We are often asked for a list of tax ‘Do’s and Don’ts’ to help ensure that no tax planning opportunities nor implications are missed.  In response, we have comprised a summary of items that are commonly overlooked or misunderstood when considering the various aspects of managing family wealth from a tax perspective.  While the following is by no means a comprehensive nor complete list of compliance and planning opportunities, each topic listed here, should encourage further communication and planning within families and/or the family office.

Estate Planning & Trust Administration

Procrastination.  Contemplating death and discussing how to distribute assets is not really a conversation starter, so many individuals decide to do it “someday.”  For some individuals that someday never arrives, and the state in which they live decides how their assets will be distributed.  A far better outcome is to have a plan in place before it is needed.  Your estate plan may consist of a will, trust, financial power of attorney, health care power of attorney, and advance care directives.  Once you have your estate planning documents in place, don’t forget to periodically review them, especially when you have a major life event (i.e., birth of a child or divorce) or there are major tax law changes.

Discussing inheritance.  Addressing the elephant in the room can be tricky and difficult. But if discussions about inheritance are started early and held often, you can set expectations to lessen disagreements (and litigation) after your death; you can ensure your goals, wishes, and intentions are clearly communicated; and, you can prepare the beneficiaries and executor for managing your estate.

You built it, now what.  You spent a significant portion of your life building and running your business.  What happens to the business when you retire, die, or become disabled?  What are your long-term plans for the business?  A business succession plan can help your business survive an unforeseen event; promote communication about and plan for the future of the company; and help the company maintain its reputation, image and credibility.

Corralling the trust return.  Trusts, like individuals, file federal and state income tax returns.  However, determining the states in which a trust must file a return can be puzzling.  A trust can be taxed in multiple states or in no states. Some states consider the residency of the beneficiary and/or trustee, such as California.  Some states consider the residency of the settlor at the time the trust was created, like New York.  Some states consider the location where the trust is administered, like Colorado.  Trust filing requirements can be a moving target.  Every year is a new year; beneficiaries move, trustees move, and trust management changes hands.

Who paid what.  Certain expenses are incurred in administering an irrevocable trust, for example, tax preparation fees, state and local real property taxes, and state and local income taxes. These expenses are the responsibility of the trust and should be paid by the trust.  When a settlor or beneficiary pays any of those expenses (on behalf of the trust), a whole host of issues presents themselves.  Did the settlor/beneficiary make a gift to the trust, and if so, how did the gift affect the trust’s generation-skipping transfer tax exemption?  Should a gift tax return have been filed? Is the beneficiary now a settlor of the trust too?  Is inclusion in the gross estate for estate tax purposes a concern?  If the trust lacks liquidity, then planning should be considered to raise the necessary cash.

Designate a beneficiary, already.  Beneficiary designations are an important estate planning tool, which allow assets to pass outside the will or revocable trust.  Certain assets, such as life insurance and retirement accounts, pass by beneficiary designations.  Not naming a beneficiary causes these assets to be distributed to the estate, often resulting in unexpected tax consequences.  Primary and contingent beneficiaries should be named.  Beneficiary designations, like estate planning documents, should be reviewed periodically for major life events and major tax law changes.


Gifts & Charitable Giving

Appraisal, appraisal, appraisal.  A gift must be adequately disclosed on a gift tax return to ensure that the 3-year statute of limitations runs on that gift, thus preventing the IRS from revaluing the gift and assessing any additional tax.  Besides providing the name of the donor and donee, a description of the transferred property, and trust information (if applicable), noncash gifts, for the most part, require qualified appraisals by qualified appraisers to meet the adequate disclosure requirements.  If a gift is not adequately disclosed, the statute of limitations never starts – meaning the IRS can revalue the gift and assess additional tax (if appropriate) beyond the deathbed.

Use it or lose it.  For 2023, the gift tax exemption amount is $12.92 million per person; however, in 2026 that amount is set to revert back to an estimated $6.40 million per person. Individuals and families seeking to lower their taxable estate may not see such a generous opportunity from the government again, so it is critical to develop giving plans and put them into motion before it is too late.

Report those gifts to trusts.  Generally, gifts equal to or less than the annual gift tax exclusion amount do not have to be reported on a gift tax return.  However, more caution is needed when transfers to a trust are made because gift tax and generation-skipping transfer (GST) tax issues can arise.  Transfers to a trust are eligible for the annual gift tax exclusion amount when trust beneficiaries are given the right to withdraw that amount at the time of the contribution.  More importantly, such transfers to trust likely will not qualify for exemption from the GST. Accordingly, decisions should be made at that time concerning whether the donor desires to allocate GST exemption to the contributions.

