Recent disclosures in a lawsuit between the State of California and the IRS have revealed an extensive, but low-profile, IRS audit initiative to uncover unreported gifts. The IRS has sent requests to many, if not all, states seeking real property filings the state received that show transfers of real estate for little or no consideration. Presumably, the IRS would like to compare these transfers with its gift tax return records and audit taxpayers who made transfers that appear to be gifts but did not file a gift tax return. The IRS may also be interested in sales of land between family members.

California refused to comply with the IRS request for its transfer records and the IRS filed suit in federal court seeking a court order forcing California to turn over the records. While the federal court in California declined to force California to produce their records to the IRS, documents filed in the case reveal that many other states, including Texas, have voluntarily complied with similar IRS requests and turned over documents relating to potentially donative transfers of real property in their states. Based on a comparison of the state records disclosed and its gift tax return records, the IRS apparently believes that noncompliance rates in this area are extremely high (from 50 percent in some states to as high as 100 percent in others).

The documents filed in the California case also reveal that a significant number of audits already have resulted from this initiative — 323 taxpayers have been examined in the past two years, 217 are currently under examination, and an additional 250 taxpayers are currently under consideration for audit. According to these documents, to date the IRS has uncovered at least 97 unreported gifts, including 12 that resulted in gift tax being due (because the value of the gift exceeded the donors’ available gift tax exemption). The IRS also has assessed penalties against some of these taxpayers.

The IRS initiative is on-going, and more audits are expected.

For more information, please contact Vinson & Elkins lawyer Don Wood. Visit our website to learn more about V&E's Federal Income Tax practice, or e-mail one of the practice contacts.