With the Tax Cuts and Jobs Act set to expire in 2025, there's a $7 MILLION dollar opportunity that could be at risk of vanishing. For 2025, the estate tax exemption is set at a whopping $13.99 million, but it could be slashed in half in 2026.
If you think there’s even a slim chance this could happen, here's the thing - if you try to rush and protect your wealth without understanding what I'm about to show you, you could end up like the Smaldino family, who lost over a MILLION dollars because of one simple mistake.
Today, I’m going to show you the strategies that can keep you out of the IRS’s crosshair and most importantly, how to avoid this MISTAKE that costs families millions.
But first, let me tell you about Louis Smaldino...
The Smaldino Story
In 2013, he had a seemingly bulletproof strategy. He owned a valuable family LLC, and he wanted to transfer some interests into a dynasty trust for the benefit of his children from prior marriage. Simple enough, right?
Here was his plan:
Step 1: Transfer LLC interests to his wife
Step 2: Wife transfers those same interests to a dynasty trust THE VERY NEXT DAY
Step 3: Trust benefits his children
On paper, it looked perfect. Using the unlimited marital deduction, he could give the interests to his wife tax-free. Then she could use her own gift tax exemption to transfer them to the trust. Two separate transactions, two different people, no problem... or so they thought.
But here's where it all went wrong. The IRS looked at these transactions and said, 'Wait a minute...' They successfully proved that the wife acted only as a middleman and hit them with a tax bill of over $1.1 million. Why? Because they fell into a trap that many wealthy families don't even know exists - something called the Step Transaction Doctrine.
Think of the Step Transaction Doctrine as the IRS's version of a detective story. They don't just look at each transaction in isolation. Instead, they piece together the whole story, looking for connections that show your true intentions.
It's like when you watch those crime shows, and the detective has a board with photos connected by red string. The IRS does the same thing with your financial moves. They look at the timing, the relationships, the documentation - everything that might suggest these 'separate' transactions were actually part of one big plan. And they're really good at it!
But before I show you how to protect yourself, you need to understand exactly how the IRS catches people in this trap. They use what I call 'The IRS Triple-Check' - three specific tests that can turn your careful planning into an expensive mistake...
The IRS Triple-Check
When the IRS investigates your transactions, they use three powerful tests - and failing any ONE of these can trigger an audit. Let me break these down for you...
Binding Commitment Test
The first test is called the Binding Commitment Test which asks whether you were legally obligated to carry out all the steps in your plan from the very beginning. If you enter into a contractual agreement that locks you into completing all the steps, the IRS could argue that the transactions are interdependent and part of a single scheme.
For instance, you agree to transfer stock to a trust with a written contract stating that the trust will then sell the stock to a third party. Even though these steps are carried out separately, the IRS might view them as pre-planned because of the binding commitment you made upfront.
The lesson here? Avoid creating legal obligations that force you to complete multiple steps - it’s a surefire way to trigger this test.
End Result Test
The second test is the End Result Test. This is where the IRS looks at the bigger picture and asks: Were all the steps clearly prearranged to achieve one ultimate goal? If the IRS sees that the steps were taken solely to reach a specific tax-saving result, they might collapse them into one transaction.
Let's look at how this might play out. Imagine this scenario:
A business owner gifts shares to their children
The children contribute those shares to a new LLC
The LLC sells the shares to an interested buyer
Each step might look legitimate on its own. But because all roads lead to that final sale, the IRS could argue it was all one transaction with the sole purpose of avoiding capital gains tax or gift tax - potentially resulting in a much bigger tax bill.
Interdependence Test
The third and most dangerous test is the Interdependence Test. This is where the IRS asks: 'Would any of these steps make sense on their own?''
It's like a line of dominoes - if each step only makes sense because of the next step, they all fall together. And when they fall, they can crush your tax planning.
