Estate May Be Assessed Penalty for Negligent Failure to Disclose Lifetime Gifts Made by Decedent

Estate may be subject to a negligence penalty for failing to disclose, on an estate tax return, the decedent’s life-time gifts.

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Haggar v. U.S., 107 AFTR 2d, 2011-488.

Facts. At the time of his death, William Haggar, who had a daughter from a prior relationship named Sandra Havard, was married to Bonnie Haggar.  William knew some tax law, and typically managed all of the finances during his marriage to Bonnie.  In 1998, William gave his daughter a gift of $200,000, and gave her two children an additional gift of $60,000.  He told his daughter that he would handle the taxes associated with the gifts and that she would not need to file any tax return.  In the same year, William also made a gift of $40,000 to Bonnie’s two children.

Bonnie knew about the gifts to William’s daughter, and she signed a gift tax return on which she consented to gift-splitting (although she signed the return without explanation from William).  The gift tax return was filed by a certified public accountant (CPA), and Bonnie did not receive a copy.

In 2004, William died with a taxable estate, naming Bonnie and Sandra to serve as the representatives of his estate.  They hired an attorney and CPA to assist them with the preparation of the estate tax return and delivered all of William’s tax records to them.  The 1998 gift tax return was not included in the documents given to the attorney and CPA.

When Bonnie and Sandra were asked if William had ever made any gifts, they both answered no.  Therefore, the CPA marked “no” in response to question 7a in Part 4 of the estate tax return regarding whether prior gift tax returns had been filed.  Bonnie and Sandra signed and filed the estate tax return.

In August of 2006, the IRS examined the estate tax return and, in determining that the estate failed to disclose the prior gifts, assessed additional estate tax, interest, and an accuracy-related penalty of 20% of the portion of the underpayment attributable to the negligence.  The estate paid the additional federal estate tax and interest owed to the IRS, but argued that the penalty was erroneously assessed because Bonnie and Sandra had acted in good faith and there was reasonable cause for the underpayment.

The IRS filed a motion for summary judgment which would have enabled it to collect the negligence penalty and cut off the reasonable cause defense of Bonnie and Sandra.

The Court’s Decision.  Under Code Sec. 7491(c), the IRS bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose penalties.  The district court held that the IRS met this burden, since William’s daughter was the recipient of the $200,000 gift and his wife signed the gift tax return only six years prior to his death, at which time both defendants told the CPA that William had not made any lifetime gifts.

Therefore, the burden of establishing a defense shifted to Bonnie and Sandra, who argued that, although they had actual knowledge of the 1998 gifts, they nonetheless acted in good faith when they incorrectly informed the estate attorney and CPA about the lifetime gifts.  Since the issue of good faith and reasonable cause was disputed, neither the IRS nor the defendants were granted summary judgment.  The credibility of Bonnie and Sandra was held to be a key factor in weighing the evidence, which the Court determined was an issue of material fact that could only be decided after a full hearing.  Accordingly, the propriety of the negligence penalty was set for trial.

Recommendation.  As demonstrated in this case, copies of filed gift tax returns (and any other tax returns) should be permanently retained with a taxpayer’s financial records. These tax returns can provide crucial information for attorneys and CPAs regarding lifetime gifts, which will effect whether an estate tax return needs to be filed and if so, the amount of estate tax that may be owed to the IRS.  Doing so potentially saves tens of thousands of dollars in needless IRS penalties, and attorney and accountant fees.