IRS may examine predeceased spouse’s estate return to determine allowable DSUE amount

The Tax Court held that the IRS acted within its authority when examining the estate tax return of a predeceased spouse to determine the correct deceased spousal unused exclusion (DSUE) amount of the surviving spouse.

Facts: Frank W. Sower died on Feb. 23, 2012. During his lifetime, he and his wife, Minnie Lynn Sower, gave taxable gifts of $997,920 and $997,921, respectively. All the gifts were given between 2003 and 2005, with a Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, filed each year. Upon Frank Sower’s death, his estate filed a timely return reporting no tax liability and did not use all of the basic exclusion amount allowed under Sec. 2010(c)(3). His estate reported a DSUE of $1,256,033 and elected portability of the DSUE to his wife. The estate reported no taxable gifts on the return itself but did indicate $945,420 in taxable gifts on the worksheet provided. On Nov. 1, 2013, the IRS issued an initial estate tax closing document to Frank Sower’s estate showing no tax liability and stating that the return had been accepted as filed.

On Aug. 7, 2013, Minnie Sower died. Her estate filed a timely return claiming the DSUE of $1,256,033 as reported by her husband’s estate. Minnie Sower’s estate also did not report any taxable gifts made during her lifetime. During 2015, the IRS began an examination of Minnie Sower’s estate return, which included an examination of the return filed by her husband’s estate to determine the proper DSUE. As a result of the examination, the IRS reduced the amount of DSUE available to Minnie Sower’s estate by $973,343. In addition, the IRS adjusted her taxable estate by the amount of her lifetime taxable gifts and her funeral costs, resulting in a total deficiency of $788,165.

Issues: Minnie Sower’s estate filed a timely petition disputing the entire deficiency. The estate argued that the estate tax closing document for her husband’s estate should be treated as a closing agreement under Sec. 7121 and the IRS should be estopped from reopening the estate. Minnie Sower’s estate also argued that this was an improper second examination of Frank Sower’s estate and that the 2010 effective date of Sec. 2010(c)(5)(B) precluded the IRS from adjusting the DSUE for gifts made before that date. Finally, the estate argued that Sec. 2010(c)(5)(B) as applied violated the statute of limitation under Sec. 6501.

Holding: The court rejected the estate’s argument regarding the estate tax closing document because it found that the closing document was not a Sec. 7121 closing agreement. According to the court, such an agreement must be negotiated, and there was no evidence that there had been any negotiations regarding the document.

The court further found that Sec. 2010(c)(5)(B) does in fact give the IRS the power to examine the estate tax return of a predeceased spouse and does not undermine the statute of limitation in Sec. 6501, as no tax was assessed against the estate of the predeceased spouse. Additionally, courts have held that Sec. 7602(a)(1) gives the IRS authority to examine any range of materials including books, papers, records, or other relevant materials.

With respect to the claim of an improper second examination, the court also held for the IRS. In Estate of Meyer, 58 T.C. 69 (1972), with similar facts, the Tax Court held that the IRS could reopen a case after initial examination. The court found that when the IRS does not obtain any new information, no second examination has taken place, citing Ballantine, 74 T.C. 516 (1980). Finally, the Tax Court noted that courts have consistently held that only the examined party is protected from second examinations (see Krilich, 470 F.2d 341, 350 (7th Cir. 1972)). Frank Sower’s estate, not Minnie Sower’s, had undergone the first examination, so Sec. 7605(b) did not protect Minnie Sower’s estate.

Regarding the effective date of Sec. 2010(c)(5)(B), the Tax Court determined that the effective date does not preclude the IRS from adjusting the DSUE amount by gifts given before Dec. 31, 2010. The court noted that the effective date limits the application of Sec. 2010(c)(5)(B) to estates of decedents dying after that date, which included both the Sowers’ estates, and that the effective date of Sec. 2010(c)(5)(B) for gifts therefore was not relevant.

• Estate of Sower, 149 T.C. No. 11 (2017)

—By Mark A. Nickerson, CPA, a lecturer in the School of Business of The State University of New York at Fredonia, N.Y.