The IRS is currently accepting comments from the public before it makes a decision on whether to finalize the regulations.

On April 26, 2022, the Internal Revenue Service released proposed regulations that aim to further clarify the application of the temporarily increased exemption against the federal estate and gift tax to estates of decedents dying after 2025. The proposed amendment seeks to prevent a potential abuse of the taxpayer-friendly regulations (the “anti-clawback regulations”), which are designed to give proper credit to a taxpayer who dies at a time when the exemption is lower than when the taxpayer made a lifetime gift. There has been a lingering question as to how to credit a person’s lifetime gift where it is includible in such person’s taxable estate, which could happen unintentionally or by design.

By way of background, in 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which included a provision to double the exemption against the unified federal estate and gift tax (referred to in the Internal Revenue Code as the “basic exclusion amount”) from $5,000,000 to $10,000,000, as indexed for inflation, on a temporary basis. In 2022, the inflation-adjusted basic exclusion amount is $12,060,000, but the TCJA included a sunset provision that would revert the exemption back to previous levels beginning in 2026.

At the time of passage, it was unclear under the TCJA whether an individual who utilized his or her increased exemption between the years 2018 and 2025 by making lifetime gifts, then subsequently died after 2025, would be taxed on his or her estate on the portion of gifts that used the higher exemption amount (as compared to a lower exemption at the time of death, post-sunset), a so-called “claw-back” tax. The IRS settled this uncertainty in 2019 by issuing final regulations that provided that taxable gifts made during a decedent’s lifetime that used an exemption higher than the basic exclusion amount in place at death would not result in additional estate tax on the excess gifts, through the application of a credit.

The new proposed regulations modify the 2019 regulations by providing an exception in the case of gifts that are includible in a decedent’s gross estate (i.e., subject to estate tax). The Code has numerous provisions that impose estate tax on assets that were transferred during life of which the decedent retains a threshold level of benefit or control. Examples of gifts includible in the decedent’s gross estate include:

• Assets in a trust funded by the decedent of which the decedent serves as the trustee with absolute discretion to make distributions;
• A residence transferred by the decedent during life in which the decedent retains the right to reside until death;
• Assets in a grantor retained annuity trust (GRAT) created by the decedent where the decedent dies during the annuity period;
• Assets in a grantor retained income trust (GRIT) intentionally created to reserve to the grantor an income interest and also to take advantage of the higher basic exclusion amount during the grantor’s lifetime; and
• A gift by promissory note.

The last two examples are potentially abusive situations where the grantor would receive the benefit of the higher lifetime basic exclusion amount without fully relinquishing control or access to the assets. In all such circumstances, the decedent’s estate would only be eligible to use the lower exemption that exists at the time of death, as compared to the higher exemption in existence at the time of gift. The proposed regulations would also preclude a grantor from “fixing” a potentially abusive situation by releasing control or access to the assets or paying off a promissory note (as in the last example) within 18 months of death.

The IRS is currently accepting comments from the public before it makes a decision on whether to finalize the regulations. Should Congress make the higher exemption in the TCJA permanent, the proposed regulations would become moot.

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Attorneys in our Private Client Services Practice Group provide estates, trusts, asset planning and related litigation services to individuals, business owners, charitable organizations and fiduciaries. They work to minimize tax exposure and implement creative strategies to preserve capital and transfer resources within the client's family and to next generations.

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