By definition, a trust may be a GST trust in which GST is automatically allocated to each transfer made to the trust, producing an exempt GST trust. On the other hand, by its terms, a trust may not be a GST trust and no GST is being allocated to each transfer made to the trust, producing a nonexempt GST trust.  Furthermore, because of the complex definition of a GST trust, a trust may be a GST trust in one year and not, in another– producing neither a fully exempt nor a fully nonexempt trust – just a mixed-up trust.

Reporting the first transfers to a trust on a timely-filed gift tax return and proactively electing to treat the trust as a GST trust will shield that trust against the imposition of GST tax, which is a 40% tax rate.  Alternatively, proactively electing out of the automatic allocation rules on a timely filed gift tax return will preserve GST exemption, allowing you to use it for more strategic transfers.  So, even though the gifts fall within the gift tax annual exclusion amount, report those gifts to trusts on a timely filed gift tax return.

Gift it or step-it up.  When you gift an asset during your lifetime, the recipient takes that asset at your carryover basis.  When a taxpayer is terminally ill, the question may arise as to whether the individual should make gifts rather than die owning the asset.  Although there are multiple factors to consider in making such a decision, it is important to understand that taxable gifts (gifts in excess of the annual exclusion amount) will be included as part of the equation to determine the estate tax liability of the individual.  Thus, there may be little or no advantage whatsoever to making such a gift to reduce overall gift or estate tax liability.  An inherited asset, on the other hand, receives a basis adjustment – either a step-up or a step-down – based on the asset’s fair market value at the time of death.

When reviewing assets of the taxpayer, including trusts established by the taxpayer, it is prudent to determine where the highly appreciated assets are located.  Often those assets have been transferred to trusts for the taxpayer’s descendants.  The assets in those trusts typically will not receive a step up in basis upon the death of the taxpayer.  If the trust established by the taxpayer is a grantor trust, the client should consider exchanging the highly appreciated property held by the trust with assets of the taxpayer that have a basis close to the value of the asset.

Substantiate, seriously.  The IRS continues to surprise taxpayers by disallowing their charitable contribution deductions, in their entirety, for failure to substantiate the contribution properly and fully.  Taxpayers have been left out in the cold, without a charitable deduction, for (i) failing to obtain a complete contemporaneous written acknowledgment, (ii) for failing to attach a qualified appraisal to the tax return (when required), and (iii) for failing to attach Form 8283 (Noncash Charitable Contributions) or attaching an incomplete Form 8283 (i.e., basis information was missing) to the tax return.


Final Estate Administration

Below the threshold, so no Form 706.  Not so fast.  If the decedent is not married at the time of death and the estate is below the filing threshold, then a Form 706 (United States Estate (and Generation-Skipping Transfer) Tax Return) is not needed. But if there is a surviving spouse, consider filing for portability.  Portability allows a surviving spouse to port the remaining exemption amount, if any, that the deceased spouse’s estate did not use.  Taking advantage of this election will shelter more of the surviving spouse’s assets and reduce overall estate tax – especially significant pending an estimated 50% reduction to the exemption amount in 2026.  For 2023, the lifetime estate and gift tax basic exemption amount is $12.92 million per person – that amount is set to revert back to an estimated $6.40 million per person in 2026.

Even if the size of the estate is below the threshold amount required to file an estate tax return, a Form 706 must be filed to make the portability election.  In those cases where the estate is below the filing threshold, the IRS recently extended the time for filing a Form 706 for portability purposes to 5 years within the date of death.  If a Form 706 is otherwise required to be filed, the portability election must be made on a timely filed return, which is within 9 months of the date of death or 15 months if an extension is timely filed.

Executors execute.  If you are an executor (aka Personal Representative) for an estate, do not delay in meeting with a CPA and attorney following the death of the person.  Administering an estate is complex and time-consuming.  As executor, you have certain legal obligations, one of which is to determine if the estate will be required to file a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return and if estate tax will be owed.  To arrive at that determination, you will need to prepare an inventory of the estate assets and have them valued.  Time is of the essence because Form 706 is due 9 months from the date of death, and 15 months from the date of death if an extension is timely filed.

A Form 706 is a complex return with multiple schedules and specific documentation requirements. Any estate tax owed is due at extension time – 9 months from date of death.  The executor needs to have a fairly complete picture of the estate’s assets, the estate’s gross value, and any estate liquidity problems within that 9-month period.  Delay does not work in an executor’s favor.