For example: you transfer cash into a trust for your child, and within days, the trust uses the exact amount of cash to purchase stock from you. The IRS might argue that these steps are interdependent because the trust wouldn’t have purchased the stock without receiving the cash, and you wouldn’t have funded the trust if it weren’t going to buy the stock.
But here's the good news - knowing these tests is like having the answer key to an exam.
Once you understand what the IRS is looking for, you can structure your transactions to pass all three tests.
And that brings us to the seven specific strategies you can use to protect your wealth while staying completely legal...
The Seven Strategies to Avoid Step Transaction Doctrine
Now that you understand how the IRS catches people, let's talk about how to protect yourself and avoid step transaction doctrine. Here are seven strategies that can help you reduce the risk of triggering the step transaction doctrine while staying completely within the law.
Space Out Transactions
This is your first line of defense. While there's no magic number the IRS accepts, transactions spaced months or even years apart are much harder to challenge. Think of it like building a fortress - each month that passes adds another layer of protection.
The expert tip? Execute your steps in different tax years. It’s like placing an entire ocean between your transactions, rather than just a river.
Avoid Pre-Arranged Agreements
Remember the Binding Commitment Test? Here's how to pass it: Don't lock yourself into future steps. Each transaction should be independent, with no strings attached.
Instead of committing to specific next steps, keep your options open. Maybe you'll sell, maybe you'll hold, maybe you'll gift - the key is maintaining flexibility.
Document Independent Purposes
Every step needs its own legitimate purpose beyond tax savings. This isn't just about having paperwork - it's about telling the true story of why each move makes sense on its own.
For example, transferring assets to a trust could be about:
Protecting assets from future creditors
Creating a legacy for your children
Managing assets for beneficiaries who aren't ready to handle them directly
Follow All Formalities
This is where details matter. Everything must be precise and in place. When you transfer LLC interests:
Update all operating agreements
Get every required signature
Issue K-1s
File all appropriate paperwork
Allow for Economic Risk
When you transfer assets, ensure there’s a real economic risk or volatility during the holding period. For instance, transferring publicly traded stock to a spouse that remains exposed to market volatility may strengthen the rationale for an expedited transfer by the second spouse to a trust.
Work With Professionals
Like you wouldn't perform surgery on yourself, and you shouldn't structure complex transactions alone. Work with:
An experienced estate planning attorney
A qualified financial advisor
A tax professional who understands these issues
Don't Leave a Trail
This might surprise you, but some attorneys may advise keeping documentation to a minimum. While you need proper legal paperwork, avoid creating unnecessary emails or messages that could later be used to show your entire plan was pre-arranged.
To be clear - this isn't about hiding anything. It's about being smart and deliberate with your planning. Every step should be legal, ethical, and able to stand up to scrutiny.
Final Thoughts
These seven strategies are designed to work like a shield, helping to minimize unnecessary taxation and safeguard your wealth for future generations. But remember - timing and execution are everything...
With 2026 approaching fast, time is running out. If you don’t want to risk missing out on today’s higher estate tax exemption, you need to act - but you need to act smart. These seven strategies aren't just theory; they're your roadmap for protecting millions in wealth from unnecessary taxation.
Remember:
The IRS is watching more closely than ever
The estate tax exemption can be cut in half at the end of 2025
One wrong move could cost you millions, just like it did for the Smaldino family
But with the right approach, you can protect your wealth legally and safely
With the estate tax exemption potentially being slashed in half by 2026, the clock is ticking to secure your wealth for future generations. Don’t let a simple mistake like the Smaldino family's cost you millions. Schedule a meeting with me today to ensure your estate plan is airtight, legally compliant, and built to withstand IRS scrutiny. Together, we’ll craft a strategy that preserves your legacy and protects your hard-earned wealth. Time is of the essence—let’s get started.
The Smaldino family lost over $1 million because of one simple error. Don’t let the same happen to you. Feel free to schedule a complimentary Estate Clarity meeting to ensure your estate plan rock-solid and free of costly mistakes.
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