Just in time for the holidays, the IRS has issued proposed regulations (REG-106706-18) clarifying that it will not retroactively “clawback” gifts made during the temporary increase in the exclusion amount should the basic exclusion amount revert back to pre-2017 tax act levels. The 2017 tax act doubled the basic exclusion amount (essentially, the amount that can be transferred free of estate, gift, or generation-skipping transfer taxes) from $5 million to $10 million for transfers made after 2017 and before 2026. The exclusion amount is set to revert to $5 million after 2025. The exclusion amounts are adjusted for inflation and assets exceeding the exclusion amount are subject to up to a 40% estate and gift tax rate. For 2018, the inflation adjusted exclusion amount is $11.18 million and in 2019, it is $11.4 million.
The 2017 tax act included a conforming amendment in §2001(g)(2) which provides that the IRS shall prescribe regulations “to carry out this section with respect to any difference between” (i) the basic exclusion amount under §2010(c)(3) applicable at the time of the decedent's death, and (ii) the basic exclusion amount applicable with respect to any gifts made by the decedent. However, there was some controversy in the tax community as to whether this provision required the IRS to issue regulations eliminating the clawback. These proposed regulations seem to answer any questions regarding the clawback.
The estate tax return requires a computation of the tax paid or made payable during the decedent’s lifetime. This hypothetical calculation (tax payable on gifts made after 1976), could have resulted in a “clawback” of gifts made during the years when the temporary increase was applicable – retroactively taxing amounts exceeding the available credit (based on the exclusion amount in the year of death). However, the IRS’s proposed regulations would eliminate this concern. The hearing on the proposed regulation will be held on March 13, 2019.
Prop. Reg. §20.2010-1(c) provides for the use of the higher amount of the credit applicable in the computation on the Form 706. This factors in gifts made when a higher exclusion amount was available without retroactively taxing them. For example, if a taxpayer made lifetime taxable gifts of $8 million and dies in 2026 when the exclusion amount is $5 million, the computation would allow a credit based on an exclusion amount of $8 million (the amount the taxpayer used).
For gifts made and deaths occurring between 2018 and 2025, the exclusion is $20 million (adjusted for inflation) for married couples as they can split gifts. With the unlimited marital deduction, this clarification on the clawback rules may not seem as exciting to taxpayers planning to couples with a combined net worth of under $10 million. However, considering that transfers to non-citizen spouses are not unlimited, the increased exclusion amount presents a great opportunity to transfer a substantial amount of assets in families with non-citizen spouses minimizing the use of special planning strategies (eg. QDOT). The elimination of the clawback will also bring back some planning vehicles that were used in 2012 when the basic exclusion amount was scheduled to revert back to $1 million in 2013. See, e.g., Michael Kitces, The Rise Of The Spousal Lifetime Access Trust (SLAT), available at https://www.kitces.com/blog/the-rise-of-the-spousal-lifetime-access-trust-slat/.
Of course, Congress can change the law at any time and the 2017 tax act is a political hotbed. Many taxpayers will probably wait until late in 2025 to make any drastic decisions on gifting their entire exclusion amount. However, advisers should keep their clients aware of the possible changes that could be made if the House and the Senate are both controlled by the Democrats – especially if the Democrats take over the Presidency in 2020 or 2024. This may hasten the need for clients to take advantage of the increased basic exclusion amount.
For everything necessary to research, plan, and implement strategies for maximizing your clients’ control while minimizing taxes, take a free trial to the Estates, Gifts and Trusts Portfolios Library.
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