Proposed IRS Rule Would Prevent Gift & Estate Tax "Clawback"

November 21, 2018
Kristine A. Tidgren

On November 20, 2018, IRS issued a proposed rule providing that individuals who make gifts while the basic exclusion amount (BEA) is temporarily doubled will get to take full advantage of that increased BEA for those gifts, even if the BEA is lower at the time the donor dies. In other words, the proposed regulations would eliminate a so-called “clawback.” The regulations would be effective after publication of a Treasury decision adopting them as final.

Background

The Tax Cuts & Jobs Act temporarily doubled the BEA from $5 million to $10 million. Indexed for inflation, this amount is set at $11.18 million for 2018. The increase in the BEA is written to be temporary, beginning in 2018 and expiring after 2025. Absent 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.

Issue and Proposed Rule

In light of the doubled BEA, questions have arisen 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 proposed regulation specifies 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. In its explanation of how it came to issue the proposed rule, IRS also explains that the increased BEA (during 2018 through 2025) is not reduced by a pre-2018 gift for which gift tax was paid.

The new proposed rule would create some planning opportunities for lifetime gifting by high asset clients as 2026 approaches. The caveat, of course, is that anything could change between now and then, including the rule itself. Advisors must closely monitor developments in this area, especially if the composition of Congress significantly shifts.

Language of the Proposed Rule

Specifically, the new proposed rule would add a new paragraph (c) to Treas. Reg. Section 20.2010-1, stating:

If  the  total  of the amounts  allowable  as a credit in computing the gift tax payable on the decedent’s post-1976 gifts, within  the meaning  of section 2001(b)(2), to the  extent  such  credits are based solely  on the  basic exclusion  amount  as defined and adjusted  in section  2010(c)(3), exceeds the  credit allowable  within  the meaning  of section 2010(a) in computing  the  estate tax,  again only to the extent  such  credit is based solely  on such  basic exclusion  amount,  in each case by applying the tax rates in effect at the decedent’s death, then the portion  of the  credit allowable in computing the estate tax on the decedent’s taxable estate that is attributable  to the  basic exclusion  amount  is the  sum of the  amounts  attributable  to the basic exclusion  amount  allowable  as a credit in computing  the gift tax  payable on  the decedent’s post-1976 gifts. The  amount  allowable  as a credit in computing  gift tax payable  for any  year may  not  exceed the  tentative  tax on  the gifts made during  that year,  and the  amount  allowable  as a credit in computing  the  estate tax  may  not exceed the  net tentative  tax  on the  taxable  estate.

Example from the Proposed Regulations

Individual A (never married) made cumulative post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by the cumulative total of $10 million in basic exclusion amount allowable on the dates of the gifts. A dies after 2025 and the basic exclusion amount on A’s date of death is $5 million. A was not eligible for any restored exclusion amount pursuant to Notice 2017-15. Because the total of the amounts allowable as a credit in computing the gift tax payable on A’s post-1976 gifts (based on the $9 million basic exclusion amount used to determine those credits) exceeds the credit based on the $5 million basic exclusion amount applicable on the decedent’s date of death, under paragraph (c)(1) of this section, the credit to be applied for purposes of computing the estate tax is based on a basic exclusion amount of $9 million, the amount used to determine the credits allowable in computing the gift tax payable on the post-1976 gifts made by A.

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