IRS Releases Proposed Regulations on Clawback of Gift and Estate Tax Exclusion

On November 23, 2018, the IRS released proposed regulations providing that for gifts made prior to January 1, 2026 (the date in which the new Tax Act will sunset), the current basic exclusion amount will apply and any reduction in the basic exclusion amount subsequent to 2025 will not result in a clawback for said gifts that may result in estate or gift tax liability. These proposed regulations will go through the period for public comment and a hearing but do provide an answer to a concern that many taxpayers have had since the passing of the Tax Cuts and Jobs Act in 2017.

Gift taxes and estate taxes work hand in hand in that each taxpayer is allowed an annual gift tax exemption amount of $15,000 per donee per year. This means that the taxpayer may make gifts to a specific person up to that amount per year and not incur any tax liability. There is also an estate tax exclusion amount that applies on an individual’s death that is currently $11,180,000. When that individual passes away, any assets that he or she owns that pass through his or her estate up to that amount will not be subject to the estate tax. These estate and gift taxes work in tandem in that any lifetime gifts made by an individual above the gift tax annual exemption amount reduce the estate tax exclusion amount by those amounts over the annual gift tax exemption. For illustrative purposes, if John made a gift to Susan in the amount of $115,000, $100,000 over the annual gift tax exemption amount, he would have to file a gift tax return and that amount of $100,000 would reduce his estate tax exclusion amount at death. If lifetime gifts are made that reach an amount above the estate tax exclusion amount, gift tax would have to be paid on those amounts over the exclusion amount and then estate tax would be imposed at death.

Prior to the Tax Cuts and Jobs Act in 2017 (the “Act”), the estate tax exclusion amount was $5.49 million and the annual gift tax exemption amount was $14,000. Under the Act, the estate tax exclusion was increased to $11,180,000 and the annual gift tax exemption was increased to $15,000. One issue that has arisen involves the fact that the Act is supposed to sunset in 2026, meaning the estate tax exclusion amount will be reduced back to its pre-Act amount (adjusted for inflation). With that sunsetting in mind, many people were concerned that gifts made prior to 2026 and after 2017 that would not amount to more than the current estate tax exclusion then may lead to estate tax liability to the individual’s estate when the exclusion amount is reduced after 2025.

These proposed regulations address this issue by providing that in such a circumstance as that provided in the previous paragraph, the new estate tax exclusion amount will not clawback to result in estate tax liability for previously made gifts that were less than the exclusion amount when they were made. Instead, the proposed regulations provide that if the total amount allowed as a credit in computing the gift tax payable on the decedent’s lifetime taxable gifts exceeds the estate tax exclusion amount at his or her death, the exclusion amount would be the larger of the previously used exclusion amount or the estate tax exclusion amount at death.

To illustrate (Prop. Regs. Sec. 20.2010-1(c)(2)), if an unmarried individual made lifetime taxable gifts of $9 million, all of which were sheltered from gift tax by $10 million in the basic exclusion amount allowable on the dates of those gifts, and the individual dies after 2025, when the estate tax exclusion amount is back to $5 million, the rule under the proposed regulations would allow the applicable credit amount against estate tax to be based on a an exclusion amount of $9 million.

The preamble to the proposed regulations also addressed whether taxpayers who exhausted their exclusion amount with gifts made before 2018 and paid gift tax and then make a further gift or die within the period of the higher exclusion amount would be able to use the higher exclusion towards the earlier gifts and reduce the amount currently available for gift or estate tax purposes. The IRS stated that this would not be available to taxpayers.

While it is possible that changes to the Internal Revenue Code could further be enacted to make this point moot, it would be unwise to do any planning assuming and hoping that the current exclusion amounts stay consistent given the sunsetting of the Act in 2026. These proposed regulations do however provide some relief for taxpayers wishing to utilize the increased exclusion amount for lifetime gifts. As these proposed regulations are likely to become final regulations, practitioners and taxpayers alike should pay close attention to these regulations when estate, tax or gift planning.

 

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December 13th, 2018|