Take-Away: In the past week I had three separate inquiries on whether the 2017 Tax Act creates a concern about ‘clawback’ that clients should be aware of when they start to make large lifetime gifts using their ‘new’ $5.0 million gift tax exemption, in light of the 2026 scheduled return to a much lower unified federal gift and estate tax exemption amount. The answer is that ‘clawback’ is probably not a big concern,  but we will not be certain until the Treasury Department provides clear direction in its regulations.

Background: The ‘clawback’ issue arises from how federal estate taxes are calculated. Keeping it simple, the value of lifetime gifts made by the decedent are ‘added back’ to the value of the decedent’s estate to determine the aggregate estate tax liability, against which amount credit is given for gift taxes that were previously paid, or for which the donor’s then-available gift tax exemption amount was applied. Clawback was a big deal back in 2012 when there was a concern when the federal gift tax exemption amount was scheduled to ‘fall back’ to a much lower exemption amount the next year, exposing those who made large lifetime gifts to possible double taxation if they died and the ‘large’  lifetime gift values were ‘added back’ to their taxable estate value with a much lower transfer tax exemption amount available to shelter estate taxes.

2017 Tax Act: The 2017 Tax Act increases a taxpayer’s federal unified gift and estate tax exemption amount from $5.45 million to roughly $11 million (the exempt amount is not, yet, exact.)  This increased exemption can be used to ‘cover’ federal gift taxes or federal estate taxes, or both. The problem is that this increased federal unified gift and estate tax exemption amount falls back to about $5.5 million beginning in 2026, creating a situation much like what existed in 2012.

Clawback: A ‘clawback’ occurs when the federal gift tax exemption amount decreases after a taxpayer makes a gift using some or all of the taxpayer’s increased exemption amount and who subsequently dies after the increased exemption amount sunsets, i.e. beginning in 2026 under the 2017 Tax Act. A taxpayer who makes a $10 million gift in 2018, resulting in no gift tax paid by virtue of that taxpayer’s increased gift tax exemption amount, will have that $10 million gift ‘added back’ to the taxpayer’s taxable estate if death occurs after 2025, when the federal estate tax exemption amount is then ‘only’ $5.5 million. Does the lifetime gift get ‘clawed back’ into the decedent’s taxable estate and thus cause an estate tax to be paid on the value of the lifetime gift? That is the ‘clawback’ concern double taxation of the same gift when the federal unified gift and estate tax exemption is lower at the time of the taxpayer’s death.

IRC 2001(g):  IRC 2001(g) was added to the Tax Code in 2010. It attempts to address the ‘claw back’ concern when federal transfer tax exemption drops. This ‘anti-clawback’ language was added to prevent, in effect, gifts exempt from gift tax under the higher exemption available from being nevertheless subject to estate tax if the increased exemption amount were to actually ‘sunset.’ IRC 2001(g) uses a convoluted formula in an attempt to address the ‘clawback’ issue but many find it not adequate to address the concern.

Earlier Senate Bill: The Senate  tried to address the ‘clawback’ issue back in 2012 when it proposed in a bill  a new IRC 2001(h) which was intended to clearly avoid the double taxation of lifetime gifts if the transfer tax exemption fell in future years, albeit also applying a somewhat confusing formula to implement that goal. Proposed IRC 2001(h) would have  provided  comfort to estate planners who were worried about  the ‘clawback’ of lifetime gifts made by their clients who relied upon and used larger federal gift tax exemptions when it came time to calculate that deceased client’s federal estate tax liability. That proposed amendment to the Code was never adopted, however.

Clawback- Passing the Buck: The 2017 Tax Act also seeks to address the ‘clawback’ concern, but in a much different manner than the Senate’s proposed IRC 2001(h) back in 2012. Rather than implement an express Congressional intent to avoid the double taxation of lifetime gifts, the 2017 Tax Act passes the buck to the Department of Treasury. Instead of adding  a new Code subsection, much like IRC 2001(h) that was suggested in the earlier Senate bill,  the 2017 Tax Act merely adds a short new subparagraph (2) to IRC 2001(g):

“(2) MODIFICATIONS TO ESTATE TAX PAYABLE TO REFLECT BASIC EXCLUSION AMOUNTS- The Secretary shall prescribe such regulations as may be necessary or appropriate to carry out this section with respect to any differences between-

  • The basic exclusion amount under section 2010(c)(3) applicable at the time of the decedent’s death, and
  • The basic exclusion amount under such section applicable with respect to any gifts made by the decedent.”

Congress chose to leave the different basic exclusion amounts at death question up to the Department of Treasury to resolve, arguably when it had previous language available that it could have adopted, i.e. IRC 2001(h) in the 2012 proposed Senate bill. In short, rather than squarely address the ‘clawback’ worry that a provision like the proposed IRC 2001(h) would have addressed, Congress deferred to the Department of Treasury to create rules to interpret IRC 2001(g).

Congress’ Purpose: Accordingly,  Congress entrusted to the Treasury responsibility to draft regulations as may be ‘necessary or appropriate’ to carry out the purpose of IRC 2001(g), but it did not give any guidance to Treasury as to what the purpose actually is. [Handing to the IRS the responsibility to divine Congress’ purpose reminds me of comedian Emo Phillips who once described his ex-wife as ‘handing an Uzi machine gun to a chimpanzee.’ But I digress.] One possible purpose might be to arrive at a unified gift and estate tax system at the individual’s death by using the tax rate that is in effect at the taxpayer’s death, versus the rate at the time of the gift for the IRC 2001(g) ‘offset.’ Another possible purpose for IRC 2001(g) is to provide fairness to the decedent’s estate by reducing the estate tax owing by the larger number in a situation in which gifts had been made under a more favorable gift tax rate, e.g. 35% vs. 40%. So we have to await IRS Regulations that will identify Congress’ purpose in enacting IRC 2001(g)(1) and how the IRS will view lifetime gifts that are added back to the decedent’s taxable estate when a much smaller unified exemption amount is then available.

Conclusion: Nationally known estate planning guru Ron Aucutt notes in his summary of IRC 2001(g)(2):

This looks simply like authority to do the math to carry out the mandate of the 2010 Tax Act in section 2001(g)(1), although some have expressed concern that it could be used to cut back the benefits to decedents’ estates that the 2017 Tax Act was intended to confer, either by Treasury and IRS drafters not necessarily as committed to the agenda of the current congressional leadership or by a new Administration (which there is certain to be before the doubling of the exemptions sunsets on January 1, 2026.”)

Probably the lingering concerns over ‘clawback’ are overstated, but it is worth at least mentioning to those clients who plan to make use of their new additional $5.0 million gift exemption amount that became available at the first of this year.