The Internal Revenue Service (IRS) processed most Tax Year (TY) 1999 estate and gift tax returns in accordance with the provisions of the Taxpayer Relief Act of 1997. However, approximately 1 percent (197) of the 18,184 TY 1999 estate tax returns processed by the IRS from November 1999 through March 2000 were filed on outdated forms that showed a lower unified credit than allowable. IRS processing procedures were not designed to identify and correct the understated credit and the resulting $1.8 million in miscalculated estate tax. If corrective actions had not been initiated, we estimate that 1 percent of approximately 125,000 TY 1999 estate tax return filers may have overpaid $11.6 million in tax.

An estimated 428,000 estate and gift tax returns are expected to be filed for taxpayers that either died or gave gifts in 1999. The Taxpayer Relief Act of 1997 changed various exemptions, limitations, and exclusions associated with TY 1999 estate and gift taxes. Implementation of these tax law changes required revisions to forms, instructions, publications and computer programs.

Prior to 1999, the maximum unified credit amount was pre-printed on the estate tax return. The latest version of the estate tax return does not contain a pre-printed unified credit amount. Rather, the executor of the decedent’s estate must enter the appropriate maximum allowable unified credit as determined by the taxpayer’s date of death.

The objective of this audit was to determine whether the IRS processed estate and gift tax returns in accordance with tax law changes effective for TY 1999.

The IRS put forth significant effort to prepare for the processing of TY 1999 estate and gift tax returns. The IRS ensured that new legislation was effectively implemented during the processing of most estate and gift tax returns, except when estate tax returns were filed on outdated forms.

The IRS took the actions necessary to ensure that all forms, publications, instructions, and computer programs related to estate and gift tax returns were updated to reflect the appropriate tax law changes. The Internal Revenue Manual instructions were updated to reflect accurate unified credit amounts, limitations, and exclusions.

The Taxpayer Relief Act of 1997 increased the maximum amount of unified credit that could be applied against a taxpayer’s estate tax to $211,300 for taxpayers who died in 1999. Most estate tax returns were processed accurately, and the correct amount of credit was applied. However, when estate tax returns were filed on outdated versions of the form, the IRS did not always correct the understated amount of unified credit during the processing of the returns.

The IRS’ procedures for handling estate tax returns did not cover the processing of older versions of the form with a pre-printed unified credit amount. As a result, when processing TY 1999 estate tax returns, the IRS did not identify and adjust the understatement of unified credit on 197 returns and the resulting $1.8 million in miscalculated taxes. If corrective actions had not been initiated, approximately 1,250 estates of entitled decedents may have overpaid $11.6 million in tax. Based on results that we provided to IRS management during the course of this review, they took the necessary actions to eliminate the potential for any future problems with this issue.

We recommended that the Assistant Commissioner (Forms and Submission Processing) review the applicable documents requesting computer programming changes to the annual exclusion amount in order to rule out a systemic programming problem and study the Code and Edit and Error Resolution instructions in the Internal Revenue Manual to determine the cause of this processing problem.

Management’s Response to Office of Audit Memorandum: IRS management provided an adequate, detailed response to our memorandum dated March 24, 2000 (see Appendices V and VI). The documents requesting computer programming changes were reviewed, and it was determined that the requirements were written and documented correctly. Processing procedures were revised to ensure that all versions of estate tax returns are coded and forced into the Error Resolution System when the unified credit amount is not appropriate for the tax period of the return. Management also stated that a different notice code would be used to allow tax examiners to provide a specific explanation of the change to the decedent’s estate.

Management’s Response to the Draft Report: Management’s response was due on July 31, 2000. As of August 2, 2000, management had not responded to the draft report.