Will IRS “Claw Back” the Temporarily Increased Gift Tax Exemption?

Blog
December 3, 2018

The 2017 Tax Cuts and Jobs Act (Tax Act) increased the estate and gift tax exemption from $5M to $10M, as indexed for inflation after 2011. For 2018 the inflation adjusted exemption is $11.18M. The exemption is to revert to $5M (as indexed for inflation) after eight years, in 2026.

Assume the following “Clawback” scenario:

In 2018, a taxpayer made a gift of $9M, all of which is sheltered from gift tax by the post-2017 exemption of $10M. The taxpayer then dies in 2026, when the exemption will be reverted to $5M. Assume that the taxpayer had a gross estate of $20M—including prior gifts but before taking the exemption into account—and, for simplicity, no expenses.

Question: Would the taxpayer’s 2026 taxable estate be $15M, determined by deducting the 2026 exemption of $5M? Or, would it be $11M, determined by deducting the $9M exemption previously used to shelter the 2018 gift from gift tax?

If only $5M can be deducted, then $4M of the 2018 gift in effect would be “clawed back,” subjecting $4M of the 2018 gift to estate tax in 2026, even though it was exempt from tax in 2018.

Answer: As indicated by recently issued IRS proposed regulations, the exemption for 2026 estate tax purposes would be $9M, rather than $5M. No clawback.

This result should alleviate a concern that might keep some taxpayers from making gifts to use the increased exemption.

Planning

It may be better to make gifts now rather than later. A future administration could conceivably seek to reduce the federal exemption before the scheduled December 31, 2025 “sunset” date.

Gifts now will also have favorable benefits for residents of Maryland and Washington, D.C., both of which have a state estate tax. Lifetime gifts serve to reduce the taxable estates in both jurisdictions.

The Maryland estate tax exemption is $4 million this year, $5 million thereafter. The D.C. exemption is $5.6M. The maximum estate tax rate is 16% for both Maryland and D.C.

For questions or more information, please contact John Ure at 240.364.2671 or Richard Lee at 301.231.6268.