Proposed regulations on gift and estate tax exemption

On Nov. 21, the Internal Revenue Service and Department of Treasury issued Proposed Regulations Section 20.2010-1 to provide guidance on the increased gift and estate tax exemption which sunsets in 2026. A public hearing is tentatively set for March 13, 2019, to address any comments submitted in response to the proposed regulations. For the years of 2018 to 2025, the gift and estate (and generation skipping, or GST, tax) exemption amount is $10 million per year, indexed for inflation, up from $5 million. Practically speaking, the exemption amount is $11.18 million in 2018 and $11.4 million in 2019.

Of concern to tax planners is what happens when the amount drops back down in 2026. The "panic" possibilities approximate 2012 when the risk of a drop in the exemption amount was also threatened. The reduction did not end up happening then, but planning had focused on last minute, year-end gifting. In the current situation, the uncertainty related to a possible claw back of gifted amounts has delayed some gifting.

The new proposed regulations are meant to clarify how the estate tax is computed when the basic exclusion amount is different in the year of death from that when earlier gifts were made. Four scenarios are described in these regulations.

The first scenario addresses when a donor has made pre-2018 gifts which exceeded the then applicable exemption amount, incurring a gift tax liability, then makes additional gifts during the time period between 2018 and 2025. At issue is whether the prior gifts, upon which gift tax has been paid, will be included in the increased exemption amount, thus limiting the exemption amount available going forward. The impact of including these amounts, upon which gift tax had already been paid, would be to decrease the exemption amount available going forward. Under the proposed regulations, this past amount, upon which gift tax was paid, will not be included in the increased exemption amount.

The next scenario is when a donor made gifts exceeding the exemption amount and paid a gift tax prior to 2018, then dies between 2018 and 2025. The question is whether the estate tax computation will apply the increased exemption amount to the pre-2018 gifts, reducing the computation exemption amount available against the estate tax during the increased exemption amount period. The proposed regulations clarify that the exemption amount is not reduced by the amount of any past gifts upon which gift tax was paid, and the full amount is available for estate tax purposes.

Under the third scenario, the donors make increased gifts during the 2018 to 2025 period, then make further gifts after 2025. The concern is whether the earlier gifts are not sheltered because the amount excluded drops later. Under the proposed regulations, the earlier gifts are sheltered, but additional gifts after 2025 are not likely eligible for any credit above the then available credit amount (unless we get further guidance telling us otherwise).

The fourth scenario is a crucial one. Under this scenario, the decedent makes a gift during the increased exemption period that is exempt from tax due and up to this increased exemption amount, then the decedent dies after 2025. At issue is whether the earlier gifts are subject to the higher exemption amount instead of the exemption amount in effect at the date of death. Is the exemption amount at date of death the one that applies retroactively? The proposed regulations clarify how this situation is to be handled by stating that the exemption amount is the larger of the exemption amount in effect on the date of the decedent's death or the total amount of the exemption allowable in determining the gift tax payable. Thus no claw back of that gifted amount back into the taxable estate occurs.

A related example given in the proposed regulations uses a gift amount of $9 million (of the un-indexed $10 million amount) and clarifies that the $9 million is used in calculating the exemption amount post-2025. Using the $9 million, and not the full $10 million, is an odd choice. Presumably, the full $10 million, indexed for inflation, would be valid and thus exempt from estate or gift tax as well.

Therefore, based on the proposed regulations (which are not final!), our clients can gift away up to the applicable exclusion amount current until 2026, knowing that the gifts will not be "clawed back" and the excess amount gifted included in their estate. However, ultimately, no one should gift away what they need to live or would rather keep. Still, the proposed regulations are very taxpayer favorable and quite clear with respect to the scenarios explained. Hopefully, they become final.