The increased lifetime exemption amount provided for by the Tax Cuts and Jobs Act (“TCJA”) used to shield certain lifetime gift transactions involving GRATs; QPRTs; custodial accounts; transfers of life insurance policies; and certain transfers of a promise to pay could be subject to claw-back after 2025 resulting in a loss of some or all of the increased lifetime exemption provided for in the TCJA.
Proposed Treasury Regulations for §20.2010-1(c)(3) were released on April 26, 2022 as a supplement to final regulations published in November of 2019 for Treasury Regulation §20.2010-1(c)(1) and §20.2010-1(c)(2). Final regulations published in November 2019 addressed the concern of whether the Treasury would “claw-back” lifetime taxable gifts made during the years the Tax Cuts and Jobs Act (“TCJA”) was in effect; recall, the TCJA doubled the lifetime tax exemption for a taxpayer’s gift and estate taxes.
The final regulations address how completed gifts made during the decedent’s lifetime which are not brought back into the decedent’s estate are included in the computation of the decedent’s applicable credit amount. This is necessary in determining the decedent’s estate tax payable when the lifetime gifts made by the decedent, in excess of the basic exclusion amount, are less at the date of death than at the time the gift was made. The proposed regulations address how the computation of the decedent’s applicable credit amount is made in determining the decedent’s estate tax payable when lifetime taxable gifts were made in a year of higher basic exclusion amount and the decedent dies in a year of a lower basic exclusion amount and a gift that was a completed transfer at the time of the gift is included in the gross estate at the time of decedent’s death.
To understand the proposed regulations, it is helpful to understand some of the terms used throughout the final and proposed regulations.
- Basic Exclusion Amount (“BEA”) – this amount is the lifetime exemption amount for taxable estate and gift taxes. This is the amount that was increased by the TCJA from $5M to $10M and inflation adjusted to $12.060M for calendar year 2022.
- Deceased Spousal Unused Exemption (“DSUE”) – this is a deceased spouse’s BEA which was not used in computing the deceased spouse’s applicable credit amount which is ported over to the surviving spouse - not all taxpayers will have DSUE.
- Applicable Exclusion Amount (“AEA”) – this is the sum of the taxpayer’s BEA and DSUE.
- Applicable Credit Amount (“ACA”) – is the amount of tentative estate tax which would be computed on the taxpayer’s AEA.
The final regulations provide that if the decedent used their doubled TCJA BEA making lifetime taxable gifts prior to 2026 even if the decedent died in a year when the BEA has reverted to the pre-TCJA levels, the ACA computed to offset the decedent’s estate will be based on the BEA used during the TCJA period.
Final Regulation Examples
The following examples help illustrate how the final anti-claw-back regulations operate with respect to lifetime completed transfers which are not subject to inclusion in the decedent’s gross estate - it is important to remember when the decedent dies, the estate is generally subject to tax on the gross estate less allowable deductions PLUS lifetime adjusted taxable gifts. Examples:
- During the TCJA period, the decedent made $10M of lifetime taxable gifts and then dies in a year when the BEA is $6.8M, the ACA computed to offset the estate tax is computed on $10M.
- During the TCJA period, the decedent only made $4M of lifetime taxable gifts and then died in a year when the BEA is $6.8M, the ACA computed to offset the estate tax is computed on $6.8M.
- Assume the decedent had $11M of DSUE and died in a year when the BEA is $12M and made zero lifetime taxable gifts; the ACA computed to offset the estate tax is computed on $23M.
- Same as example 3 but this time the decedent died in a year when the BEA is $6.8M; the ACA computed to offset the estate tax is computed on $17.8M.
Note the BEA is subject to fluctuation not the DSUE. Also note, that when making lifetime taxable gifts the DSUE is deemed to be used first – only when DSUE has been exhausted does the client’s BEA start to be used to offset lifetime taxable gifts.
The examples in the final regulations assume all transfers are completed during life which will not be subject to inclusion in the decedent’s gross estate at death. However, certain transactions which are completed transfers during the decedent’s lifetime may sometimes be subject to inclusion in the decedent’s gross estate at the time of their death. The inclusion of the lifetime taxable gifts in the gross estate leads to a reduction of the decedent’s lifetime taxable gifts and a restoration of the ACA computed on those transfers. The proposed regulations address those situations where completed lifetime taxable transfers made during the period of the increased BEA are then included in the decedent’s gross estate after the expiration of the TCJA when the BEA has reverted back to pre-TCJA levels; these transfers which are included in the gross estate are exceptions to the anti-claw back rules in the final regulations.
Example of Completed Lifetime Transfer Subject to Estate Inclusion
Assume during the TCJA period the decedent had already used $6.8M of their BEA and then made a $2M lifetime taxable gift to a custodial account of which they were also the custodian; following this transfer the decedent appeared to have used $8.8M of BEA. The decedent then died in a post TCJA year when the BEA was only $6.8M and the value of the account was $4M.
The decedent’s gross estate will be increased by $4M for the inclusion of the value of the custodial account on the date of death. The decedent’s lifetime taxable gifts would also by reduced by $2M and the ACA computed on the value of the transfer at the time the transfer occurred would be reduced to zero. The ACA computed to offset the decedent’s estate tax is computed on AEA of $6.8M – the use of the additional $2M of BEA during the TCJA period is lost.
Commonly used estate planning techniques such as GRATs; QPRTs; and transfers of life insurance policies to an irrevocable life insurance trust could also be subject to inclusion in the gross estate if the decedent does not survive the term of the trust or the look-back period under IRC §2035.
Example of a Transfer of Enforceable Promise to Pay Unsatisfied at the Decedent’s Date of Death
During the TCJA period, D gratuitously transferred to C a promissory note in which D promised to pay C a sum of money on a date after the TCJA period expired. The note was legally enforceable under state law. On a date after the TCJA period expired, D died. The note had not been satisfied at D's death.
At the time D transferred the enforceable future interest to pay C in the future the promise was a completed lifetime taxable transfer. When D died during the post-TCJA period and the note was outstanding, D’s lifetime taxable gifts will be reduced for the amount of the promise and the portion of the ACA computed on the transfer reduced to zero. Additionally, the promise to pay is not a debt allowed as a deduction from the gross estate and the assets which would have been used to satisfy the promise to pay would be included in the gross estate.
The preceding are examples to help illustrate the mechanics of the proposed regulations, however there are some more nuanced aspects to the proposed regulations, like five-percent exception to the claw-back regime if the taxable portion of the transfer at the time of the transfer and the eighteen month look-back period for certain termination interests.
Count on Friedman
These rules are complex. They may not become final in their current form if, for example, there are additional legislative changes. We will keep you updated as the regulations move forward. Feel free to contact your Friedman LLP advisor with any questions and for advice on maximizing utilization of your BEA.