In Audits We Trust


A taxpayer’s chances of being audited can vary depending on a lot of different factors, both within and completely outside of one’s control. One factor that especially attracts the attention of the IRS is estate tax returns – in 2012, the IRS audited nearly one in three!

Large estates are especially at risk, and even with proper planning, the IRS can end up taking a big chunk of an estate. Take William Davidson. A Detroit native, Davidson grew Guardian Industries onto one of the world's top manufacturers of architectural glass, automotive, and building products. He also owned the NBA's Detroit Pistons, the WNBA's Detroit Shock, and the NHL's Tampa Bay Lightning. Davidson died on March 13, 2009, at age 86, with a net worth estimated at $5.5 billion.

As a savvy businessman and former attorney, Davidson knew the IRS would take a close look at his estate tax return. He and his lawyers took careful steps to protect his heirs from the worst of the tax, so you can imagine their surprise in May, when the IRS sent them a bill for 2.8 billion dollars.

Davidson's case involves three main issues. First, how much was the privately-held stock that  he transferred into trusts for his children and grandchildren worth? The IRS says Davidson undervalued it by as much as $1,500 per share. Davidson's lawyers say that automotive and construction stocks were tanking in late 2008 and 2009, and it was entirely foreseeable at that time that the company's sales and profits would plunge. Second, how much should the trusts have paid for the stock? Davidson used a "self-canceling installment note," or SCIN, which meant the trusts would make payments to Davidson for that stock while he lived, but the debt would expire at Davidson's death. The IRS has no problem with the SCIN strategy itself, but says the payments should have been higher based on Davidson's life expectancy when he made the transfer. And third, they argue, Davidson owes extra tax on gifts he made to his family as far back as 2005.

Of course, Davidson's estate lawyers aren't taking the $2.8 billion bill lying down. Last week, they filed a petition in U.S. Tax Court opposing the IRS’s assessment. Experts say that the strategies he used aren't the issue – it’s the size and scale of the estate that makes the case so interesting. It's one of the largest estate-tax fights ever, so we can probably expect a long and difficult battle.

We realize you probably don't have a $5.5 billion estate. But that doesn't make you or your estate any less important. Proper planning is the key to making the most of your legacy too, no matter how much you have to leave. And you can take a little comfort knowing that the IRS only gets to audit your estate tax return once!