Proposed regulations would “claw back” gift tax exemption for certain gifts

The basic exclusion amount (BEA, also known as the gift and estate tax exemption) is protected from federal gift and estate tax. The BEA protects a specified total dollar amount from tax. Congress changes the amount from time to time.

The Tax Cuts and Jobs Act of 2017 (TCJA) increased BEA to $10 million from $5 million for individuals dying and gifts made after Dec. 31, 2017 and before Jan. 1, 2026. With annual indexing, the BEA is $12.92 million per person ($25.84 million for married couples) in 2023. However, the increased amount is only temporary and will revert to $5 million (adjusted for inflation) after Jan. 1, 2026.

Because of this scheduled decrease to the BEA, the question remained after TCJA’s passage as to what would happen if a decedent’s BEA at death was lower than the amount applied to lifetime gifts. For example, what would be the result if a donor made $11 million worth of gifts in 2021 but dies in 2026 when the BEA is only $6 million?

Generally, the estate tax is calculated by first adding back taxable gifts to a deceased person’s gross estate and then reducing that sum by the BEA applicable at death. In the example above, this computation could result in the donor’s estate having to pay estate taxes on the portion of the gift that exceeded the $6 million BEA at death. Essentially, a portion of the gift (i.e., $5 million) made during the increased exemption period would be clawed back into the donor’s estate.

Anti-clawback rule 

To help clarify this issue, the IRS adopted a special rule (known as the “anti-clawback” rule) in final regulations published Nov. 26, 2019. The anti-clawback rule generally ensures that a donor’s estate will not be taxed on gifts made during the increased exemption period by allowing estates to use the BEA calculated for gifts made between 2018 and 2025 instead of the BEA at the date of death.

Although offering some clarity, the final regulations left open the treatment of gifts that are includible in a deceased person’s gross estate, as opposed to true lifetime gifts. Such includible gifts include, for example: (1) gifts subject to a retained life estate or subject to Internal Revenue Code sections 2035 through 2038 and 2042, (2) gifts made by enforceable promises and (3) gifts subject to the special valuation rules of Code sections 2701 and 2702.

New proposed regulations would limit the anti-clawback rule

Seeing the potential for abuses in circumstances where a donor makes an includible gift to secure the increased BEA while continuing to retain possession and enjoyment of the transferred property, the Treasury and IRS issued proposed regulations in April 2022 to limit the anti-clawback rule.

Affected transactions 

The proposed regulations would make the anti-clawback rule inapplicable to the following types of estate planning transactions. In other words, the proposed regulations would claw back the following transfers into the donor’s estate and apply the BEA applicable at the donor’s death rather than the increased BEA.

• Certain transfers made within three years of death,  
• Transfers with retained interests, 
• Certain transfers where possession or enjoyment of the transferred property can only be obtained by surviving the decedent,  
• Certain revocable transfers,  
• Transfers of life insurance on the decedent’s life where the decedent possessed incidents ownership over the policy,  
• Transfers made by an enforceable promissory note that remains unsatisfied at death,  
• Certain transfers subject to the special valuation rules of Code sections 2701 and 2702, and 
• Transfers that would have been included above if not for the transfer, relinquishment or elimination of an interest, power or property, effectuated within 18 months of death. 

This list is not exhaustive. As a result, the proposed rule could be applicable to other types of transactions as well, though it seems the rule will not impact standard completed gifts that are outside of the donor’s estate. Gifts to intentionally defective grantor trusts should still be effective to lock in the increased BEA.  For taxpayers with concerns about maximizing their use of the exemption, this may be the safest way to ensure that nothing is clawed back into their estate at death.  

Effective date and action item 

If finalized as proposed, these regulations would apply to the estates of decedents dying on or after April 27, 2022. They will only apply if they are finalized; at this point, the regulations are merely proposed. If you have made a transfer that may be affected by the proposed rules (for instance, a transfer by an enforceable promissory note), contact your Baker Tilly professional to discuss next steps.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.