On November 26, 2019, the Treasury Department and the IRS issued final regulations under IR-2019-189 confirming that there will be no “clawback” for gifts made under the increased estate and gift tax exclusion put in place by the Tax Cuts and Jobs Act of 2017 (the “Act”). These final regulations provide a window for strategic gift planning for individuals to review and discuss with their estate planning attorney.
By way of background, the Act increased the estate and gift tax exclusions from a base of $5,000,000 to a new base of $10,000,000 (indexed for inflation). After taking into account inflation, in 2020, the exclusion will be $11,580,000 (or a combined $23,160,000 for a married couple). These increases will only last until the end of 2025 (unless Congress acts sooner), at which time the exclusions will sunset, or revert, to the amounts under the prior law with a base of $5,000,000 (indexed for inflation).
The sunset created a question as to whether gifts greater than the inflation-adjusted $5,000,000 exclusion would be subject to gift and estate tax after 2025. Now, in IR-2019-189, the IRS confirms that individuals who take advantage of the increased estate and gift tax exclusion or portability 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.
The final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the basic exclusion amount applied to gifts made prior to January 1, 2026, or the basic exclusion amount applicable on the individual’s date of death. A similar special rule applies to an exclusion that is “ported” to the surviving spouse. As a result, individuals who have made or plan to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025. Similarly, spouses who have the benefit of additional “ported” exclusions made in this period will continue to have the benefit of those ported exclusions after 2025.
As an example, assume an individual transfers $10,000,000 into an irrevocable trust this year, and subsequently dies after January 1, 2026, when the estate and gift tax exclusion has reverted to an inflation-adjusted $5,000,000. The estate would not have to pay estate tax on the extra $5,000,000 gift. Instead, the IRS rules provide that the full $10,000,000 would be exempt from estate tax.
The regulations set out a “use it or lose it” benefit, so the time to act is now. If an individual dies after 2025 and did not make gifts between 2018 and 2025 in excess of the lower scheduled exclusion amount in effect at his or her death, then the excess exclusion will be lost. Even though the increased exclusion amounts are not set to expire until January 1, 2026, an earlier lowering of the exclusion amount could occur if the political landscape in the executive and legislative branches changes as a result of the upcoming November 2020 elections.