Proposed Tax Regulations Eliminate Possibility of Clawback of Lifetime Gifts for Estate Tax PurposesAs previously posted, the Tax Cuts and Jobs Act signed into law in December 2017 (the “2017 Act”) made significant changes to the federal wealth transfer system with respect to gift and estate tax transfers during the calendar years 2018 through 2025. One of these changes was increasing the basic exemption amount that can be transferred free of gift, estate and generation skipping transfer (GST) taxes. Prior to the enactment of the 2017 Act, the exemption amount was $5 million (as adjusted for inflation in years after 2011). Under the 2017 Act, the exemption amount was doubled to $10 million, which, after being adjusted for inflation, is now $11.4 million in 2019 (or $22.8 million for a married couple). However, the increased exemption amount is scheduled to “sunset” on January 1, 2026, to the 2017 levels, as adjusted for inflation.

One recommendation included in our earlier blog post was for individuals to consider using their increased exemption amounts to make significant gifts to family members. While almost any asset can be used for making gifts, interests in closely held businesses can be an attractive asset to use for a number of reasons, including business succession and tax valuation reasons.  This can be especially true if such significant gifts are combined with other estate planning strategies, such as gifts to intentionally defective grantor trusts. However, there are always a number of tax considerations that need to be taken into account in making significant gifts, including whether such gifts are made efficiently from an income tax perspective. In any event, an advantage of making such significant gifts would be to use the increased exemption amounts prior to their sunset in the year 2026, or earlier if the tax laws are changed by Congress before such time. This is similar to estate planning that occurred in late 2012, when the exemption amount was scheduled to be reduced from $5 million per person to $1 million per person.

One concern of making such lifetime gifts prior to the sunset of the increased exemption amounts is whether the IRS would try to “clawback” such gifts into someone’s taxable estate when he or she later died, if the amount of such person’s lifetime gifts exceeded the exemption amount at the time of that person’s death. For example, if someone makes a $10 million gift in 2019 (when the exemption amount is $11.4 million) and then dies 10 years when the exemption amount has been decreased to $5 million (as adjusted by inflation), would the IRS take the position that estate taxes are owed at the time of that person’s death? This has been a concern because the gift and estate tax system is “unified,” and the amount of lifetime gifts is taken into account in calculating estate taxes in a decedent’s estate.

In November 2018, the Treasury Department issued proposed regulations stating that in such a situation, the credit to be applied in computing estate tax in a decedent’s estate would be based upon the higher exemption amount in effect at the time of the gift. Thus, there would be no clawback of lifetime gifts that later exceeded the exemption amount at a decedent’s death, if the exemption amount is decreased due to the sunset of the increased exemption amount in the 2017 Act or other changes by Congress.

Please feel free to reach out to any of Bradley’s trust and estate attorneys if you would like to discuss the possibility of making gifts to take advantage of the increased exemption amount. As gift and estate tax laws change (either due to the sunset of the increased exemption amounts or potential changes by Congress), we will update the Family Business Advocates blog to inform clients and others of such changes, and the advisability of making lifetime gifts in connection with such changes.