IRS Issues Guidance on the Clawback for Lifetime Gifts

Attorney Alyssa Graham Garrigan

November 2018

The Tax Cuts and Jobs Act of 2017 (“the Act’), effective as of January 1, 2018, made sweeping changes to the tax code, including increasing the base estate, gift, and generation skipping transfer tax exemption amount from $5,000,000 to $10,000,000 (both numbers are indexed for inflation). When taking into account the inflation-adjusted numbers, the result was an increase in the amount an individual can shelter from these taxes from $5,490,000 in 2017 to $11,180,000 in 2018. Like many of the other individual tax rules included in the Act, however, these rules are set to sunset in 2025.

This temporary increase in the transfer tax exemption amount left concerns over clawbacks for gifts made during this period of increased exemption. The concern is that these gifts made during the period of increased exemption would later be taxed when an individual died after the exemption had reverted to a lower amount. The fear can be illustrated with the following example (which has been simplified for illustration purposes):

Jane has never made any taxable gifts, and has a total net worth of $17,000,000. She decides to make a gift of $11,000,000 in 2018 to her children. In 2018, she has $11,180,000 of exemption; therefore, the entire amount passes to her children tax free. She makes no further gifts and dies in 2026. At that time of her death, the exclusion amount has reverted to a base of $5,000,000, but as adjusted for inflation, the exemption amount is $6,000,000. Her remaining estate at the time of her death is $6,000,000.

If her 2018 gift had to be brought back into her taxable estate or clawed back, then the tax at her death would need to be calculated using only the 2026 estate tax exemption amount ($5,000,000 indexed to $6,000,000), even though at the time the 2018 gift was made it was not subject to gift tax, resulting in a total tax at her death of $4,400,000. The same as would be imposed if she had not made the gift in 2018 at all. If the gift was not subject to a clawback, then her estate would only face an estate tax of $2,400,000 at the time of her death. The amount that she gifted in 2018 would remain a tax-free gift.

The Internal Revenue Service has now addressed these concerns with proposed regulations, Proposed Reg. §20.2010-1. They are still awaiting finalization, but the proposed regulations indicate that there will be no clawback imposed on gifts made during the period of time with the increased exemption amount. Essentially, the calculation of tax will be based on the larger of the exemption in place at the time an individual dies or the exemption in place at the time a gift is made.

Lifetime gifting is an effective strategy for the tax-efficient transfer of wealth because gifts remove future appreciation on transferred assets from an individual’s taxable estate. This is good news! Individuals can now proceed with gifting using the increased exemption amount without fear that these gifts will later be clawed back and subject to a transfer tax.

The IRS has also recently released the new inflation adjusted amounts for 2019. The federal estate, gift and GST tax exemptions will increase to $11,400,000 per person and $22,800,000 million per married couple. The annual gift tax exclusion amount remains $15,000 per person and $30,000 per married couple.

As the year draws to a close it is important to remember that if you plan to take advantage of this year’s annual gift tax exclusion, a gift is considered to be made on the date the individual receives the gift, but checks must be cashed before the end of the year.

If you would like to consider making a gift to take advantage of the new increased federal estate, gift and GST tax exemption amounts, please contact our office to set up a time to discuss a gift with Christine or me.