Economic Environment Poised for Estate and Gift Planning: COVID-19 & Clawback Update
At the end of 2019 the IRS released guidance regarding final anti-clawback issues relating to the estate and gift tax exclusion. At the time, the U.S. was unaware of what was awaiting the economy. In January 2020 in the U.S., the first confirmed case of SARS-CoV-2 virus and the incidence of COVID-19 (COVID-19) was diagnosed in Snohomish County, Washington, and almost four months later the U.S. is still heavily affected by the outbreak. The economic environment is now poised for strategic transfers of wealth.
On November 26, 2019, the U.S. Department of the Treasury (Treasury) and IRS released final regulations finalizing the previously proposed REG-106706-18, which amends Treasury Regulation Section 20.2010-1 (TD 9884). Under these final regulations, estate tax will be calculated with the increased basic exclusion amount (BEA) that was in place, and used, between December 31, 2017, and January 1, 2026.
The estate, gift and generation-skipping transfer (GST) tax exemption amounts were doubled and adjusted for inflation by the Tax Cuts and Jobs Act (TCJA) for tax years 2018 to 2025. For 2020, the lifetime exclusion amount is $11,580,000 per person, which can be used to transfer property during life and at death. A concern for taxpayers was the exclusion threshold used to calculate the estate tax for taxpayers who pass away after January 1, 2026, but who made gifts during the 2018 to 2025 tax years when the higher exemption amounts were in place. This issue is referred to as clawback. The final regulations confirm that gifts made between 2019 and 2025 will not be clawed back at the lower exclusion amount. This rule allows taxpayers to take advantage of the increased exclusion now available and assures taxpayers they will not be negatively affected when the exclusions expire in 2026.
For example, John, an unmarried taxpayer, gifts $11,580,000 in 2020 and subsequently passes away after 2025 when the BEA is $5,000,000 (adjusted for inflation). John’s estate tax exclusion amount will be $11,580,000, since that was the exclusion amount at the time he made the gift in 2020 (instead of the $5,000,000 BEA at the time of death).
In addition, the final regulations provide confirmation a deceased spousal unused exclusion (DSUE) will not be reduced once the higher exclusion amounts sunset if the executor elected portability. For example, Jack’s spouse, Jill, passes away in 2020 when the BEA is $11,580,000. Jill’s executor elected portability, pursuant to §20.2010-2, to allow Jill’s $11,580,000 DSUE amount to transfer to Jack. Jack subsequently passes away in 2026 when the BEA is $5,000,000 (adjusted for inflation). Jack’s estate tax exclusion amount will be $16,580,000 (based on the $5,000,000 BEA available at the time plus the $11,580,000 DSUE).
The final regulations did not address whether the increased GST exemption could be applied to trusts created prior to 2018. The IRS stated that this is “beyond the scope of this rulemaking” and referenced the Joint Committee on Taxation, General Explanation of Public Law No. 115-97 indicating the bonus GST exemption was allowed during the increased BEA period. According to the supplementary information in the final regulations, the IRS did not discuss the potential GST exemption clawback because “[t]here is nothing in the statute that would indicate that the sunset of the increased BEA would have any impact on allocations of the GST exemption available during the increased BEA period.”
The final regulations apply to estates of decedents passing away after November 26, 2019, and may be applied to estates of decedents who passed away after December 31, 2017, and before November 26, 2019.
The increased exemption is temporary and scheduled to sunset after 2025. Multiple gifting and estate planning strategies incorporate valuations affected by economic conditions. In addition, gift transfers and estate planning calculations incorporate current interest rates, which are at a historic low with June’s midterm AFR at 0.43 percent. The current federal funding of COVID-19-related relief is likely to require budgetary considerations after the outbreak, which may call into question the increased BEA remaining in place through December 2025. In summary, taxpayers should consider this a call to action—not a call to delay—and consider using their increased unused exemption.
For additional information about the increased exemption under the TCJA, read our prior BKD Thoughtware® article.
Taxpayers should review and discuss tax planning strategies with their tax advisors and estate planners to consider taking advantage of this taxpayer-friendly guidance before the BEA is reduced in 2026 under current tax law. For more information, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.