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IRS audits estate; charity wins

November 17, 2009

It's a holy grail of tax planning: a tax strategy that prevents you from paying additional tax even if the IRS adjusts your return on audit. A South Dakota estate has achieved something close to that.

Helen Christiansen owned South Dakota ranch properties at her death. Her will gave her property to her only child, a daughter, but it had a "qualified disclaimer" provision. If the daughter declined any of her inheritance, it would go to a charitable trust and a charitable foundation. The daughter cleverly disclaimed any amount over $6.3 million as "finally determined for estate tax purposes.

The IRS audited Ms. Christiansen's Form 706 estate tax return. The auditor increased the value of some of the property reported on the return. The executor said fine; because the daughter's share of the estate was still the $6.3 million "finally determined for estate tax purposes," the increase in the taxable value of the estate just increased the amount going to charity, and the charitable deduction.*

The IRS didn't like this. They argued that the estate tax audit was a post-death event that shouldn't count in determining the charitable deduction. They also argued that if they increase the value of property of property shown on an estate tax return, they should get additional tax for their trouble. Otherwise, what would be the point of auditing such a return? (And who says incentives don't matter?)

The Tax Court, in an opinion worth reading just for fun, held for the taxpayer. Last Friday the U.S. Court of Appeals for the Eighth Circuit, which includes Iowa, agreed:

For several reasons, we disagree with the Commissioner's argument that we must interpret the statute and regulations in an effort to maximize the incentive to audit. First, we note that the Commissioner's role is not merely to maximize tax receipts and conduct litigation based on a calculus as to which cases will result in the greatest collection. Rather, the Commissioner's role is to enforce the tax laws

Of course, the result doesn't make the IRS go away. While the IRS got no more as a result its audit, the charity got more property at the expense of the daughter. But if a goal of your estate plan is to limit what goes to the IRS while giving to charity once you've taken care of your children, this "Charitabile LID" plan could be very attractive. Roger McEowen has posted an excellent analysis of Christiansen and its planning implications.

Links:

Eighth Circuit decision
Tax Court decision

*A technical problem with the trust apparently disqualified it from being eligible for a charitable deduction on the estate tax return, so the IRS did get some tax under the facts in the case, but they would have gotten nothing absent the techncal problem.

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