Tax

Caught in the Estate Tax Fight

Are small business owners about be the target of more aggressive IRS estate tax audits?
Marie LeoneAugust 9, 2006

For about a week, it looked as though small businesses owners would be able to breathe a little easier after they died — so to speak.

On July 23, The New York Times broke a story about a plan by the Internal Revenue Service to cut 157 of its 345 estate tax attorneys, a 54 percent decrease in lawyer power. The reduction, alleged the article, would also reduce the number of IRS estate tax audits, and theoretically, fewer heirs would have to defend their estate tax position to an IRS examiner.

Currently, the estate tax affects people who die and leave an estate worth more than $2 million to heirs. The tax rate for 2006 is 46 percent, and repeal of the tax has been a political hot potato for a decade. Republicans anxious for repeal christened the law a “death tax,” while opposing Democrats dub any attempt at its repeal as “another tax break for the rich.”

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For small business owners, however, the estate tax feels like double taxation on non-liquid assets, like real estate, equipment, and inventory, that are needed to keep the company humming. As a result, news of a cutback in audits must have felt like a bit of relief after watching posturing lawmakers fail at pushing repeal through Congress.

Relief wasn’t long lived, though. Sources in the Times article alleged that the Bush Administration orchestrated the cutback as a way to circumvent Congress while achieving the same result as if the tax repeal had passed. Basically, former IRS attorneys told the Times that the cutback would hamstring enforcement and collection efforts, allowing many wealthy individuals, some of them small business owners, to avoid IRS audits. The claim ruffled Administration feathers.

On July 31, about a week after the Times article ran, the government shot back in an editorial authored by IRS Commissioner Mark Everson, and carried by USA Today. In the piece, Everson declared that, “the IRS is increasing its audits of the rich.” Furthermore, Everson said that the claim that the staff reduction is part of a hidden Administration agenda was “off-the-mark.”

In fact, Everson noted that since 2000, IRS audits of high-income individuals have more than doubled, and that the agency has aggressively targeted tax shelters. And since 2003, the increase in audits of high-income individuals and small corporations has been the “centerpiece” of IRS enforcement efforts, wrote Everson.

According to the commissioner, estate tax return filers have been in the sights of IRS auditors for the last few years, with the agency currently auditing 28 percent of the returns that post assets of $5 million or more. Everson wrote that he does not expect that level of audit activity to change.

Alvin Brown, a former IRS estate tax attorney who did not appear in the Times article, told CFO.com that the IRS has indeed been “aggressive and extreme,” with their audits in general. But Brown believes that the Bush Administration is being “disingenuous” when it says the cutbacks have nothing to do with repeal of the estate tax. “Anytime the Administration doesn’t like a tax statue, it takes away the IRS’s ability to enforce it,” says the private practice tax attorney who now represents clients before his former employer.

Everson offered a more bland explanation for the job cutback in his editorial. He said that since Congress raised the threshold required to file an estate tax, the number of returns has dropped by 73 percent, from 121,000 to 33,000. “With that large a workload decline, any responsible business would adjust its activities accordingly,” wrote Everson.

According to the IRS website, 62,700 taxpayers filed estate tax returns for a total of $193 billion in assets in 2004, the most recent year statistics are available.

Currently, no action has been taken regarding reducing the number of attorneys at the IRS, Robert Marvin, an IRS spokesman told CFO.com. The IRS does intend to make a “substantial reduction in staff,” said Marvin, but he added that the final job cut total depends on the number of retirements taken. More than 40 percent of the estate tax attorney staff is eligible to retire, noted Marvin.

For small business owners, estate tax relief may be further off than ever if the IRS is ramping up efforts to scrutinize 9,240 returns (28 percent of 33,000) this year. Indeed, the agency may now feel it has to prove what its Commissioner stated publicly, that the IRS has not gone soft on “the rich.”

In the meantime, small business owners may want to remember the lyrics written by late Beatle George Harrison: “Now my advice for those who die, declare the pennies on your eyes — ’cause I’m the taxman.”

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