Let’s start by saying that no one likes getting audited. But the average income tax audit isn’t the end of the world. For tax year 2012, the IRS audited just 1,481,966 returns out of over 143 million filed, or barely one in a hundred. And according to the IRS Databook, the average “deficiency notice” demanding more tax was just $10,331. That’s nobody’s idea of a party, of course. But it shouldn’t bankrupt anyone who makes enough to owe that much extra tax.

Things are a little different when it comes to estate taxes. For starters, the tax applies to the value of your assets, not the income they produce. It doesn’t kick in until your taxable estate after all deductions tops $5.25 million ($10.5 million per couple). But the tax itself is 40%, which is higher than the top income tax rate. With so much more at stake, the estate-tax audit percentage is naturally far higher than the percentage for income tax – for 2012, the IRS audited 3,762 out of 12,582 estate tax returns filed, or nearly one in three. As for the average deficiency, well, here’s hoping you’re sitting down – it’s a whopping $305,529!

Of course, that’s just the average. Half of those 3,762 deficiency notices are mercifully lower. And half of them are higher – some far, far higher.

Which brings us to William Davidson. A Detroit native, Davidson grew Guardian Industries onto one of the world’s top manufacturers of architectural glass, automotive, and building products. He also owned the NBA’s Detroit Pistons, the WNBA’s Detroit Shock, and the NHL’s Tampa Bay Lightning. Davidson died on March 13, 2009, at age 86, with a net worth estimated at $5.5 billion.

Now, Davidson didn’t make his fortune by being stupid. As a former attorney, he knew the IRS would take a close look at his estate-tax return. He and his lawyers took careful steps to protect his heirs from the worst of the tax. So you can only imagine their surprise in May, when the IRS sent them a bill for 2.8 billion dollars!

 Davidson’s case involves three main issues. 

First, how much was the privately-held stock worth, which he transferred into trusts for his children and grandchildren? The IRS says Davidson undervalued it by as much as $1,500 per share. Davidson’s lawyers say that automotive and construction stocks were tanking in late 2008 and 2009, and it was entirely foreseeable at that time that the company’s sales and profits would plunge.

Second, how much should the trusts have paid for the stock? Davidson used a “self-canceling installment note,” or SCIN, which meant the trusts would make payments to Davidson for that stock while he lived, but the debt would expire at Davidson’s death. The IRS has no problem with the SCIN strategy itself, but says the payments should have been higher based on Davidson’s life expectancy when he made the transfer.

And third, they argue, Davidson owes extra tax on gifts he made to his family as far back as 2005.

Needless to say, Davidson’s lawyers aren’t taking the $2.8 billion bill lying down. Last week, they filed a petition in U.S. Tax Court telling the IRS to take a hike. Experts say that the strategies he used aren’t the issue – it’s the scale that makes the case so juicy. But it’s one of the biggest estate-tax fights ever, so we can probably expect a long and difficult battle.

We realize you don’t have $2.8 billion for the IRS to claim. But that doesn’t make you any less important. Proper planning is the key to making the most of your legacy too, no matter how much you have to leave. So call us with your questions. And take at least a little comfort in knowing that the IRS gets to audit your estate tax return only once!

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