The Tax Cuts and Jobs Act of 2017 doubled the estate and gift tax exemption for tax years 2018-2025. In 2018, the exemption doubled from $5.49 million in 2017 to $11.18 million in 2018, and that amount has been indexed for inflation annually since then, resulting in a current exemption of $13.61 million per individual in 2024.
The Exemption Sunset and the “Clawback” Worry. This increased exemption is set to sunset at the end of 2025, at which time – barring legislative action – the exemption will go down to one-half of its then- indexed-for-inflation amount. Forecasts predict the exemption to be approximately $7 million as of Jan. 1, 2026.
This creates a planning opportunity for some individuals who make inter vivos gifts (or happen to die), in 2024 and 2025, to transfer more assets to their heirs tax-free compared to other individuals who die in 2026 or later.
This sunset raises an issue about the potential “clawback” of the estate tax exemption — the possibility that the IRS could try to recover some of the tax benefits that individuals obtain from using the higher exemption amount with gifting before the doubled exemption expires.
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Anti-Clawback Regulations. Fortunately, the IRS has issued anti-clawback regulations that prevent this from occurring. The regulations ensure that individuals can compute their estate tax based on the exemption amount that was available when they made gifts during their lifetime, not when they die. The Treasury Department and the I.R.S. confirmed, in announcing Treasury Decision 9884 (IR-2019-189, November 22, 2019), “that individuals taking advantage of the 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.” Unfortunately, the regulations clarify the “use or lose” feature of the 2018-2025 doubled exemption.
The new regulations enacted in 2019 recognize that changes in the basic exclusion amount between the date of a donor’s gift and the date of the donor’s death may cause the basic exclusion amount allowable on the date of a gift to exceed that allowable on the date of death. 26 CFR § 20.2010–1 (T.D. 9725, 80 FR 34285, June 16, 2015, as amended by T.D. 9884, 84 FR 64999, Nov. 26, 2019). New § 20.2010–1, paragraph (c), provides that if the total of the amounts allowable as a credit in computing the gift tax payable on the decedent’s post- 1976 gifts exceeds the credit allowable in computing the estate tax, then the portion of the credit 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.
Four Examples. The regulations provide 4 examples under paragraph (c), with hypothetical inflation adjustments. (Unless otherwise stated, in each example the decedent’s date of death is after 2025, and gifts were post-1976.)
Example 1. Individual A (never married) gave away $9 million in gifts during their lifetime, when the estate tax exemption was $11.4 million. This means A did not have to pay any gift tax on those gifts. However, when A died, the estate tax exemption had dropped to $6.8 million. Normally, this would mean that A’s estate would have to pay tax on the difference between the exemption amount and the gifts ($9 million – $6.8 million = $2.2 million). But the IRS rules say that A can use the exemption amount that was in effect when they made the gifts ($11.4 million), not when they died ($6.8 million). So, A’s estate does not have to pay any tax on the gifts, and the estate tax credit is based on the $9 million exemption amount that A used during their lifetime.
Example 2. Assume that the facts are the same as in Example 1 except that A made cumulative taxable gifts of $4 million. Because the total of the amounts allowable as a credit in computing the gift tax payable on A’s gifts is less than the credit based on the $6.8 million basic exclusion amount allowable on A’s date of death, this paragraph (c) does not apply. The credit to be applied for purposes of computing A’s estate tax is based on the $6.8 million basic exclusion amount as of A’s date of death, subject to the limitation of 26 U.S.C. section 2010(d).
Example 3. Individual B was married to C, who died before 2026. C did not owe any gift or estate tax, and C’s executor let B use C’s unused exemption amount of $11.4 million. This is called the DSUE amount. B did not make any gifts or remarry. When B died, the exemption amount was $6.8 million. This paragraph (c) does not apply to B, because B did not use any of their own exemption amount for gift tax purposes, so gifts attributable to the basic exclusion amount (zero) were less than the credit based on the basic exclusion amount allowable on B’s date of death. B’s estate can use the total exemption amount of $18.2 million, which is the sum of B’s own exemption amount ($6.8 million) and C’s DSUE amount ($11.4 million), subject to the limit of section 2010(d).
Example 4. B is in the same situation as in Example 3, except that B also gave away $14 million in gifts after C died and before 2026. The exemption amount when B made the gifts was $12 million. B can use C’s DSUE amount of $11.4 million first, and then B’s own exemption amount of $2.6 million, to cover the gifts. The gift
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tax credit for B’s gifts is $5,545,800, which is the tax that would be due on $14 million. Out of this credit, $1,031,519 is based on B’s own exemption amount of $2.6 million, which is 18.6% of the total exemption amount of $14 million. When B died, the exemption amount was $6.8 million. The estate tax credit based on B’s own exemption amount is $2,665,800, which is the tax that would be due on $6.8 million. This is more than the gift tax credit based on B’s own exemption amount ($1,031,519). Therefore, this rule does not apply to B, and B’s estate can use the full exemption amount of $18.2 million, which is the sum of B’s own exemption amount ($6.8 million) and C’s DSUE amount ($11.4 million), subject to the limit of section 2010(d).
Disparate Planning Opportunities to Use or Lose the Doubled Exemption. New § 20.2010–1, paragraph (c), offers additional advantages to very wealthy individuals who can afford to give away amounts up to the doubled exemption amount before 2026, compared to less wealthy individuals who cannot now afford to make gifts beyond the expected sunset exemption amount. Once the exemption amount is reduced after 2025, they will only be able to transfer assets up to the lower exemption amount without incurring gift or estate tax. The temporary increase in the exemption amount thus provides a window of opportunity for individuals to transfer more assets tax-free than they would be able to once the exemption amount is reduced. However, for gifts that do not exceed the expected reduced exemption amount, this window does not offer any additional tax benefit, as the gifts would fall within the lower exemption amount that will be in effect after 2025. This creates a disparity in the tax benefits received by very wealthy individuals compared to those with less assets to give away.
*By Jeremy J. Ofseyer, Esq., located at 74-000 Country Club Drive, Suite H-2, Palm Desert, CA 92260