Wealth Advisers Must Ensure Estates Use Pre-Sunset Exclusion

Planning and audit prevention strategies can alleviate the burdens of estate and gift tax audits. Advisers experienced with tax, planning, and audits can help clients prepare their financials to limit surprises even in the biggest and most complex gifting or estate transfers.

Thanks to Inflation Reduction Act funding, the IRS has pushed to increase enforcement and compliance on above the 90th income percentile to close the $688 billion tax gap. The focus on the highest income generators, through holdings in partnerships and as investors, means this demographic likely will see an increase in estate and gift tax audits—especially as the temporary gift tax exclusion comes closer to running out.

Wealth advisers must ensure clients with taxable estates (over $5 million net worth individually) use the remaining temporary exclusion to make gifts directly and to tax planning vehicles, such as trusts or family investments, before the 2025 sunset.

A concentrated period of large gifts, combined with a corresponding focus on auditing the wealthy, is the perfect recipe for increased audits. Complying with an audit is time-consuming and expensive, even when the planning and strategy may be sound. When it comes to the estate tax, it forces the taxpayer’s family to relive the loss of a loved one almost three years later.

The strategic planning to survive audits of several forms—Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return; Form 706-NA, the estate tax return for nonresident alien decedents; or Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return—begins with the structuring of the transaction and the reporting of the transfer.

Consider the hypothetical example of Sam and Suzie, a married couple where Sam is a US citizen and Suzie is a permanent resident. They have filed joint income tax returns and lived in Bethesda, Md., where the home they purchased decades ago has ballooned to a value of over $3 million.

They are within the target audit group of 90% percentile or higher net worth (which is $1.9 million). When adding in lifetime investments in retirement accounts, life insurance, brokerage accounts, the family consulting business, and a vacation home, the couple’s net worth easily surpasses $25 million with most of the assets jointly owned or in the retirement accounts.

Their advisers did limited estate planning because they assumed that as a married couple, Sam and Suzie could benefit from the unlimited marital deduction, and transfers to limit estate tax can be done after the first spouse’s death. Sam died in 2023 with most of the $25 million attributed to him.

This case alone presents several complex audit triggers. The estate tax return allows for an equal division between spouses for jointly owned property, except for transfers to non-citizen spouses.

Due to lack of planning and that the full marital deduction doesn’t apply for the transfer to Suzie as a non-citizen spouse, their advisers put into place a post-mortem qualified domestic trust, or QDOT, to move the assets into a trust for non-citizens.

The only issue is that this trust essentially holds the principal until the spouse becomes a US citizen or dies and ensures that the estate tax on those assets is paid then. No planning can be done to move those assets out of Suzie’s estate.

Holding retirement accounts in QDOTs also requires special disclosures and information statements, which can void the transfer if done incorrectly. Finally, a family-owned business interest must be valued correctly, and any discounts taken for the lack of control or minority interest must be property justified.

To prevent a time-consuming audit, advisers should know their clients’ specific circumstances when engaging in post-mortem planning. This means:

• Being aware of the estate’s value, including a qualified appraisal of all assets of value (such as jewelry, art, and collectibles)
• Ensuring a thorough review of prior gift tax returns, as well as proper allocation and valuation for those transfers
• Ensuring information statements and asset valuations are fully detailed in a client’s tax return

Estate tax attorneys’ review of estate and gift tax returns, with complete and thorough information where they can effectively recreate the return, may prevent a full audit and be more expedient and efficient for the client and their families.

In our hypothetical scenario, Sam and Suzie should have engaged advisers much earlier to evaluate their assets and split ownership so attribution to the non-citizen spouse is limited. They also should have planned to make gifts steadily over the years, and used asset protection trusts and business succession methods to incorporate a combination of intrafamily sales and gifting to lower the estate with the most tax efficiency.

A series of similar transfers in gifting can be more efficient overall and limit an audit. Over a period of years, the gift structure and amounts may be lower to not be within a targeted group. However, trying to remain within gifting thresholds by gifting through multiple transactions can also cause audit failures under the step transaction doctrine.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Priya Prakash Royal is managing attorney of Royal Law Firm, an international private client tax law firm representing multinationals and business owners with US and cross-border wealth preservation and asset protection.

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