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Carolyn A.W. Whitworth (AEP®)

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Gifting and Estate Tax in Period of Big Changes

Carolyn A.W. Whitworth (AEP®), cwhitworth@tuckerlaw.com, (412) 594-3923

The Tax Cuts and Jobs Act of 2017 increased the federal estate and gift tax exclusion amount (sometimes called the “basic exclusion amount” or “BEA”) from $5 million to $10 million.  (Those numbers are adjusted for inflation each year after the base year of 2011, but for ease of discussion, the base year amount is used.)

During the period of 2018 through 2025, gifting between $5 million and $10 million is within the exclusion amounts.  The higher BEA expires, however, and drops back to $5 million on January 1, 2026. 

A concern for many donors was that the gifts they make during that period of higher BEA would be brought back into their estates if they die after the BEA drops back down.

The IRS issued final regulations providing for “anti-clawback” provisions in 2019 to alleviate this concern (a new provision at 26 CFR Sec. 20.2010-1(c)).  The anti-clawback regulations generally provide that amounts over the $5 million but within the applicable limit would not be taxed later.  In the Preamble to the final Regulations, the IRS indicated that it would evaluate possible exceptions to this general rule because that rule did not distinguish between gifts that are not included in the donor’s gross estate at death (those included in “adjusted taxable gifts”) and those that are treated as completed but testamentary in nature such that they are included.

To avoid some perceived abuses, on April 26, 2022, the IRS proposed regulations including some limitations on that general rule so that some transfers in which the donor retains certain interests in the transferred property do not get the benefit of the anti-clawback protection, and those assets may be brought back into the donor’s estate at death.  (The new provision would be 26 CFR Sec. 20.2010-1(c)(3).)

Some transfers are completed gifts that are treated as testamentary, and the property is included in the donor’s gross estate.  The retained interest is sometimes the result of an estate tax inclusion period.

The regulation specifies that transfers that do not get the benefit of the anti-clawback include (a) transfers that are includible in the gross estate under Sections 2035, 2036, 2037, 2038, and 2041 (even if all or part is deductible under 2522 or 2523), transfers made by enforceable promises to the extent they are unsatisfied as of the date of death, transfers described in Regulations 25.2701-5(a)(4) or 25.2702-6(a)(1), or such transfers that would have been included under the above except that the interest, power, or property was transferred, relinquished, or eliminated within 18 months of the donor’s death.

Examples of transfers that fall into this category include:

  • The gift of a remainder interest in a grantor retained annuity trust (a “GRAT”) if the donor dies during the term of the GRAT (known as the estate tax inclusion period or “ETIP”).

  • Gift to a qualified personal residence trust (a “QPRT”) if the donor dies during the term of the QPRT (during the ETIP).

  • Transfer of an existing life insurance policy into an irrevocable trust if the donor dies within three years of transfer.

  • The Donor entering into a split dollar arrangement with an irrevocable trust while retaining the power at any time to terminate the split dollar agreement.

  • Transfer of a life insurance policy while retaining incidents of ownership, for example, the right to change beneficiaries or cancel the policy.

  • Transfer of stock of a controlled corporation if donor retains the right to vote the stock.

  • Gratuitous gifts of enforceable promissory notes representing a future promise to gift assets that remains unsatisfied at the donor’s death.

  • Relinquishing or eliminating any of those interests in any of the above within 18 months of the donor’s death.

Is there a way to cure a transfer that might fall into that category?  If the donor relinquishes or eliminates the powers that cause the exception to apply and lives for at least 18 months, the exception will no longer apply.

There are also two exceptions to the exception:  (1) the de minimis rule, and (2) changes based on passage of time or death of a person.  Under the de minimis rule, if the value of the taxable portion of the transfer determined as of the date of the transfer was less than 5% of the total value transferred, the clawback that would otherwise apply based on this proposed regulation does not apply.  The second exception to the exception applies when the passage of time or the death of a person causes the transfer, relinquishment, or elimination of the interest that would otherwise cause inclusion.

When looking at these rules, it is important to recognize that because no exemption is used for gifts to which the marital and charitable deductions apply, the anti-clawback and clawback regulations do not apply to them.

The comment period ended July 26, 2022, but there is no indication of when the IRS will finalize the regulations.

For more information, contact Carolyn Whitworth at cwhitworth@tuckerlaw.com, (412) 594-3923.

October 03, 2022

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