To distribute or not to distribute.  The executor often receives substantial pressure from beneficiaries to distribute assets from an estate.  As executor (aka Personal Representative) of an estate, you will be responsible for distributing the assets of the estate pursuant to the decedent’s Last Will and Testament.  Distributing an estate asset prematurely can be a huge problem. Have taxes, estate and income, been paid? Have all creditor claims been satisfied? Have expenses been paid?  Will the estate hold back an amount for audit contingency?  If the assets have been distributed before all estate liabilities have been satisfied – particularly those of the IRS – the IRS can hold the executor personally liable.  The IRS can collect from the executor first, then leaving it up to the executor to try and collect from the beneficiaries.


International Tax Compliance

Worldwide reporting.  As long as you are a U.S. citizen, you are taxed on your worldwide income, no matter where you live, and no matter for how long. U.S. taxes are based on citizenship, not country of residence.  As a U.S. citizen, you are required to file a U.S. federal income tax return and pay U.S. taxes on your worldwide income. By the way, resident aliens also are required to report their worldwide income.

Disclose, disclose, disclose.  Enquiring minds want to know, and the IRS definitely wants to know what foreign assets a U.S. citizen and resident alien owns, even if those assets do not generate income. Foreign assets include foreign bank accounts, foreign securities, foreign partnership interests, foreign investment assets held by a trust, and foreign-issued life insurance or annuity contracts.  Also, the IRS wants to know about the creation of, transfer to, and transactions with a foreign trust.  And the IRS wants to be kept up to date on gifts from a foreign estate, nonresident alien, foreign corporation, or foreign partnership.

The IRS has provided a handful of forms to disclose these various foreign assets and gifts: Form 114, Form 8938, Form 3520, Form 3520-A, Form 5471, Form 5472, and Form 8865. Penalties can be substantial for taxpayers who fail to timely file the form.

Congratulations, it’s a foreign trust.  U.S. citizens who work abroad often participate in foreign pension plans.  These plans are commonly encountered in countries such as Canada, France, Australia, Hong Kong, Singapore, and the United Kingdom.  Foreign pension plans are a foreign asset that must be disclosed by the taxpayer. Certain pension plans (e.g., self-funded plans) are considered foreign grantor trusts, in which there is no deduction for contributions and no tax deferral on accrual of income, unless treaty benefits apply.  Australia superannuation plans and United Kingdom self-invested personal pensions (SIPPs) are generally treated as foreign grantor trusts for U.S. tax purposes.  This treatment raises the level of reporting required and complexity encountered.


IRS & State Controversy

Ignoring notices.  Never a good idea.  The proverbial clock is ticking, and if you are not familiar with the deadlines and procedures for responding to notices, your rights are vanishing, and penalties and interest are accruing.  Collections may be forthcoming.  Notices do not expire; nor do they go away.  Keep your address up to date with the IRS; notices are not automatically forwarded to your current living address.  Even a slight delay in responding to a notice may preclude a simple resolution.  So, read the notice when received or seek out your nearest tax professional for assistance.  You also may wish to consider granting a power of attorney to your CPA or legal counsel, so that they also will receive copies of the notice.  This provides some assurance that someone will receive a copy of the notice and timely respond to the IRS, especially during vacation times.

Representing yourself.  Also, not a good idea.  Taxpayers, generally, have no clue what their rights are during an audit and are unfamiliar with the audit methods and procedures of the IRS.  An unrepresented taxpayer can inadvertently expand the scope of an audit and negatively affect the audit outcome by simply providing too much information.  A tax professional can restrict the scope of the audit, handle all contact with the auditor, help avoid or minimize penalties, and appeal the outcome, if needed.

The proof is in the pudding.  New York and California are examples of state tax authorities that will aggressively challenge whether a taxpayer has successfully changed their residency out of their state. Establishing and proving state residency does not hinge on just one act but on several acts.  Of course, understanding the residency requirements for the state you are moving out of and for the state you are moving to are essential because states differ in their requirements.  Common steps taxpayers may take to establish residency in a new state include purchasing a home, registering to vote, engaging local medical professionals, obtaining a new driver’s license, changing your mailing address, filing a resident state income tax return (if applicable), changing bank accounts to the new state, bringing your family and pets with you to the new state, filing a nonresident state income tax return in your former state (if applicable), and focusing your activities in your new state.  Believe it or not, it is possible to be a resident of more than one state at the same time!

The need to document and retain documentation cannot be overemphasized.  For those taxpayers that winter in one state and summer in another state, the number of days spent in each state can be important.  Keep a daily calendar showing where you were each day, including receipts for those days.


Written  by Kathy Walter. Copyright © 2023 BDO USA, P.C. All rights reserved. www.bdo.com