Each person has a permanent exclusion amount of $5 million which they can give during life or at death. That amount is inflation adjusted. The Tax Cuts and Jobs Act doubled that exclusion for years 2018 through 2025.
In 2018, the inflation adjusted, temporarily doubled, exclusion is $11.18 million. Shortly after passage, questions arose regarding hypothetical taxpayers who utilized the doubled exclusion during their lifetime and then died in 2026 or later, when the exclusion reverts to the standard $5 million (adjusted for inflation).
Since prior taxable gifts ordinarily are included when determining the estate tax and then the exclusion is applied, this is a legitimate question.
Here’s an example:
Mary owned $14.18 million in assets. She gives away $11.18 million in 2018, relying on her interest from the $3 million, together with social security and a pension to pay her expenses after the gift.
When she gives the assets away in 2018, she would owe no gift tax since the exclusion in 2018 is doubled and inflation adjusted to $11.18 million.
Mary dies in 2026, when the exclusion is $5 million. Let’s assume the exclusion amount is inflation adjusted to $6 million in 2026. She has $3 million in assets at her death in 2026. But she has prior taxable gifts of $11.18 million. So, her grossed up estate would be $14.18 million. Would she owe tax on the amount above the exclusion in effect at her death, ($5 million, inflation adjusted to $6 million)? If so, then her estate would owe 40% tax on the amount above $6 million. $14.18 million less $6 million = $8.18 million. The tax on that amount would be over $3 million.
The Treasury Department and the IRS have issued Proposed Regulations which address the so-called “clawback” issue. Those regulations provide that there wouldn’t be a tax on assets that were gifted when the exclusion covered the gift.
In Mary’s situation, she wouldn’t owe tax on the amount she had already gifted. Of course, she wouldn’t have any remaining exclusion. She’d only owe tax on the $3 million remaining in her estate, or $1.2 million. Mary could leave $1.8 million to her surviving beneficiaries rather than having that amount be used to cover gifting which she had done in 2018, when the gifting had been fully covered by the exclusion amount.
The Proposed Regulations are quite favorable to the taxpayer. Here’s a link to the Proposed Regulations. There will be a public hearing on these Proposed Regulations at the IRS building in Washington, DC, on March 13, 2019. It’s doubtful there will be many in opposition.
Once the Proposed Regulations are finalized, this confirms the benefit for higher net worth taxpayers to utilize the doubled exclusion for gifts prior to the sunset at the end of 2025.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128