The Tax Cuts and Jobs Act (TCJA) presented taxpayers with a kind of ‘good news, bad news’ proposition. The good news is that, effective January 2018, the estate, gift and generation-skipping transfer (GST) tax exemptions were approximately doubled to $11.18 million, effective January 2018. The bad news is that, much like many of the income tax provisions in the new law, the increase is temporary. After 2025, the exemptions will sunset. They will drop back to their pre-2018 amounts, i.e., $5 million indexed from 2017.
Taxpayers and their advisors have seen this movie before. The plot is eerily familiar. Back in 2012, the exemption of $5.12 million was scheduled to drop to $1 million as of 2013. That drop was popularly known as the ‘fiscal cliff”. Many taxpayers were eager to use the increased exemption while the using was good. However, the enthusiasm for wealth transfer was curbed by concern that if a taxpayer made tax-free gifts of up to $5.12 million before 2013 and then passed away when the exemption was $1 million, 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’.
Fast forward to TCJA, where its déjà vu all over again, except at a loftier level of exemption. This time around, however, Congress anticipated the concern about clawback and provided that the Secretary (of the Treasury) shall prescribe such regulations as may be necessary or appropriate to make sure that gifts that were made when the exemption was high(er), meaning before 2025, will not be treated as made after 2025 when the exemption is lower. In other words, the regulations would preclude clawback.
In a welcome return to the good news, the IRS issued proposed section 2010 regulations 106706-18 on Nov. 20, 2018. The proposed regulations 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 exceeds the previous amount of exemption used, the actual exemption amount would be applicable. The gifts will not be clawed back into the estate tax calculation as though made at a lower exemption amount. Indeed, Treasury and the IRS emphatically underscored the point by titling their Nov. 20 news release, “Treasury, IRS: Making large gifts now won’t harm estates after 2025.”
The proposed regulations will be effective once they are final. The IRS will receive comments from the public by Feb. 21, 2019 and, if comments are received, will hold a public hearing on March 13, 2019.
The implications of the proposed regulations are clear and can be summed up in just one phrase, “use it or lose it!” With that in mind, taxpayers who have identified opportunities to take advantage of the increased exemption before 2026 (or sooner if the political winds suggest a mid-course correction) but have been hesitant to do so because of the risk of clawback now find themselves on firmer ground for moving forward with those plans.