One year (Year 1), a taxpayer made a gift of a one-half undivided interest in real property.  However, she failed to file a gift tax return.  If she’d filed a return that year, she could have used up part of the unified credit against gift tax, which was $192,800.

Perhaps she learned her filing lesson in Year 2, when she made additional gifts, reported them on a gift tax return for that year and used the entire unified credit of $345,800 then in effect.

In Year 3, the taxpayer died.  Her estate filed an estate tax return, in which it disclosed the gift made in Year 1.  The Internal Revenue Service applied Internal Revenue Code Section 6601 to assess interest on the Year 1 liability, but was unclear whether the interest should start running as of the date the Year 1 gift tax return should have been filed or as of the date the Year 2 gift tax return was due.

In Chief Counsel Memorandum No. 201249015 (released Dec. 7, 2012), the IRS determined that underpayment interest for a gift tax deficiency starts to accrue on the date the Year 1 gift tax return was due.  And, because the taxpayer used up the entire unified credit in Year 2, her estate couldn’t use it to offset the tax for the unreported Year 1 gift.

Unified Credits

Under IRC Section 2501, a tax is imposed each year on an individual who transfers property by gift.  If a taxpayer doesn’t file a gift tax return, the IRS can assess the gift tax at any time, under IRC Section 6501(c)(3).  A unified credit against the gift tax is allowed, but that amount must be offset by any amount allowed as a credit to the taxpayer for all preceding calendar years (IRC Section 2505).  A taxpayer’s available credit is thus what’s used in computing her net gift tax liability.

In this instance, not only did the taxpayer fail to report her first gift in Year 1, but also, she should have used some of the unified credit to eliminate her gift tax liability in the first year.  She then should have used what was remaining from the unified credit in Year 2 to reduce her gift tax liability.  Instead, she used the entire unified credit in Year 2, so there wasn’t any credit available to apply to her gift made in the first year, and the deficiency was for the entire amount of gift tax due.

When Does Interest Accrue?

IRC Section 6601 requires that interest be paid beginning from the date prescribed for payment, up to the date paid.  Typically, a gift tax return is due April 15 of the year following the year in which a gift was made (IRC Section 6075(b)).  In this instance, the assessment is made for the first tax year in which the taxpayer failed to file a return (Year 1), and interest accrues beginning on the date the gift tax return was due.  The IRS didn’t mince words: “There is no other logical start date, since the deficiency now arises in Year 1.”