IRS rules eliminate estate and gift tax clawback

By Sally P. Schreiber, J.D.

In T.D. 9884, the IRS finalized proposed regulations issued in November 2018 (REG-106706-18), amending Regs. Sec. 20.2010-1 to conform with the temporary increase in the basic exclusion amount for estate and gift tax enacted by the legislation known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.

For gifts made and estates of decedents dying before Jan. 1, 2018, prior law (Sec. 2010(c)(3)(A)) provided an exclusion from taxable gifts or estates of $5 million, indexed for inflation after 2011. For gifts made or estates of decedents dying after Dec. 31, 2017, and before Jan. 1, 2026, the TCJA increased the amount to $10 million, also indexed for inflation after 2011 (Sec. 2010(c)(3)(C)). Thus, the amount for 2017 was $5.49 million and, for 2018, $11,180,000 (rising to $11.4 million in 2019 and $11.58 million for 2020). The final regulations amend Regs. Sec. 20.2010-1(e)(3) to conform to the TCJA's increase in the exclusion amount and changes regarding the cost-of-living adjustment.

The TCJA also, in Sec. 2001(g)(2), granted the IRS authority to prescribe regulations to carry out Sec. 2001, which governs the imposition and rate of estate and gift tax, with respect to any difference between the basic exclusion amount (BEA) that applies at the time of a decedent's death and with respect to any gifts the decedent made.

The statutory sunset of the higher BEA and reversion to the lower amount could, in effect, retroactively deny taxpayers who die after 2025 the full benefit of the higher exclusion amount applied to previous gifts. This scenario has sometimes been called a "clawback" of the applicable exclusion amount.

Consequently, the IRS has adopted a special rule for those cases: In calculating a decedent's estate tax, when the portion of the credit as of the decedent's date of death that is based on the exclusion amount is less than the sum of the credit amounts attributable to the exclusion amount allowable in computing gift tax payable on post-1976 gifts, the portion of the credit against the net tentative estate tax that is attributable to the exclusion amount is based on the greater of those two credit amounts (Regs. Sec. 20.2010-1(c)).

For example, if an unmarried individual made post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by the cumulative $10 million in BEA allowable on the dates of the gifts, and he or she dies after 2025, when the BEA is $5 million, the special rule allows the applicable credit amount against estate tax to be based on a BEA of $9 million (Regs. Sec. 20.2010-1(c)(2)).

The IRS received a number of comments on the proposed regulations and adopted the final regulations with a few revisions in response to those comments.

Several commenters noted that the proposed regulations' example does not reflect the annual inflation adjustments to the BEA, and they asked the IRS to clarify the effect of those adjustments on the special rule. The inflation adjustments were not included in that example to more simply illustrate the special rule, the IRS said. But, because, by definition, the term "BEA" refers to the amount of that exclusion as adjusted for inflation, the examples in the final regulations reflect hypothetical inflation-adjusted BEA amounts.

The final regulations also include examples illustrating how the deceased spousal unused exclusion (DSUE) amount is calculated under the clawback rules. As recommended by the AICPA in a Feb. 15, 2019, letter to Treasury and the IRS, the regulations confirm that the reference to "basic exclusion amount" in Sec. 2010(c)(4), defining the DSUE as the lesser of the BEA or the unused portion of the spouse's applicable exclusion amount, is a reference to the BEA in effect at the time of the deceased spouse's death rather than the BEA in effect when the surviving spouse dies. This ensures that a DSUE amount elected during the increased BEA period will not be reduced when the increased BEA sunsets.

The IRS declined to add examples related to the generation-skipping transfer tax because doing so would go beyond the scope of the regulatory project. Although it found that a suggested anti-abuse rule would be within the scope of its regulatory authority, it concluded that an anti-abuse provision would benefit from prior notice and comment and reserved the issue.

Rejecting comments to the contrary, the IRS determined that the special rule is well within the scope of its regulatory authority and accurately reflects the purpose of that authority. In addition, the IRS rejected an alternative rule to the special rule that was proposed by a commenter.

The regulations apply to estates of decedents dying on or after Nov. 26, 2019, the date they were published as final in the Federal Register, but they may be applied to estates of decedents dying after Dec. 31, 2017, and before Nov. 26, 2019.

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