Off topic -- long NYT article about I.R.S. / gift taxes / estate taxes.
April 1, 2000
I.R.S. Sees Rise in Evasion of Gift Taxes
By DAVID CAY JOHNSTON
To save on taxes, Americans routinely understate the value of what they
give their heirs, particularly stock in family-owned businesses and real
estate, new data from the Internal Revenue Service shows. But the
agency has almost no resources to stop the problem, and a recently passed
law has only increased the chances of not getting caught.
More than 80 percent of the 1,651 tax returns reporting gifts of $1 million or
more that were audited last year understated the value of the gift, the I.R.S.
found.
The average understatement was about $303,000, on which about $167,000
in additional gift taxes was due. This alone cost the government about $275
million last year.
Understatement also appears to be flagrant among the quarter-million
Americans who each year make smaller gifts, I.R.S. records show. On the
650 of these returns that were audited, the average additional gift tax the
I.R.S. recommended was $97,000. The I.R.S. would not estimate the total
cost to the government of understated gifts.
But it is clear that a far greater percentage of Americans who owe gift taxes
shortchange the government than do Americans paying income taxes and
other levies. What is more, the sums involved in each case are much larger.
Taxes on gifts and estates, while intended to make the system fairer, breed
tremendous resentment, and many Americans think they should be eliminated
or sharply reduced. Last year, Congress voted to repeal the gift and estate
tax. President Clinton vetoed the measure.
But as long as they are the law, people are obligated to pay them, said the
I.R.S.
commissioner, Charles O. Rossotti. People who do not, and whom the I.R.S.
fails to force to pay, end up with a much better deal than their neighbors who
are playing by the rules.
"Our system depends on voluntary compliance," Treasury Secretary
Lawrence D. Summers said. "Individuals cannot decide for themselves if the
rules apply."
The I.R.S., its auditing and legal staff shrinking in recent years even as the
number of complex tax returns grows, lacks the resources to find most of
the Americans who understate the value of their gifts and estates or even fail
to report any transfer of property, said John Dalrymple, director of I.R.S.
operations. The I.R.S. has just 78 lawyers assigned to gift tax audits, each of
whom is responsible for auditing more than 3,300 gift tax returns this year.
And even when the agency does find abuses, it lacks the resources to fight
more than a small number of the cases in court.
I.R.S. lawyers said they were frustrated by their inability to stop what they
described as rampant cheating on gift taxes.
One such lawyer in Manhattan, the nation's wealthiest tax district, said his
desk was piled high with gift tax returns that will get little scrutiny.
"There is all this added work and no staff," said the lawyer, who insisted he
not be identified. "I know that there are millions and millions and millions of
dollars being passed untaxed right over my desk and there is nothing I can do
about it."
Of the more than 250,000 gifts of less than $600,000, only 1 in 400 is even
audited, while among gifts of $600,000 to $1 million, fewer than 1 in 55 is
audited. By contrast, the I.R.S. has been auditing 3 of every 4 gifts of more
than $1 million, but says that this is inadequate and that it is hiring 3 more
lawyers so it can audit 85 percent of returns reporting very large gifts.
The agency's task has only become more difficult. For one thing, the number
of gifts of $1 million and up jumped 21 percent last year from 1996, and the
I.R.S. expects additional increases of at least 5 percent annually.
Resources are further strained by a sharp rise in estate tax returns, which are
expected to grow by a third in the next four years.
Each year, nearly three times as many gift tax returns are filed as estate tax
returns, although the estate tax raises six times as much money.
But the gift tax, more than the estate tax, has recently increased the I.R.S.'s
workload, because of a law passed by Congress in 1997 to require speedy
audits of gift tax returns.
The Taxpayer Relief Act of 1997 gives the agency three years to audit gift
tax returns -- or accept them as filed. Under the old law, such returns could
be audited and challenged years or decades later, typically when the donor
had died and his estate tax return was filed. The new law, and the widespread
knowledge that the I.R.S. can hardly audit all gift tax returns, has encouraged
some taxpayers to aggressively undervalue assets on the assumption that the
I.R.S. either will not notice or will fail to act before the three-year audit
period ends.
Data compiled by the I.R.S. shows how the problem has grown.
In 1996, 1,816 gift tax returns with values of $1 million or more were filed.
Last year, there were 2,194 such returns. The average amount of additional
taxes owed because gifts were undervalued was $167,000 last year, up 45
percent from $115,000 in 1996.
These numbers show "we have a compliance problem," said Tom Hull,
national director of specialty taxes for the I.R.S.
