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Husband's fraud will not toll limitations period for spouse's split-gift tax return.

Taxpayer T'S husband H owned 100% of an S corporation's issued and outstanding stock. H is a highly sophisticated, well-known businessman. H gifted 48% of his stock to his children. T and H then timely filed separate gift tax returns. H hired a return preparer to prepare Forms 709, United States Gift (and Generation-Skipping Transfer) Tax Return, for himself and T, and gave the return preparer false information as to the stock's value. On each Form 709, H and T identically valued the aggregate shares and split the value in accordance with Sec. 2513. On H's Form 709, T indicated her consent to the split gift. Similarly, H indicated his consent to split the gift by signing T's Form 709. Neither T nor H paid any gift tax on the split gift. More than three years have passed since the filing of the gift tax returns.

The IRS maintains that the stock's fair market value (FMV) substantially exceeded the amounts reported on T's and H's gift tax returns. The Service proposes to issue gift-tax deficiency notices to T and H, asserting a Sec. 6663 fraud penalty against H because it determined that he intentionally undervalued the stock on Form 709. The IRS does not intend to assert the fraud penalty against T, because it has no evidence establishing fraudulent intent on her part.

The limitations period on the assessment of H's gift tax liability remains open based on fraud, despite the passage of more than three years from filing of his gift tax return. The Service raised the question of whether it can rely on H's fraud as a defense to the argument that the limitations period for assessing deficiencies has expired with respect to T's gift tax liability.


Under Sec. 2502(c), a donor pays gift tax. As an exception to the general rule, Sec. 2513(a)(1) provides that, if each spouse consents, a gift made by one spouse to any person other than his spouse would be considered as made half by him and half by his spouse. Consequently, both spouses are treated as a donor under Sec. 2513(a), and each is obligated to pay any resulting gift tax liability. By consenting to split-gift treatment under Sec. 2513(a)(2), the entire gift tax liability of each spouse for that tax year is joint and several.

Under Sec. 6501, the Service must assess tax within three years after a taxpayer files his return, whether or not he files such return on or after the date prescribed. As an exception, Sec. 6501(c)(1) provides that, in the case of a fraudulent return with the intent to evade tax, the IRS may assess tax (or begin a proceeding in court for collection of such tax without assessment) at any time.

To determine whether Sec. 6501(c)(1) applies to T's return, an understanding of the concept of "fraud" is necessary. Neither the Code nor the regulations define fraud. The Service has defined tax fraud "as an intentional wrongdoing on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing" (IRM Thus, a return that contains both a tax underpayment and a taxpayer's fraudulent intent is a "fraudulent return."

Sec. 6501(c)(1) phrases the fraud exception to the usual three-year limitations period in terms of a fraudulent return with intent to evade tax, and does not explicitly require fraudulent intent on the taxpayer's part.

A fraudulent return places the IRS at a special disadvantage in discovering and ascertaining fraud; this disadvantage is present whether the fraud is that of T or H. By its very nature, a fraudulent return generally appears correct on its face and the true facts concerning the tax liability are deliberately withheld from the Service.

To compensate for the burden imposed on the IRS to prove fraudulent intent and ascertain the correct tax liability, under Sec. 6501(c)(1), the Service has an unlimited time in which to ascertain the correct tax liability and establish the facts necessary to prove that the return is fraudulent. Only in this way can the government's interest be protected.

In the present case, H filed his own gift tax return, but he is not a taxpayer with respect to T's return, nor a return preparer or T'S agent acting in a capacity similar to that of a return preparer. Further, because the present case involves joint and several tax liability, it is similar to court cases holding that the fraud of one spouse on a joint income tax return holds the limitations period on assessment open for both spouses.

In addition to joint and several liability, other similarities exist between this case and joint-return situations. Each Form 709 in this case contains the signatures of both spouses; H's consent is signified on line 18 of T's return and vice versa. Further, Form 709 instructs the spouses to mail their Forms 709 in the same envelope.

Ultimately, however, this case is different. In the income tax context, there are two taxpayers reporting a single tax liability on one return. This liability is computed based on the spouses' aggregate incomes, deductions, exemptions and credits. Under Sec. 6013(d)(3), each spouse is jointly and severally liable. If one spouse commits fraud, the joint return is thereby rendered fraudulent and the limitations period remains open under Sec. 6501(c)(1) for both taxpayers. A different limitations period cannot apply to each spouse, because only one tax liability and one return exist.

In contrast, in the split-gift tax context, two taxpayers exist, each of whom reports a separately computed gift tax liability on a separate return. Depending on each spouse's available unified credit and annual exclusion amounts, their overall gift tax liabilities for the year may not be equal. The husband is not a taxpayer with respect to the wife's return, and neither is the wife with respect to the husband's return. It is of crucial importance that T's return is not a joint return.

In this case, T's return is not rendered fraudulent simply because H's return is fraudulent; two separate liabilities and two separate returns are involved. An analysis of whether Sec. 6501(c)(1) applies to T's return must be separate from the analysis of whether Sec. 6501(c)(1) applies to H's return.

In the present situation, the IRS determined the stock's actual FMV to be substantially higher than the value T reported. This results in a deficiency in T's gift tax liability. This tax underpayment was not the result of T's intent to defraud the government. The Service has no reason to believe T or her agents in preparing the return (e.g., the return preparer) had any knowledge of H's fraudulent undervaluation. Moreover, T had no reason to suspect that H had committed fraud in undervaluing the stock. Thus, T's return is not a "fraudulent return;" it does not reflect a fraudulent intent on the part of T or her agent.

IRS LETTER RULING (CCA) 200205027 (10/30/01)
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Article Details
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Author:Fiore, Nicholas J.
Publication:The Tax Adviser
Geographic Code:1USA
Date:May 1, 2002
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