The Treasury Department and the IRS have issued eagerly awaited final regulations (TD 9884) that confirm that where a taxpayer makes gifts of their entire exemption between 2018 and 2025, when the exemption is $11 million (indexed), and then passes away after 2025 when the exemption drops (“sunsets”) to $5 million (indexed), the benefit of the higher exemption would not be retroactively eliminated. The final regulations go on to address in favorable fashion a lingering question about the impact of the sunset on portability. The final regulations are effective on and after Nov. 26, 2019. They will affect taxpayers who make gifts after 2017 and the estates of decedents dying after 2025.
Effective 2018, the Tax Cuts and Jobs Act (TCJA) approximately doubled the estate, gift and generation-skipping transfer (GST) tax exemptions to $11.18 million. The increase in exemptions afforded taxpayers significant opportunities for wealth transfer or, in many cases, new found flexibility to address problems with existing planning at little or no gift tax cost. However, there was always the nagging concern that if a taxpayer made tax-free gifts of up to $11 million (indexed) before 2026 and then passed away after 2025 when the exemption was $5 million (indexed), the taxpayer’s estate tax would be calculated based on the lower exemption in place in the year of death. In other words, the benefit of the higher exemption would be retroactively eliminated. Advisors referred to this scenario as ‘clawback’ and asked for clarification.
Back in November 2018, the IRS issued proposed regulations (REG–106706–18) that would effectively ensure that where a taxpayer made gifts between 2018 and 2025 and then passed away after 2025, the minimum amount of exemption would be the exemption that applied to the pre-2026 gifts, e.g. the exemption amount in place at the time the gifts were made and not in the year of death. If the actual exemption after 2025 were to exceed the previous amount of exemption used, the actual exemption amount would be applicable. The gifts would not be clawed back into the estate tax calculation as though made at a lower exemption amount. The final regulations simply confirm the proposed regulations.
Still, there is more to the story than confirmation that there will be no clawback. Another provision in the regulations creates (or perhaps reinforces) the notion that taxpayers who intended to take advantage of the increased exemptions before 2026 should do so in a timely fashion. That is because, an ordering rule directs that a taxpayer who uses exemption is deemed to use the base $5 million (indexed) exemption first and then the additional layer of exemption available through 2025. Taxpayers cannot claim that they used the increased portion of the exemption first so that the base remains after 2025.
As mentioned, the final regulations also addressed portability, noting that sunset would have no impact on it. That question was whether, if a spouse dies before 2026 and his or her executor elects portability of the deceased spouse’s remaining exemption, would the survivor still get the benefit of the full amount of remaining exemption even after sunset. In other words, would there be a clawback of the amount available to the surviving spouse? The final regulations confirm again that there will be no clawback. While planners assumed that was the case, it is obviously helpful to see it in print.
The final regulations did not address the late allocation of the increased exemption for transfers in trust prior to 2018. The IRS referred to an example in the Joint Committee on Taxation General Explanation of Public Law 115-97 wherein a late allocation of GST exemption was allowed for a transfer in trust prior to 2018. The final regulations also did not address the potential for clawback of the GST exemption. The IRS said that there is nothing in the statute that would indicate that sunset would have any impact on allocations of GST exemption between 2018 and 2025. The IRS said that providing regulatory guidance was “beyond the scope of this rulemaking.” Planners are left to, and will no doubt assume, that there will be no clawback for GST purposes as well.