The amounts were calculated using rules set by Congress and the courts to
measure the value of assets. The rules are based on factors like the cash flow
of a business or its history of dividends or, in the case of real estate, sales of
comparable properties.
In cases of direct gifts of cash and publicly traded securities, there are few
problems, Mr. Hull said. The understatements involve harder-to-value assets,
mostly family-owned businesses and real estate.
Gift and estate taxes, which are taxes on transfers of property during life and
after death, respectively, are the fastest-growing source of tax revenue for
both the federal government and the states. This reflects the rise in the stock
market and in real estate in the past decade, the aging of the World War II
generation, which owns most of this wealth, and the decision by Congress
not to adjust the gift and estate tax to take inflation and other factors into full
account.
The I.R.S. collected $2.7 billion in gift taxes in 1997, a figure that is expected
to grow to $3.6 billion this year.
The gift tax works this way. For each gift to another person of more than
$10,000 in a year, a gift tax return must be filed indicating the amount of the
gift. When the total of such gifts exceeds $675,000 during the giver's
lifetime, the gift tax kicks in. It must be paid on additional gifts greater than
$10,000 per person each year.
The gift tax rates are the same as those levied on estates when people die, but
the law creates powerful incentives to give before one dies.
Consider an individual with $1 million to give who is in the top tax bracket,
which is 55 percent. When a gift is made while the giver is still alive, the heir
gets $645,000 and the gift tax is $355,000. But if he gives away the money
after death, the heir gets $450,000 and the estate tax will take $550,000.
Thus, making the gift during the giver's lifetime puts $195,000 extra, or 43
percent more, in the heir's pocket.
But many Americans resent the tax and easily find ways to lower the amount
they pay. "In my experience as an estate planner, it is very hard to get people
to make taxable gifts," said Professor Edward J. McCaffery of the University
of Southern California Law School.
"So when such gifts are made, we are by definition looking at extremely
wealthy and extremely aggressive and dynastically inclined people, who are
very sophisticated and who are going to shop around for a good appraiser
and let him know they want to come in on the low side."
Professor McCaffery said, "There is a way of signaling to even the best of
the appraisers whether you want a high value, which you want if you are
selling your business or making a charitable gift, or if you want a low value
because you are doing tax planning."
He said many wealthy business owners planning to make large gifts to their
children "will first kind of muck up the business" by taking on debt or making
other temporary changes to help an appraiser justify a figure much lower
than the true value of the business.
Luther J. Avery, a San Francisco lawyer who often writes on flaws in the
gift and estate tax system, said: "There is a tremendous competition among
appraisers, and each is trying to buy business from someone else, so they are
low-balling their appraisals. Of course a client will choose the lowest
appraisal."
Mr. Rossotti, the I.R.S. commissioner, said a rapidly growing industry is
luring many prosperous Americans into illegal tax avoidance schemes with
promises of huge savings through methods like placing their homes in trusts
or opening offshore investment accounts. These schemes are illegal if they
lack a business purpose other than tax avoidance or if the income from
offshore accounts is not fully reported. Americans are taxed on their
worldwide income.
Shannon Pratt, widely regarded as the father of the business appraisal
industry and the publisher of a newsletter read by many estate tax lawyers,
said that in valuing businesses and real estate no one figure is correct. "There
is a range of values" depending on how one interprets cash flow, competition
and comparable sales of real estate, he said. He said reputable appraisal firms
come up with a fair range of values, but there are also disreputable firms
producing unjustifiably low appraisals.
The I.R.S. said its problems are with appraisals, and with discounts applied
to those appraisals, that fall outside a reasonable range. Discounts may be
applied for such factors as restrictions on the resale of stock in a family
business or a minority interest in real estate.
But the I.R.S. does not have the staff to stop even many of the most
outrageous cases.
Take the tax agency's Fresno, Calif., office, whose workload is typical of
many I.R.S. offices. It received 11,000 gift tax returns last year, and has
three lawyers to audit them, Joseph D'Amico, a recently retired I.R.S.
supervising estate lawyer, told a legal seminar in January.
Over all, such lawyers will spend 31 minutes auditing each tax return
reporting a very large gift this year. Such returns typically run dozens of
pages, with appraisals, descriptions of trusts and legal opinions.
One major area of cheating cannot even be detected under the current
auditing system, two I.R.S. lawyers said. When a gift tax return indicates
that total lifetime gifts have not reached the $675,000 threshold where taxing
begins, the return is not audited. But both lawyers said that when they
examined such returns at random, they found many cases in which gifts
declared at a sum like $10,000 were really worth many times that.
Copyright 2000 The New York Times Company |
