in 2013. Her estate filed a return claiming the DSUE from her husband's estate. Like Mr. Sower's estate, Mrs. Sower's estate did not include the lifetime taxable gifts on the return. However, rather than reporting zero in gifts as on Mr. Sower's estate return, Mrs. Sower's estate's return left the entry blank.

The IRS audited Mrs. Sower's estate tax return beginning in February 2015. In connection with that examination, it also opened an examination of the return filed by Mr. Sower's estate to determine the proper DSUE amount available to Mrs. Sower's estate. In March 2015, an IRS attorney sent the executors of Mr. Sower's estate a letter and a draft revised report showing an adjustment to the amount of Mr. Sower's lifetime taxable gifts. In July 2015, the IRS issued a second ETCD to Mr. Sower's estate, which was in substance identical to that of the first ETCD sent in 2013. The IRS did not request any additional information from, or determine any additional liability for, Mr. Sower's estate.

After examining the return for Mr. Sower's estate, the IRS reduced the DSUE available to Mrs. Sower's estate to approximately $282,000. Mrs. Sower's taxable estate was also adjusted by the amount of her lifetime taxable gifts. The adjustments increased the estate tax liability for Mrs. Sower's estate by around $788,000, and in December 2015, the IRS sent the estate a notice of deficiency for that amount. Mrs. Sower's estate filed a Tax Court petition disputing the full amount of additional estate tax.

Before the Tax Court, Mrs. Sower's estate made four arguments. First, the estate said that the first ETCD should be treated as a closing agreement under Code Sec. 7121 and that the IRS should be estopped from reopening the estate. Second, it argued that the examination that occurred after the IRS had sent the first ETCD was an improper second examination. Third, the estate said that the effective date of Code Sec. 2010(c)(5)(B), which addresses the statute of limitations period relating to an audit of a DSUE amount, and the text of the regulations precluded the IRS from adjusting the DSUE amount for gifts made before 2010. Fourth, the estate argued that the IRS's application of Code Sec. 2010(c)(5)(B) in this case was contrary to Congress's intent to permit portability and was a due process violation because it overrode the statute of limitations on assessments.

The Tax Court rejected all of the estate's arguments. First, it determined that the original ETCD was not a closing agreement under Code Sec. 7121 because, under the regulations, only Form 866, Agreement as to Final Determination of Tax Liability, and Form 906, Closing Agreement on Final Determination Covering Specific Matters, qualify as closing agreements. The court noted that in rare cases, courts have bound the IRS to an agreement not executed on a Form 866 or Form 906, but only where there was evidence of negotiation and an offer and acceptance. In this case, the Tax Court found no such evidence. The estoppel argument failed because the Tax Court found that the estate established none of the necessary elements for an estoppel claim. To prevail on an estoppel claim against the IRS, a taxpayer must show four essential elements: (1) a false representation or wrongful misleading silence, (2) an error in a statement of fact and not in an opinion or statement of law, (3) a taxpayer ignorant of the true facts, and (4) a taxpayer that is adversely affected by the acts or statements of the person against whom an estoppel is being claimed (for example, by having to pay a tax twice). The Tax Court found that there was no false statement of fact because the issues in the case were questions of law and the facts were known by both parties. Further, the estate was not at risk of double taxation, and there were no facts showing that it acting in reliance on the first ETCD.

The Tax Court also did not agree that the IRS had conducted an impermissible second examination of the return filed by Mr. Sower's estate. The court cited the general rule that the IRS does not conduct a second examination when it does not obtain any new information. As the IRS did not request any additional information from Mr. Sower's estate, there was no second examination. The Tax Court further reasoned that only the examined party is protected from second examinations. Therefore, according to the Tax Court, even if there had been a second examination, it was not a second examination of the return of Mrs. Sower's estate.

The Tax Court rejected the estate's argument regarding the effective date of Code Sec. 2010(c)(5)(B), which authorizes the IRS to examine a deceased spouse's return after the statute of limitations has run in order to determine the DSUE amount. First, the estate argued that the IRS did not have the power to examine the return of Mr. Sower's estate a second time because the DSUE was not applied to a taxable gift transfer. The estate also said that because the gifts at issue in the case were given before the effective date of Code Sec. 2010(c)(5)(B), the IRS could not make adjustments to the DSUE as a result of those gifts. The Tax Court held that it was irrelevant whether the DSUE was applied to a taxable gift transfer because the DSUE was applied to the transfer of the estate, which was all that was required by the statute. The Tax Court further found that Code Sec. 2010(c)(5)(B) applies to decedents dying after December 31, 2010, which was true of both Mr. and Mrs. Sower. The fact that the gifts were made before that date had no relevance, according to the Tax Court.

Finally, the Tax Court rejected the estate's Congressional intent and due process arguments. The Tax Court reasoned that Congress adopted Code Sec. 2010(c)(5)(B) with the explicit purpose empowering the IRS to examine a predeceased spouse's return outside of the period of limitations in order to adjust the DSUE amount. This was a clear indication, in the Tax Court's view, that the IRS's exercise of this power with respect to Mr. Sower's return was not a violation of Congressional intent. Nor was there a due process violation because the statute of limitations was not subverted by Code Sec. 2010(c)(5)(B), according to the Tax Court. The statute does not give the IRS the power to assess any tax against the estate of the predeceased spouse outside the statute of limitations, and the regulations specifically provide that beyond adjusting the DSUE amount, the IRS can assess additional tax only if it is within the statute of limitations. Because the IRS did not assess any tax against Mr. Sower's estate, and the DSUE adjustment was not an assessment of tax against Mr. Sower's estate, the statute of limitations for assessment was not implicated.

For a discussion of the DSUE, see Parker Tax ¶227,200.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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