The popular adage that the only two things that are certain in life are death and taxes is a good starting point as we begin our discussions on the topic of the possibility of the claw back of gift transfers under the 2017 Tax Cuts and Jobs Act.
According to the Internal Revenue Service (IRS), an estate tax is a tax on an individual’s right to transfer property (cash, real estate interests, or other holdings) at his or her death. An accounting of everything owned on the date of death is made and a tax is levied. This tax can greatly reduce the value of the overall estate, cutting the value of the gifts bequeathed in the will, because the tax must be paid before the gifts made in the will can be disposed.
A method people use to reduce the imposition of the estate tax is to make a gift of money or property to someone during an individual’s lifetime. This gift however may subject the person giving the gift called a donor to federal gift tax. Each year, donors are permitted to make gift transfers that are tax free if they are made under the threshold limit. For example, in 2019, the gift tax exemption amount is $11.4 million. By making a transfer by gift under the threshold limit, the donor and estate avoid paying taxes on that portion of the estate.
In late 2017, the Tax Cuts and Jobs Act was passed introducing a provision for gift transfers occurring after December 31, 2017. The exemption amount applicable to federal estate and gift tax was increased to $10 million. The exemption amount will continue to increase with inflation annually until 2025. In 2026, the increased exemption amount is scheduled to end and revert to the 2017 levels.
Some unfinished business of the Tax Cuts and Jobs Act of 2017 is what would happen to the donor’s gift and estate tax liability after 2026 when the increased exemption amount reverts to the 2017 levels. On November 23, 2018, the Internal Revenue Service (IRS) issued proposed regulations offering guidance on the issue.
Still in its comments phase, the proposed guidelines are attempting to address the elephant in the room – the 2017 Tax Cuts and Jobs Act left open the possibility that a gift taking advantage of the increased exemption amount would be subject to estate tax upon the donor’s death, popularly referred to as “clawed back,” if the estate tax exemption applicable at the donor’s death were lower than the exemption amount at the time of the gift.
The proposed rule provides that if an individual makes a gift taking advantage of the increased exemption amount between January 1, 2018 and December 31, 2025, the exemption amount used in calculating the federal tax payable on the aggregate of the individual’s lifetime gifts and taxable estate will be the greater of (1) the exemption amount at the time of the individual’s death and (2) the portion of the increased exemption amount previously applied to lifetime gifts.
This formula provides the donor and his or her estate with options to get around the claw back provision and avoid having to pay an increased estate tax at the time of the donor’s death.