Executive Summary

Objective and Scope

Background

Results

Conclusion

Appendix I – Detailed Objective, Scope, and Methodology

Appendix II – Major Contributors to This Report

Appendix III – Report Distribution List

Appendix IV – Outcome Measures

Appendix V – Memorandum: Processing of Estate Tax Returns

Appendix VI – Management’s Response to the Memorandum

Appendix VII – Hypothetical Case Example

Executive Summary

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(197) of the 18,184 TY 1999 estate tax returns processed by the IRS from November 1999 through March 2000 were filed on outdated forms that showed a lower unified credit than allowable.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implemented during the processing of most estate and gift tax returns, except when estate tax returns were filed on outdated forms.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.

Objective and Scope

The Taxpayer Relief Act of 1997 changed various exemptions, limitations, and exclusions associated with estate and gift taxes. The objective of this audit was to determine whether the Internal Revenue Service (IRS) processed estate and gift tax returns in accordance with the tax law changes effective for Tax Year (TY) 1999.

In order to achieve our objective, we reviewed computer extracts for 29,498 TY 1999 estate and gift tax returns processed by the IRS from November 1999 through March 2000. We performed additional research and reviewed returns when processing data indicated a potential difference from tax law provisions.

We performed this audit in accordance with Government Auditing Standards from October 1999 through April 2000. The audit was conducted at the National Office and the Brookhaven IRS Center. Data and cases reviewed were selected from estate and gift tax returns processed nationwide.

Details of our audit objective, scope, and methodology are presented in Appendix I. Major contributors to this report are listed in Appendix II.

Background

Processing returns and implementing the provisions of tax law changes were included on the list of the top 10 management issues facing the IRS. Implementation of tax law changes affecting the processing of approximately 428,000 estate and gift tax returns of taxpayers who died or gave gifts in 1999 required revisions to forms, instructions, publications, and computer programs.

The Taxpayer Relief Act of 1997 provided for gradual increases to the maximum amount of unified credit that can be applied against a taxpayer’s estate and/or gift tax. For taxpayers who died or gave gifts in 1999, the maximum allowable amount of unified credit was $211,300. This amount is scheduled to increase until it reaches $345,800 in 2006.

A credit is an amount that eliminates or reduces tax. A unified credit applies to both the gift tax and the estate tax. The unified credit is subtracted from any gift tax that a taxpayer owes. Any unified credit the taxpayer applied to his/her gift tax in one year reduces the amount of credit that can be applied to his/her gift tax in a later year. If a taxpayer does not use the entire maximum allowable unified credit during his or her lifetime, the estate can use the remainder to eliminate or reduce estate tax upon the taxpayer’s death.

If the correct amount of unified credit was not used on an estate and/or gift tax return and was not corrected by IRS return processing procedures, the tax, refund, account balance, and penalty and interest calculations would be incorrect. Further, erroneous notices would be generated and sent to some taxpayers.

The executor of a decedent’s estate uses an estate tax return form to figure the estate tax imposed by the Internal Revenue Code. The estate return must be filed within nine months of a taxpayer’s date of death.

In order to accommodate the future increases to the unified credit amount, the IRS revised the 1999 estate tax return. Prior to 1999, the return had a maximum unified credit amount appropriate for that particular tax year pre-printed on line 11. However, for TY 1999, line 11 was left blank to accommodate the anticipated changes to the unified credit over the next few years. The executor of the decedent’s estate must enter the appropriate maximum allowable unified credit, which is determined by the taxpayer’s date of death.

Results

The IRS put forth significant effort to prepare for the processing of TY 1999 estate and gift tax returns. It 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.

Most Estate and Gift Tax Returns Were Processed in Accordance With Tax Law Changes

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. Requests for Information Services, the documents submitted to the IRS Information Systems Division requiring programming changes, were submitted timely and reflected the correct dollar amounts, limitations and exclusions. The Internal Revenue Manual processing instructions were updated to reflect accurate unified credit amounts, limitations, and exclusions. Most estate and gift tax returns were processed in accordance with the provisions of the Taxpayer Relief Act of 1997.

The Internal Revenue Service Did Not Give Some Estate Tax Return Filers the Maximum Allowable Tax Credit

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 1,250 estates of entitled decedents may have overpaid $11.6 million in estate tax.

We reviewed data extracted by specialized computer programs for all TY 1999 estate and gift tax returns (29,498) processed by the IRS from November 1999 through March 2000.

We identified no material problems associated with the processing of 11,314 gift tax returns. An in-depth analysis of 58 randomly selected cases confirmed this conclusion.

However, we found that 535 (3 percent) of the 18,184 estate tax returns processed by the IRS were filed on outdated versions of the estate tax return form. These forms showed a lower unified credit than allowable. During processing, these estate tax returns were given the unified credit amount that was pre-printed on line 11, rather than the maximum allowable amount of $211,300 for taxpayers who died in 1999.

