Tax News & Views Blog
The Tax Cuts and Jobs Act of 2017 increased the unified Gift and Estate Tax Exemption from $5.5 million to $11 million per person. Adjusted for inflation, the exemption now stands at $12.06 million for 2022.
This increased exemption is scheduled to sunset on December 31, 2025, and revert to $5 million per person, as adjusted for inflation. The exemption as of the sunset date is expected to be somewhere between $6 million and $7 million per person.
The Potential Clawback and Impact of Treasury Regulations
It was unclear how the treatment of gifts made under the increased exemption amount from 2018 to 2025 would be treated after January 1, 2026, when the exemption amount reverts to $5 million. There was a potential for a so called “clawback” if an individual were to gift away their entire exemption during 2018 through 2025, and then die after December 31, 2025 (when the exemption is less than the amount in effect between 2018 through 2025).
To address this issue, the Treasury issued final regulations in 2019 eliminating any potential clawback. They did this by adopting a special rule applicable in cases where the exemption is less at the date of death than the exemption allowable at the time that gift tax was computed with regard to a decedent’s lifetime gifts.
The regulations allow an estate, for tax purposes, to use the credit calculated for the gift made under the increased exemption amount during 2018 through 2025 in place of the credit based on the lower date-of-death exemption amount. In that case, the portion of the credit against the net tentative tax attributable to the exemption amount would be based upon the greater of those two credit amounts. The allowable credit would be limited to the actual calculated credit.
For example, if D had lifetime taxable gifts of $9 million, all of which were sheltered from gift tax by an exemption of $11.4 million applicable on the dates of the gifts, and if D died sometime after 2025 when the exemption was $6.8 million, the credit applied in computing the estate tax would be based upon the $9 million of exemption used to compute the gift tax payable.
When issuing the final regulations, the Treasury stated further consideration would be given to the issue of whether certain gifts that are not true lifetime transfers should be excepted from the special rule.
Proposed Rules on Exemption Amount Allowable in Computing Federal Gift and Estate Taxes
On April 26, 2022, the IRS released proposed regulations, applicable to the estates of decedents passing on or after April 27, 2022, that would provide an exception to the special rule for transfers includible in the gross estate or are treated as includible in the gross estate after 2025 (when the exemption amount will be reduced).
Such transfers, therefore, are subject to the exemption amount in effect at the time of a decedent’s death instead of the amount in effect at the time of the gift.
Proposed regulations are not binding upon taxpayers but are generally binding upon the IRS until they become final, at which time they become binding upon both taxpayers and the IRS.
Estate planning transactions that would be subject to the proposed exception include:
- Certain gifts made within three years of death
- Transfers with a retained life estate
- Transfers where possession or enjoyment of the property by the transferee can be obtained only at or after the transferor's death
- Transfers in contemplation of death
- Grantor-retained income trusts
- Gifts in the form of a promissory note
- Gifts made under the preferred partnership freeze technique
- Transfers that would have been included above, but for the transfer, relinquishment, or elimination of an interest, power, or property, within 18 months of the date of a decedent’s death
The proposed regulation provides that the affected items include those specific items. So, the list is not an exclusive list of what would be covered by this rule. If Congress adds other provisions to the law that are similar in nature, they would be caught by this rule even if the Treasury doesn’t update the regulation.
What Can You Do with Your Estate Plan in Light of this Proposed New Rule?
Taxpayers with existing estate plans, or taxpayers considering plans prior to the 2025 sunset, can consider meeting with a trusted wealth transition services advisor to determine next possible steps.