Take-Away: As was indicated a week or so ago, the proposed Treasury Regulations published on November 20 make it clear that the fear of ‘claw-back’ when calculating an individual’s estate taxes if an individual makes large lifetime gifts before 2026 is unwarranted. A couple of folks asked for a clearer definition of the ‘claw-back’ problem and how it was resolved by the Regulations.

Claw-back: If a large gift now is entirely or partly exempt from federal gift tax because of the ‘doubled’ basic exclusion amount under the 2017 Tax Act, and the donor dies after 2025 when the ‘doubled’ basic exclusion amount has sunset, will part of the gift in effect be taxed anyway (clawed back) in the donor’s estate tax calculation? Lifetime gifts are added to the value of the decedent’s taxable estate, then reduced by the basic exemption amount used to off-set those taxable gifts, in order to calculate the decedent-donor’s adjusted taxable estate which is then reported on the decedent’s federal estate tax return [Form 706.] By using the lower [post-2025] basic exclusion amount, not the ‘doubled’ basic exclusion amount [gifts made between 2018 and 2015] could expose those ‘excess’ lifetime gifts to federal estate taxation.

Change: The proposed Regulations would revise the definition of ‘basic exclusion amount’ in Treasury Regulation 20.2010-1(d)(3) [redesignated as 20.2010-(1)(e)(3)] by adding a clause (iii) to reflect the temporary ‘doubling’ of the basic exclusion amount caused by the 2017 Tax Act.

Effective Date of Change: This change is effective as of January 1, 2018.

Quick Observations: The proposed Regulations do not:

  • Use the words ‘claw-back.’
  • Make no mention of the generation skipping transfer tax (GST), which was also ‘doubled’ by the 2017 Tax Act, but that ‘doubled’ GST exemption also sunsets in 2025.
  • Apply to pre-2018 gifts that generated a federal gift tax, thus reducing the credit otherwise available to the donor to shelter gifts from tax during the 2018 to 2025 period.
  • Address whether the gift tax on a gift made after 2025 will be inflated by a theoretical gift tax on gifts made during the 2018-2025 period that were sheltered from gift tax when made.
  • Have any impact on the ability to claim a deceased spouse’s unused basic exemption amount [DSUEA.]

Conclusion: If Congress makes other changes in the basic exemption amount, e.g. it increases transfer tax rates or it decreases the basic exemption amounts, and it does not address the potential claw-back issue in the context of those subsequent changes, the generic anti-claw-back changes [to IRC 2001 (g)(1) and (2)] will produce a complicated set of adjustments and calculations that may be hard to implement. Since Congress anticipated the ‘claw-back’ concerns when it passed the 2017 Tax Act, hopefully it will keep the problem in mind if it decides to change the tax rates or basic exemption amounts in future legislation.