In 197 (1 percent) of the 18,184 cases, the understatement of unified credit resulted in the overpayment of approximately $1.8 million in estate tax, an average of $9,329 per return. Since the remaining 338 (2 percent) of the cases had no estate tax due before the application of the credit, there were no tax consequences to the decedent’s estate.

Based on IRS Statistics of Income estimates, we calculated that 1 percent (1,250) of the projected 125,000 estate tax returns estimated to be filed for Calendar Year 1999, multiplied by the average tax consequence of $9,329 per return, would equate to approximately $11.6 million in understated unified credit and miscalculated estate tax.

At the IRS Centers, the Code and Edit function scans returns and ensures that returns with omissions or errors are directed to the Error Resolution System (ERS) for correction. The Code and Edit and ERS correction procedures for estate tax returns did not provide instructions covering the processing of older versions of the estate tax return form with a pre-printed unified credit amount. As a result, most of these estate tax returns were not coded properly, if at all, and most of the returns were not routed to the ERS for correction.

We found that a small number of estate tax returns that were submitted on an older version of the form were coded in such a manner as to cause them to be routed to the ERS. However, actions taken by ERS tax examiners were insufficient to ensure correct processing. Further, in some instances, their efforts caused the Integrated Data Retrieval System (the IRS’ computerized tax account system) to reflect incorrect processing information and generate incorrect and confusing notices to the decedents’ estates.

Appendix VII illustrates a hypothetical example of an estate tax return filed on an outdated version (1998) of the form and the most current version of the form (1999).

In this example, we assumed the decedent’s date of death was February 5, 1999, which would have entitled the estate to a maximum unified credit of $211,300. However, the 1998 estate tax return has $202,050 pre-printed on line 11 because that was the maximum allowable amount of unified credit for that particular tax year.

We found that returns filed on an outdated form such as this were usually processed without a correction to the unified credit amount. In this hypothetical example using the incorrect unified credit, the balance due would be $57,501.

As shown in our illustration, the most current version of the estate tax return (1999) has no pre-printed maximum unified credit amount on line 11. Therefore, the executor of the estate would have put $211,300 on that line and the result would be a correct balance due of $48,251. This is a difference of $9,250 from the calculation arrived at when the incorrect version of the form was used. In our example, the decedent’s estate would have owed the IRS $9,250 less than the executor’s calculations indicated.

Further, if the return had been filed late, the IRS would have calculated the interest and penalties due on the higher incorrect balance. If the tax had been paid when the return was filed and the error had been corrected upon issuance of a closing letter by the Examination function, the IRS would then have to pay interest to the estate on the $9,250 difference. This could be up to 18 months after the filing of the estate tax return.

The Assistant Commissioner (Forms and Submission Processing) should:

1. Review the applicable documents requesting computer programming changes to the annual exclusion amount in order to rule out a systemic programming problem.
2. 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: The Acting Assistant Commissioner (Forms and Submission Processing) provided an adequate, detailed response to our memorandum dated March 24, 2000 (see Appendices V and VI). Processing procedures were revised to ensure that all estate tax returns are coded and forced into the ERS when the pre-printed unified credit amount on line 11 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. These actions should eliminate the potential for any future problems with this issue.

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.

Conclusion

In general, most estate and gift tax returns were processed accurately and the amount of unified credit applied during processing was correct. 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 and miscalculated estate tax during processing.

The number of estate tax returns filed each year is expected to increase 18 percent by the year 2006. The unified credit amount is expected to increase 4 more times before reaching $345,800 within the same time period. The increasing number of potentially affected returns, combined with the numerous expected changes to the maximum unified credit amount, increase the risk and impact of this processing problem in the foreseeable future. When we brought this issue to IRS manage-ment’s attention, they took prompt corrective action, which should prevent any future problems with this issue.

Detailed Objective, Scope, and Methodology

The overall audit objective was to determine whether the Internal Revenue Service (IRS) processed estate and gift tax returns in accordance with the tax law changes effective for Tax Year (TY) 1999. To accomplish our objective, we:

1. Reviewed recent tax laws and determined the changes applicable to the processing of TY 1999 estate tax returns.
2. Reviewed recent tax laws and determined the changes applicable to the processing of TY 1999 gift tax returns.
3. Reviewed the National Office Legislative Affairs Action Plan to identify the changes which affected estate and gift tax returns and determined whether all the changes were identified and the responsible individuals named to coordinate the changes.
4. Contacted the responsible individuals, held discussions and interviews, and determined whether the necessary changes were made. Determined whether tax forms, instructions, and publications were adequately revised to help taxpayers comply with the new tax laws.
5. Determined whether the applicable Requests for Information Services were submitted to Information Services and that computer programs were changed and in place to ensure timely and accurate processing of estate and gift tax returns.

