What are the IRS Examination Limits?

Under the old gift and estate tax rules, the IRS generally could not challenge the valuation of gifts and the taxes paid on those gifts after a three year statutory period had expired. This three-year period began upon the filing of the gift tax return and the paying of the gift tax. This worked fine while the donor was alive; however, when the donor died, the IRS was free to examine the valuation of all prior gifts made during the donor’s life in determining the ultimate estate tax liability. In effect, this gave the IRS unlimited time and free rein to challenge the valuation of gifts made to determine the gift and estate tax liability of the donor. The taxpayer’s estate was subject to potential taxes and penalties.

Following the Taxpayer Relief Act of 1997 and the IRS Restructuring and Reform Act of 1998, the IRS adjusted its policies concerning the examination of prior gifts. Under the new law, the three-year statute of limitations on gifts applies in both the gift tax as well as the estate tax context. Upon the death of a donor, the IRS can only go back three years in examining prior gifts. The catch in this new law is that the gifts must be adequately valued and disclosed, as defined by the IRS. Any gift made that is not adequately valued and disclosed is subject to examination and challenge by the IRS at any time, including and especially at the death of a donor. If the gift tax valuation reports are adequately valued and disclosed, the business valuation professional creates a safe harbor for those gifts made more than three years ago.