Tax Cuts and Jobs Act (The “Act”) – “Clawback”

Prior to the passage of the Act, effective January 1, 2018, the individual exclusion from Federal estate, and gift tax was approximately $5,600,000.00.  Under the Act, the exclusion is doubled to approximately $11,200,000.00, per individual.  That increased exclusion, however, “sunsets” on January 1, 2026, when it will revert to the exemption of $5,600,000.00 in effect prior to January 1, 2018.  This Article will discuss the possibility of a “clawback” of the doubling of the exclusion, when the sunset takes place and the exclusion reverts to the pre-existing $5,600,000.00, i.e. will any gifts made between 2018 and the sunset date be “clawed back” to the taxable estate of the donor who passes away after the sunset date.

Discussion

As a result of the increase in the gift and estate tax exclusions individuals have the opportunity to make gifts utilizing the increased exclusion up to approximately $11,200,000.00 per person, without subjecting those gifts to either life time gift tax, or being included in the individual’s taxable estate upon his death.

Of course, where assets are gifted, those gifts would not be entitled to a step up in income tax basis of those assets upon the death of the donor.  Thus, the advisability of such gifts will continue to require an analysis of the potential income tax cost of the loss of that step up in tax basis in case of a sale of any such assets following the death of the donor.

However, utilizing the increased gift tax exclusion during life time, does raise a question as to whether the death of the donor after the “sunset” of the increased exemption, when the exemption reverts to the pre January 1, 2018 amount, will result in some form of “clawback” or recapture of the benefit of the increased exclusion.  Thus, will the IRS in determining the taxable estate of the donor who dies after the sunset date, apply the exclusion at the time of the gift, i.e. when the Act doubling of the exclusion was still in effect, or will it apply the amount of exemption at the time of death, when the exclusion has been “sunset” back to $5,600,000.00, thus, “clawing back” the benefit of the pre sunset exclusion.

To deal with this question, the Act contains a separate provision, which together with a clarifying Conference Committee Report, directs that the Secretary of the Treasury adopt regulations necessary or appropriate to deal with the difference “between the exclusion amount applicable at the time of a decedent’s death”, and that applicable “at the time of any gifts by the decedent.”

What is not clear is whether that provision directs the adoption of regulations requiring the inclusion in the taxable estate of an individual who passes away after the sunset, of the full amount of the gifts made during life, but only allowing the lower exclusion amount in effect following the sunset, in determining the estate tax due i.e. the “clawback” approach.  That approach could result in an additional estate tax in excess of $2,000,000.00, depending on the amount of gifts made during the pre-sunset period.

On the other hand, the non “clawback” approach would only include in the taxable estate of a donor who dies after the sunset dates, pre sunset gifts in excess of the exclusion in effect at the date of gift, i.e. $11,200,000.00.

A related issue is what, if any, regulations will be adopted to deal with the situation where the donor during the pre-sunset period may not have utilized the then full amount of the gift and estate tax exclusion.  It is possible that, in those circumstances, the donor may still have the unused exclusion amount available for gift tax purposes, even after the sunset indeed even after sunset, the unused portion of the pre-sunset lifetime gift tax might be used in calculating the exclusion amount for estate tax purposes.

Clearly, uncertainly exists as to how the Treasury Department will exercise its statutory authority to issue regulations dealing with the sunset and the change of the exclusion amounts.  The IRS has published a so-called 2017-2018 Priority Guidance Plan, in which it indicates that a near term priority in issuing guidance with respect to the Act is “Guidance on computation of estate and gift taxes to reflect changes in the basic exclusion amount”.  Although no specific date with respect to such guidance has been reported, it is expected sometime in 2018.

Obviously, planning now to take advantage of the current increase in the lifetime exemption to $11,200,000.00, leaves uncertainty as what the effect may be following sunset, and how the Treasury would approach its mandate to deal with the different exclusions existing at the date of the gift and following sunset.

In general where the donor is in a position to take advantage of the increased gift tax and estate tax exclusion, it may still be beneficial to do so.  Even if the IRS were to issue regulations clawingback the amount of the pre sunset exclusion in excess of the post sunset exclusion amount, into the taxable estate, in case of death following sunset, which many do not believe will happen, it would likely be subject to challenge as exceeding its statutory authority. In any event, this will all depend on the structure of the donor’s estate plan, and at a minimum, those individuals in a position to take advantage of the increased exclusion should reexamine their current estate plan.