Expect Scrutiny: Estate and Gift Tax Examinations in Focus

Although IRS enforcement efforts have evolved, estate and gift tax examinations remain an area of focus, particularly for high value estates and sophisticated wealth transfer transactions.  With the rising exemption, there are fewer returns filed each year subjecting a larger percentage of returns to audit.  As the IRS continues to dedicate resources in this area, fiduciaries and advisors should expect increased scrutiny of complex planning techniques and valuation issues particularly in larger more complex estates.

Valuation continues to be one of the most frequently contested issues during estate and gift tax audits.  Closely held business interests, family limited partnerships, real estate, and other difficult to value assets often attract IRS attention, especially when valuation discounts are applied.  Likewise, transfers involving grantor trusts, intrafamily loans, and other estate planning vehicles may be examined to determine whether they reflect arm’s length terms and are supported by adequate documentation.

The possibility of an audit underscores the importance of thorough preparation by the estate’s fiduciary before filing an estate tax return.  A well-documented return – including qualified appraisals, complete financial records, and contemporaneous support for elections and deductions – can significantly streamline the examination process and strengthen the estate’s position, if challenged.  Given the amount of time that may pass between filing the return and an audit, lately close to three years from filing, it is important that all records supporting the valuation and elections made on the return are maintained.

The takeaway here is that audit readiness begins long before an audit notice arrives.  Estate fiduciaries and their advisors should work together to ensure that valuations are well-supported, planning decisions are thoroughly documented, and returns are carefully prepared.