Tax Nugget: Proposed Regulations on Clawback Issued
The Tax Cuts and Job Act of 2017 (the "2017 Tax Act") increased the basic exclusion amount from $5 million as adjusted for inflation to $10 million as adjusted for inflation. The increased basic exclusion amount expires on December 31, 2025, after which the exemption will revert back to $5 million as adjusted for inflation. The sunset of the increased basic exclusion amount prompted the question of what would happen if a donor took advantage of the increased gift tax exemption amount but dies after 2025. Would the Internal Revenue Service attempt to clawback the gifts made in excess of the basic exclusion amount applicable on the decedent's date of death.
The answer is no, according to proposed regulations issued by the Internal Revenue Service on November 20, 2018. The proposed regulations carry out the mandate set forth in Internal Revenue Code Section 2001(g)(2) adopted by the 2017 Tax Act, which reads as follows:
(2) MODIFICATIONS TO ESTATE TAX PAYABLE TO REFLECT DIFFERENT BASIC EXCLUSION AMOUNTS. - The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any difference between -
(A) the basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent's death, and
(B) the basic exclusion amount under such section applicable with respect to any gifts made by the decedent.
The proposed regulations (Treas. Reg. 20-2010-(c)) were issued to reassure taxpayers and their advisors that a decedent's estate is not inappropriately taxed for gifts made during the interim period of time the basic exclusion amount was increased by the 2017 Tax Act. The following example in the proposed regulations allays the concern that a death after 2025 may trigger an unexpected tax if the decedent took advantage of the temporary increase in the gift tax exemption amount from 2018 through 2025.
(2) Example. 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 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 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.
The proposed regulations are necessary to prevent a person having lifetime gifts being clawed back into the estate tax calculation if the person made use of the increased exemption amount under the 2017 Tax Act and died after 2025. Under the proposed regulations, the decedent's estate “computes its estate tax credit amount using the higher of the basic exclusion amount applicable to gifts made during life or the basic exclusion amount applicable to the date of death.” (The quoted language is from a press release issued by the Internal Revenue Service.)
According to some commentators the IRS has taken an unexpected position that denies any inflation adjustments to the basic exclusion amounts if gifts have been made to take advantage of the increased exemption amount under the 2017 Tax Act, “until the inflation adjustments to the basic exclusion amount exceed the total of gifts made that were sheltered from the gift tax by the $10 million basic exclusion amount.” (See Evans Estate Law Resources Proposed Regulations on Exclusion Amount Changes.)
A cautious practitioner representing ultra-high net worth individuals will want to discuss having the client make top off gifts each year (i.e., making taxable gifts each year that use the increased basic exclusion amounts)) to lessen the impact of the proposed regulations denial of the loss of inflation adjustments in the above situation.
As expected, the proposed regulations follow what has been referred to as a use it or lose it principle. Any increased gift tax exemption amount that is not used under the 2017 Tax Act will not be carried forward after the end of 2025. As noted above, the IRS allows a decedent dying after 2025 to use the higher of the basic exclusion amount applicable to gifts made during life or the basic exclusion amount on the date of death. In addition, the proposed regulations lead one to firmly believe no off the top option is available to taxpayers. An off the top option would allow taxpayers who make taxable gifts between 2018 thru 2025 to designate those gifts as using only the temporary additional exemption amount from the 2017 Tax Act. Thus, if that option was available the basic exclusion amount of five million as adjusted for inflation would remain intact.
Robert B. Labe is a Shareholder with Williams, Williams, Rattner & Plunkett, P.C. in Birmingham, Michigan. Labe practices in the areas of estate planning, trusts and estates, probate disputes, tax law, and business law. Labe is a Fellow of the American College of Trust and Estate Counsel. He has been included in the Michigan Super Lawyers since 2009, is listed in Best Lawyer’s in America and is also designated as a Leading Lawyer by the Chicago Law Bulletin. Labe has made multiple presentations on business succession planning, estate planning, and estate and trust law for the Institute of Continuing Legal Education and State Bar of Michigan. Labe is a fellow of the American Bar Foundation.