1. Reviewed data extracted by specialized computer programs developed by the Treasury Inspector General for Tax Administration’s Information Technology staff on all TY 1999 estate tax returns processed by the IRS from November 1999 through March 2000:

2. Reviewed computer extracts of all TY 1999 gift tax returns (11,314) processed by the IRS from January through March 2000 and determined whether they were processed accurately. No discrepancies were noted, but we selected a judgmental sample of TY 1999 gift tax returns (58 cases) and determined whether they were processed in accordance with recent tax law changes.

Major Contributors to This Report

Gordon C. Milbourn III, Associate Inspector General for Audit (Small Business and Corporate Programs)

Richard J. Dagliolo, Director

Robert K. Irish, Audit Manager

Kathleen A. McFadden, Senior Auditor

Dolores Castoro, Auditor

Margaret F. Filippelli, Auditor

Carol Gerkens, Auditor

Joseph Butler, Computer Specialist

Report Distribution List

Deputy Commissioner Operations C:DO

Commissioner, Large and Mid-Size Business Division LM

Commissioner, Small Business and Self-Employed Division S

Chief Information Officer IS

Chief Operations Officer OP

Assistant Commissioner (Customer Service) OP:C

Assistant Commissioner (Forms and Submission Processing) OP:FS

National Director, Customer Service Compliance, Accounts and Quality OP:C:A

Director, Customer Account Services, Small Business and Self-Employed Division

Director, Legislative Affairs CL:LA

Director, Office of Program Evaluation and Risk Analysis M:O

Office of Management Controls M:CFO:A:M

Office of the Chief Counsel CC

National Taxpayer Advocate C:TA

Audit Liaisons:

Deputy Commissioner Operations C:DO

Outcome Measures

This appendix presents detailed information on the measurable impact that our recommended corrective action will have on tax administration. These benefits will be incorporated into our Semiannual Report to the Congress.

The Internal Revenue Service (IRS) did not give some estate tax return filers the maximum allowable tax credit. The Taxpayer Relief Act of 1997 provided for a maximum unified credit of $211,300 to be applied against the estate tax of taxpayers who died in 1999, if the credit had not already been applied towards gift tax during their lifetime. We found that 1 percent (197) of the 18,184 Tax Year (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 miscalculated estate tax during processing. As a result, these estates overpaid their estate tax by $1.8 million. If corrective actions had not been taken, we estimate that 1 percent (1,250) of approximately 125,000 TY 1999 estate tax return filers may have overpaid $11.6 million in estate tax.

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.

Taxpayer rights and entitlements

The estates of 197 taxpayers who died in 1999 overpaid $1.8 million in estate tax by submitting their TY 1999 estate tax returns on outdated forms. If the percentage and average dollar of error cases identified in the sample remain the same, we estimate that if corrective actions had not been taken, 1 percent (1,250) of approximately 125,000 TY 1999 estate tax return filers may have overpaid $11.6 million in estate tax during the processing of their returns.

We reviewed data extracted by specialized computer programs for all 18,184 TY 1999 estate tax returns processed by the IRS from November 1999 through March 2000. We performed Integrated Data Retrieval System research and requested data for all the returns where the unified credit amount differed from the maximum credit allowed for taxpayers who died in 1999.

We found that 535 (3 percent) of the 18,184 estate tax returns processed by the IRS were filed on outdated versions of the estate tax return form. These forms showed a lower unified credit than allowable. During processing, these estate tax returns were given the unified credit amount that was pre-printed on line 11, rather than the maximum allowable amount of $211,300 for taxpayers who died in 1999.

In 197 (1 percent) of the 18,184 cases, the understatement of unified credit resulted in the overpayment of approximately $1.8 million in estate tax, an average of $9,329 per return. The remaining 338 (2 percent) of the cases had no estate tax due before the application of the credit and there were no tax consequences to the decedents’ estates.

Based on IRS Statistics of Income estimates, we calculated that 1 percent (1,250) of the projected 125,000 estate tax returns estimated to be filed for Calendar Year 1999, multiplied by the average tax consequence of $9,329 per return, would equate to approximately $11.6 million in understated unified credit and miscalculated estate tax that may have been overpaid.

Memorandum: Processing of Estate Tax Returns

The memorandum has been removed due to its size. To see the complete memorandum, please see the Adobe PDF version of the report on the TIGTA Public Web Page.

Management’s Response to the Memorandum

The response has been removed due to its size. To see the complete response, please go to the Adobe PDF version of the report on the TIGTA Public Web Page.

Hypothetical Case Example