Taxpayer Does Some Creative Do-It-Yourself Estate and Gift Tax Planning and Then Tells the World About It

By Joel N. Crouch on January 31, 2022

On January 20th, a U.S. Magistrate Judge in Illinois issued a memorandum opinion and order in R. David Yost v. Morgan Carroll, No. 20-C-5393 (N.D. Illinois), which involved a promissory note enforcement dispute between a soon-to-be former father-in-law (Yost) and his soon-to-be former son-in-law (Carroll). The lawsuit was filed after Carroll and Yost’s daughter, Annie, started divorce proceedings. The promissory note case does not involve the IRS or any tax issues, but based on the court’s order, the IRS, and possibly the Department of Justice, could be making inquiries of the parties soon.

According to the court, “[t]his, it must be said, is an unusual and perhaps troubling case in which the defendant’s soon to be former father-in-law is suing his soon to be former son-in-law to collect on what are claimed to be, and are in form, certain promissory notes totaling in excess of $8 million”. That sounds fairly straightforward until Carroll filed an answer saying that the intent of the various money transfers by Yost to Annie and Carroll was to “avoid having to pay gift taxes to the United States Treasury”. According to the answer, the notes were implements of the scheme and the loans were really disguised gifts. The answer uses the word “illegal” five times and the word “evade” four times. As that famous philosopher Scooby-Do would say “ruh roh”.

According to the memorandum order:

At the time of the “loans” Mr. Yost wrote letters to Annie explaining that the loans were actually intended to be gifts, but Mr. Yost went through the formality of the promissory notes so he would not incur gift taxes.
The handwritten letters, which were included as evidence, said Mr. Yost intended that the notes would be forgiven upon his death, at which time his estate would even out “all of these extravagant gifts to” his daughters.
When Annie applied for mortgages, she did not list the notes as liabilities, however she did declare them as liabilities during the divorce proceedings. According to a footnote in the order, “there may be some concern over laws related to bank fraud”.

Although the court granted Yost’s motion to dismiss the counterclaim and affirmative defenses, it did so without prejudice because “to put it colloquially, there is a good deal of smoke here, and Carroll should be allowed to adequately allege there is fire”.

The court then added the following “epilogue” to the order:

“Mr. Yost claims that ‘it is true chutzpah’ for Mr. Carroll to have filed the Counterclaim he did in light of the latter's admitted involvement in the ‘loan’ transactions. But, it was Mr. Yost who brought the family's dirty laundry to federal court, and given the repeated allegations by Mr. Carroll of an attempt by Mr. Yost to evade gift taxes — not to mention the fact that the taxpayers are, in effect, subsidizing this case — the needle on the ‘chutzpah’ detector would seem to point to Mr. Yost perhaps as much as it does to Mr. Carroll — depending, of course, on the truthfulness of the allegations by Mr. Carroll. Where the truth lies remains to be seen.”

A few thoughts:

Although it is self-inflicted, this is another example of do-it-yourself estate planning going bad and it could turn out to be potentially worse. The order indicates that Mr. Yost may have had these same “loan” arrangements with his other daughters and Yost and others could be facing significant civil and criminal penalties.
Even if Mr. Yost had not tried to enforce the promissory notes, the potential gift tax problems are not necessarily over. If his estate files a Form 706 Estate Tax Return, IRS examiners are very good at uncovering disguised gifts and unfiled gift tax returns.
Annie and Mr. Carroll may not be out of the woods even if the loans were gifts. A recipient of a gift can be liable for unpaid gift tax to the extent of the value of the gift received.
In light of the court’s order and the now very public airing of his family’s dirty laundry, Mr. Yost would be wise to proactively address his potential tax issues quickly. A voluntary disclosure to the IRS may be in his future and those of other family members.

There are many legitimate gift tax planning options that Mr. Yost could have used instead of his do-it-yourself plan that is about to backfire on him and his family and cost them significant money. At a minimum, Mr. Yost could have made annual gifts of up to the amount of the annual gift tax exclusion, ($16,000 in 2022) to each of his daughters, sons-in-law or anyone else, without having to pay gift tax. If Mr. Yost is married, he and his wife have a combined annual gift tax exclusion of $32,000 per gift recipient. Although any gift in excess of the annual gift tax exclusion would require the filing of a Form 709 Gift Tax Return, in lieu of paying gift tax, the maker of the gift may elect to reduce his or her lifetime estate tax exemption, which is currently $12 million.

For questions regarding this blog post or any other civil or criminal tax related matter, please feel free to contact Joel Crouch at (214) 749-2456 or jcrouch@meadowscollier.com.