New final regulations released by the Internal Revenue Service on Nov. 22, 2019 are welcome news for high-net-worth clients who make large gifts using their increased estate/gift tax exemption now but die in a year when the exemption is lower. The new regulations make clear that gifts made within the increased exemption amount used before the client’s death won’t be “clawed back” into the client’s estate.
In response to Internal Revenue Code Section 2001(g)(2), enacted as part of the Tax Cuts and Jobs Act (2017 Tax Act), in which the Secretary of the Treasury was directed to prescribe regulations to carry out IRC Section 2001(g) with respect to the difference between the basic exclusion amount applicable at the time of a decedent’s death and the basic exclusion amount applicable with respect to any gifts made by the decedent, the Secretary issued Proposed Regulations Section 20.2010-1(c).
Treasury Regulations Section 20.2010-1(c) ensures that, if a decedent uses the increased basic exclusion amount for gifts made while the 2017 Tax Act was in effect and dies after the sunset of the 2017 Tax Act (currently scheduled for Jan. 1, 2026), such decedent won’t be treated, on such decedent’s estate tax return, as having made adjusted taxable gifts solely because the increase in the basic exclusion amount effectuated by the 2017 Tax Act was eliminated.
Mechanism Used by IRS
The mechanism by which Treas. Regs. Section 20.2010-1(c) achieves this result is to provide that, if the total credits that were used in computing a decedent’s gift tax on post-1976 gifts, within the meaning of Section 2001(b)(2), is greater than the applicable credit amount used, pursuant to IRC Section 2010(a), to compute the estate tax on the decedent’s estate, the credit that can in that circumstance be used to compute the estate tax is deemed to be the total credits that were used in computing the decedent’s gift tax.
Unlike Prop. Regs. Section 20.2010-1(c), Treas. Regs. Section 20.2010-1(c) explains how the deceased spousal unused exclusion (DSUE) amount interacts with the basic exclusion amount to produce the intended “no clawback” result. Treas. Reg. Section 20.2010-1(c)(1)(ii) and Example 4, taken together, make several important points clear. First, when a surviving spouse makes taxable gifts, any DSUE amount that was available to him is deemed to have been applied to those gifts before his basic exclusion amount was so applied. Second, if that surviving spouse dies after the sunset of the 2017 Tax Act, the DSUE amount applied to those gifts isn’t reduced. Third, if both the DSUE amount and the surviving spouse’s basic exclusion amount were applied to those gifts, in calculating the amount of the credit available in computing the surviving spouse’s estate tax, the undiminished DSUE amount is removed. Fourth, the total credits that were used in computing the surviving spouse’s gift tax based on that intact DSUE amount, plus the credit determined by applying the general “no clawback” rule of Treas. Regs. Section 20.2010-1(c), are available to offset the surviving spouse’s estate tax liability.
Although, surprisingly, it took a year to bring this relatively small regulatory project to a conclusion, it’s a welcome development. In particular, the IRS’ treatment of the DSUE amount in the “no clawback” context is good news. It’s somewhat disappointing that the IRS declined to address whether GST exemption allocated before sunset of the 2017 Tax Act would, like the basic exclusion amount and the DSUE amount applied in computing the gift tax on post-1976 gifts, remain in place without reduction. It seems significant, though, that, in the preamble to the final regulation, after observing that the GST exemption amount is defined by reference to the basic exclusion amount, the IRS stated: “There is nothing in the statute that would indicate that the sunset of the increased [basic exclusion amount] would have any impact on allocations of the GST exemption available during the increased [basic exclusion amount] period.”