Final Regulations Confirm No Estate Tax Clawback

November 26, 2019
Kristine A. Tidgren

On November 22, 2019, IRS released TD 9884, finalizing regulations confirming that individuals taking advantage of increased gift and estate tax exclusion amounts in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels. These regulations finalized proposed rules issued on November 20, 2018, with a few clarifications.

Background

The Tax Cuts & Jobs Act temporarily doubled the basic exclusion amount (BEA) from $5 million to $10 million. Indexed for inflation, this amount is set at $11.58 million for 2020. The increase in the BEA is written to be temporary, beginning in 2018 and expiring after 2025. Absent a statutory change, the BEA will again be $5 million in 2026, indexed for inflation.  The BEA is a credit against property for which the taxpayer would otherwise owe gift or estate tax. Additionally, the taxpayer gets to claim any available deceased spouse unused exclusion (DSUE), which is the preserved amount of any BEA the taxpayer’s last-deceased spouse was unable to use at death. To preserve a DSUE, the executor of the deceased spouse’s estate must have elected portability by filing a Form 706 after the death of the spouse.

Final Rule

In light of the doubled BEA, questions arose as to how the temporary increase would impact gifts made between 2018 and 2025 if the taxpayer were to die in 2026 or beyond, assuming the BEA is allowed to reset to $5 million, indexed for inflation. In other words, if a taxpayer made a $9 million gift in 2024, filing a proper Form 709 to report the gift and applying $9 million of his or her BEA to offset the tax liability for that gift, would tax liability arise for a portion of that gift if that taxpayer then died in 2026 after the BEA had reset to $5 million? The final regulations affirm that no such clawback would step in to impose gift and estate tax liability on the gift that was amply covered by the BEA in place at the time the gift was made. To take advantage of the increased BEA, however, the gift must actually have been made. The final regulations clarify that the special rule allowing the increased BEA is inapplicable to a decedent who did not make gifts in excess of the date of death BEA as adjusted for inflation. It is a "use it or lose it" rule.

The final rule also confirms that, even if the amount of the allowable BEA decreases after 2025, a DSUE amount elected during the increased BEA period will not be reduced as a result of the sunset of the increased BEA. In other words, the reference to BEA is to the BEA in effect at the time of the deceased spouse’s death, rather than the BEA in effect at the death of the surviving spouse. If a surviving spouse elects portability for the estate of a spouse that dies between 2018-2025, the full DSUE amounts may be applied after 2026, even if it exceeds $5 million, as adjusted for inflation.

The preamble to the final regulations responds to several comments questioning the authority of the Treasury to create regulations impacting post-2025 calculations. The agency states that it was Congress’ intent for Treasury to create regulations governing the impact of 2018-2025 gifts on those dying after 2025. In support, the preamble cites a statement from the Joint Committee on Taxation Bluebook:

Because the increase in the basic exclusion amount does not apply for estates of decedents dying after December 31, 2025, it is expected that … guidance will prevent the estate tax computation under section 2001(g) from recapturing, or ‘‘clawing back,’’ all or a portion of the benefit of the increased basic exclusion amount used to offset gift tax for certain decedents who make taxable gifts between January 1, 2018, and December 31, 2025, and die after December 31, 2025.

The final regulations provide several calculation examples, including clarification of the treatment of inflation adjustments.

The final rule brings more certainty to potential planning opportunities for lifetime gifting by high asset clients as 2026 approaches. The caveat, of course, is that the law could change between now and then or anytime thereafter. Advisors must continue to closely monitor developments in this area.

CALT does not provide legal advice. Any information provided on this website is not intended to be a substitute for legal services from a competent professional. CALT's work is supported by fee-based seminars and generous private gifts. Any opinions, findings, conclusions or recommendations expressed in the material contained on this website do not necessarily reflect the views of Iowa State University.

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