IRS Gives the Gift of Certainty to Taxpayers: No Clawback on Increased Exemption Amount

‘Tis the season of giving, and even the Internal Revenue Service is feeling generous, with proposed regulations that would allow taxpayers to take advantage of the increased exemption amount for estate and gift taxes without fear of retroactive taxation.

The federal transfer taxation system is based on the fair market value of property transferred, either during lifetime or at death, to others. Two components of this system, the gift tax and the estate tax, are part of a unified method of transfer taxation whereby the aggregate value of both lifetime and testamentary gifts is subject to a single tax. Prior to 2018, a “unified exemption” amount permitted an individual to make taxable transfers by gift during life or at death to the extent of $5,000,000 (as indexed for inflation) in value without having to pay the gift and/or estate tax on such transfers.

On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”), which increases the unified estate and gift tax exemption amount to $10,000,000 per person ($11,180,000 in 2018 and $11,400,000 in 2019, as indexed for inflation). However, this increase is currently set to expire at year-end of 2025, when the exemption amount will drop back to the pre-TCJA amount. This looming expiration date caused significant concern among estate planning professionals, who were hesitant to advise clients to make gifts above the pre-TCJA exemption amount for fear that the IRS would retroactively tax such gifts.

In response to these concerns, the Internal Revenue Service issued proposed regulations which state that there will be no clawback of the increased exemption amount used prior to 2026. So, for example, if an unmarried taxpayer makes a $7 million gift in 2024 and dies in 2027 (after the exemption has returned to $5 million), there will be no tax due on the extra $2 million gift.

Clients with estimated estates above the pre-TCJA exemption amount, and the estate planning professionals advising them, are likely to take a “wait-and-see” approach – meaning they will wait until it is certain, from Congressional action or inaction, that the increase in the exemption amount will in fact sunset. As such, assuming complete legislative silence on the matter, it is expected that the bulk of the gifts benefitting from the anti-clawback regulations would take place during 2025, when the expiration of the increased exemption amount would be inevitable.

However, taxpayers should feel fairly confident that any gifts made between now and 2025 will be safe from any clawback.

The IRS will hold a hearing on the proposed regulations on March 13, 2019.