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The lifetime exemption amount has increased dramatically since 1987 from $600,000 to an inflation-adjusted $5 million ($5,490,000 for 2017). Under the Tax Cuts and Jobs Act (TCJA), the lifetime exemption amount doubled from $5 million to $10 million, adjusted for inflation, for the 2018–2025 tax years. This results in an $11,400,000 exemption per person for 2019 that can be used during life and at death to transfer property.

To illustrate, let’s analyze the scenarios in light of the following facts: Ben and Kate have an estate with roughly $30,000,000 in marital assets. Ben and Kate are 50 years old in 2019 and don’t have any health concerns. Under the TCJA, in 2019 Ben and Kate each have a lifetime exclusion amount of $11,400,000 ($22,800,000 as a marital unit). If Ben and Kate haven’t previously made any taxable gifts, they could each gift $11,400,000—or a total of $22,800,000—in addition to annual exclusion gifts, and remove $22,800,000 from their taxable estate, leaving only $7,200,000 in their joint estates.

While this taxpayer-friendly increase has allowed for increased estate planning, it also has generated a number of questions within the estate planning community:

  1. Is there a potential for a clawback to occur in 2026? What’s a clawback, and why would we fear it?
  2. What’s the effect of the increased basic exclusion amount on the gift tax calculation for gifts incurred during the period after December 31, 2017, and before January 1, 2026?
  3. What’s the effect of the increased basic exclusion amount on the estate tax calculation for decedents passing away during the period after December 31, 2017, and before January 1, 2026?
  4. What’s the effect of the presumed decrease of the basic exclusion amount on the gift tax calculation for gifts incurred after January 1, 2026?

The concept of clawback begs the question, “What’s the effect if we’re in tax year 2030 and Ben and Kate both pass away having gifted $11,400,000 in 2019 during the period of an increased basic exclusion?” Will Ben and Kate owe an estate tax for the difference between the tax year 2030 basic exclusion and the basic exclusion used to make gifts during life?

On November 20, 2018, the U.S. Department of the Treasury (Treasury) and IRS provided insight to answer that question with the issuance of the proposed regulations REG 106706-18. This guidance addresses the clawback issue by proposing to amend Treasury Regulation Section 20.2010-1 to provide a special rule that allows a taxpayer who passes away after January 1, 2026, having used more than the sunsetted exemption, to calculate their estate tax with the increased basic exclusion that was in place and used to make gifts during the period after December 31, 2017, and before January 1, 2026.

The proposed regulations clarify that if the taxpayers pass away after January 1, 2026, having used more than the statutory $5,000,000 indexed basic exclusion but less than the $10,000,000 indexed basic exclusion, the taxpayer will be allowed a basic exclusion equal to the amount of the basic exclusion they had used. Building on our example, if instead Ben had gifted only $10,400,000 instead of $11,400,000 during 2019 and passes away in tax year 2030, the unused $1,000,000 won’t be allowable as an additional basic exclusion on death. Ben’s estate tax basic exclusion, presuming it’s higher than the indexed year of death basic exclusion, would be $10,400,000.

The three other questions asked above are addressed in the preamble to the recently proposed regulations. Treasury and the IRS walk through the basic statutory calculation for estate and gift tax and clarify that the calculation for questions two through four above are unaffected by the change in the basic exclusion rate increase and subsequent decrease. As a result, there isn’t a need for updated guidance from the IRS.

The Opportunity

This guidance is a call to action for taxpayers at all asset levels. Taxpayers with individual assets in excess of $5,000,000 pre-index and marital unit assets in excess of $10,000,000 pre-index should consider using their increased basic exclusion before the sunset of increased basic exclusion in 2026. This guidance is even more relevant to taxpayers with marital unit assets in excess of $20,000,000 pre-indexed, as using the increased basic exclusion before 2026 may result in a limited-time opportunity to remove in excess of $10,000,000 from the marital estate.

Furthermore, in light of the increased exemption, using estate planning strategies such as sales to intentionally defective grantor trusts (IDGT) should be considered by younger taxpayers to use the extra basic exclusion to reduce a future estate tax burden. IDGTs allow for the shift of low-basis assets with anticipated appreciation to be removed from the estate while allowing the growth of the asset to occur outside the estate.

Spousal lifetime access trusts remain a strategic option for situations where the couple would like to retain access to funds while removing assets from their estate. Additional estate planning techniques, such as split-interest gifts, grantor retained annuity trusts, charitable remainder annuity trusts and charitable remainder unitrusts, also can help preserve the wishes of the couple regarding income streams during life while planning for the ultimate disposition of the assets. For a further discussion on estate planning strategies, watch our archived webinar “Wealth Transfer Strategies for Families.”

For taxpayers who anticipate a combined marital estate to fall under the basic exclusion of $5,000,000 pre-indexed, it’s important to note that by keeping assets in the estate, rather than following the aforementioned strategies for shifting assets out of an estate, the taxpayers’ heirs may benefit from the step to fair market value provided to assets included in the estate.

Taxpayers should carefully review the assets remaining and being removed from the estate with their tax and legal advisors. Remember, the IRS guidance in the proposed regulations should be taken as a call to action. Taxpayers should meet with their tax advisors and estate planners to verify they’re taking the right steps before January 1, 2026. For more information, reach out to your BKD trusted advisor or use the Contact Us form below.

FORVIS Private Client services may include investment advisory services provided by FORVIS Wealth Advisors, LLC, an SEC-registered investment adviser, and/or accounting, tax, and related solutions provided by FORVIS, LLP. The information in this presentation should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies, mentioned in this presentation may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax, or other strategy mentioned herein. The information herein is believed to be accurate as of the time it is presented and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.

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