US Treasury Confirms No Clawback
The Tax Cuts and Jobs Act (“Trump Tax Law”) of 2017 increased the federal estate tax exemption from $5 million dollars per taxpayer to $10 million. That amount is effectively doubled for married couples. The exemption amount is indexed for inflation, meaning that it goes up incrementally every year. It is the exemption amount in the year that someone dies that is used to calculate estate taxes owed. For this year (2020), the exemption amount, with inflation, is $11.58 million per person, or $23.16 million for a married couple. In simple terms, if someone dies this year owning less than $11.58 million (whether things, homes, cash, etc.), then no federal estate taxes are owed.
The estate tax (gifts at the time of death) exemption is linked to our gift tax system (gifts during life). The amount of lifetime gifts you give is added to the total amount of property you own when you die. For example, if George makes $5 million of gifts during his life, and then dies owning $7 million worth of property, then he would be on the hook for $12 million of gifts. That would use his entire $11.58 million dollar exemption, and his estate would owe some estate taxes. I know, it’s a pretty good problem to have.
The Trump Tax Law provision elevating the estate tax exemption is set to sunset (expire) on January 1, 2026. If Congress does nothing between now and then, the exemption level will revert back to the $5 million amount, indexed for inflation. Essentially, the exemption will be cut in half if Congress does nothing.
So what happens if someone makes lifetime gifts in 2025, and then the exemption amount reverts back to the lower amount in 2026, and then the person dies thereafter? (To use the example above, George gives $5 million in 2025 and then dies in 2027 when the exemption amount is “only” $5 million, indexed for inflation.)
On November 26, 2019, the Treasury Department and the IRS issued final regulations adopting the regulations that were proposed in November of 2018, effectively ensuring that if a decedent uses the increased exclusion amount for gifts made while the Trump Tax Law is in effect and dies after the sunset of the Trump Tax Law, the decedent won’t be treated as having made taxable gifts in excess of his or her exclusion amount.
In plain English, this means that there won’t be a clawback if George uses the exclusion amount in effect now, even if the exclusion amount is lower when George dies. For George, the IRS will use the greater of the exclusion amount used during the transfer or on the date of death. So George will not be penalized later even though the exemption amount dropped.
The final regulations also reinforce the notion of a “use it or lose it” benefit and direct that a taxpayer who uses the exemption is deemed to use the base $5 million (indexed) exemption first and then the additional amount of exemption available through 2025. For individuals dying after 2025, if no gifts were made between 2018 and 2025 in excess of the basic federal exclusion amount in effect at the time of death, the additional exclusion amount is no longer available. In other words, unless George uses the increased exemption amounts before 2026, he will not receive that benefit later.
Either way, the exemption amounts cover a vast majority of American estates. However, for very high net worth families, we anticipate very large transfers of wealth to occur between now and 2026 so that the benefit of the heightened exemption amounts are not lost.