In 2006, Frank made an installment sale of real property to Stu, his son, for $1 million. Payments are due over a 10-year period. Frank did not file a gift tax return. For 2013, Frank reported taxable gifts so large that he used all of his unified credit then available. In 2015, the IRS audits Frank’s 2013 income tax return and discovers the sale. The IRS then contends that the property Frank sold was worth $2.5 million in 2006 and that Frank made a $1.5 million gift to Stu in 2006.
a. Can the IRS collect the gift tax on the 2006 gift? If not, will the 2006 gift affect the tax due on gifts that Frank makes in the future?
b. Will Frank potentially incur any penalty? Explain.