A Look into the Final Treasury Regulations on the Temporarily Expanded Federal Gift and Estate Tax Exemptions

Kevin Matz, JD, Esq., CPA, LLM
Published Date:
Jan 1, 2020

On Nov. 26, 2019, the U.S. Department of Treasury and the IRS published final regulations addressing the effect of recent legislative changes to the basic exclusion amount allowable in computing federal gift and estate taxes. The final regulations confirm that gifts made using the temporarily expanded federal gift tax basic exclusion amount (commonly referred to as the federal exemption) will not result in a “clawback” or recapture of estate tax for decedents dying after 2025, which is when the exemption is scheduled to “sunset” in favor of pre-2018 federal exemption levels. The final regulations also expressly apply a “use it or lose it” analysis to the exemption.

The Legislative Background

On Dec. 20, 2017, Congress passed far-reaching changes to the Internal Revenue Code that were signed into law by the president on Dec. 22, 2017, under the Tax Cuts and Jobs Act. The tax law provides significant estate planning opportunities for high–net worth individuals to take advantage of a temporary doubling—from $5 million to $10 million (subject to indexing)—of the federal estate, gift, and generation-skipping transfer (GST) tax exemptions. This temporary doubling (as indexed) of the exemptions from $5.49 million in 2017 to $11.58 million per person (and to $23.16 million for a married couple) as of January 1, 2020, creates both—

  • a window of opportunity for gifting, due to the significant expansion of federal gift and GST tax exemptions, and
  • a need to review existing Wills and other estate planning documents to ensure that they continue to carry out planning objectives.

Sunset of the Expanded Exemptions in 2026

There is a significant wrinkle in the new law: It sunsets its exemption doubling on Jan. 1, 2026, reverting them to their pre-2018 exemption levels, as indexed for inflation. This will create incentive for wealthy individuals to begin using their increased exemptions at the risk of losing them come 2026. 

That said, there had been some concern that the sunset provisions could potentially pose a “clawback risk” if an individual were to gift away his entire gift tax exemption during his lifetime, then die after Dec. 31, 2025, when the unified estate and gift tax exemption was less than the amount that he had gifted.  Yet the final regulations—referred to by many as the “anti-clawback regulations”—clarify that this no longer poses a risk.

The preamble to the final regulations expressly states that the increase for the basic exclusion amount for estate and gift tax purposes is a “use or lose” benefit and is available to a decedent who survives the increased basic exclusion amount period only to the extent that the decedent used it by making gifts during the increased basic exclusion amount period. The final regulations include examples that illustrate this. In addition, they confirm that a decedent dying after 2025 will not benefit from post-2025 inflation adjustments to the basic exclusion amount, to the extent the decedent made gifts in an amount sufficient to cause the total basic exclusion amount allowable in the computation of gift tax payable to exceed the date of death basic exclusion amount as adjusted for inflation. Further, the final regulations confirm that the sunset of the increased basic exclusion amount has no impact on the portability of a deceased spouse’s unused exclusion amount to the surviving spouse for federal estate and gift tax purposes.    

Allocations of the GST Exemption Prior to the Sunset

An additional area that was confirmed in the final regulations’ preamble (although not addressed in the body of the regulations) is the effect of the sunset of the increased basic exclusion amount on allocations of the GST exemption, including on late allocations of the increase in the GST exemption to lifetime trusts created prior to 2018. An increase in the basic exclusion amount correspondingly increases the GST tax exemption, which is defined by reference to the basic exclusion amount for federal estate and gift tax purposes [IRC section 2631(c)]. In response to a comment requesting confirmation and examples showing that allocations of the increased GST exemption made during the increased basic exclusion amount period (whether to transfers made before or during that period) will not be reduced as a result of the sunset of the increased basic exclusion amount, the preamble states that, although this request is beyond the scope of this regulations project, “[t]here 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.” Estate planners and other advisors should be able to derive significant comfort from this.

Use It or Lose It—And How to “Use” the Temporarily Expanded Exemptions

“Use or lose” is the key takeaway from the final regulations, and this mantra takes on added significance given that 2020 is an election year, which introduces the unknown of whether a future Congress and president may change the tax laws currently in effect, including potentially by accelerating the Jan. 1, 2026 sunset date to an earlier point in time. Accordingly, many wealthy individuals will want to consider using the expanded basic exclusion amount during 2020—the only remaining year for which there is practical certainty that the expanded basic exclusion amount will continue to be in effect. 

The increase of the exemptions gives individuals vast opportunities to leverage their gifting for multiple generations through the following techniques:

  • Topping off prior planning by making gifts to existing and/or new family trusts, including generation-skipping trusts, insurance trusts, spousal lifetime access trusts, and grantor retained annuity trusts.
  • Making new sales to intentionally defective grantor trusts (IDGT) or, where appropriate, making cash gifts to facilitate the prepayment of existing installment obligations to senior family members.
  • Making new intra-family loans (or, where appropriate, cash gifts to facilitate the prepayment of existing loans from senior family members).

Considerations specific to state estate tax may apply in the wake of the temporarily expanded federal exemptions. For example, for those who reside in New York (with a state estate tax as high as 16% of the New York taxable estate), the expanded federal exemptions give New Yorkers greater opportunities to plan ahead to reduce their New York taxable estates. New York has a unique feature of its estate tax law under which there is a “cliff” built into its estate tax calculation, which quickly phases out the benefits of the New York basic exclusion amount (currently $5.85 million for 2020, which is up from $5.74 million for 2019) if the decedent’s New York taxable estate, plus certain taxable gifts made within three years of death, is between 100% and 105% of the exclusion amount available on the date of death. The cliff completely wipes out the benefits of the exclusion if the decedent’s New York taxable estate (and any such gifts added back) exceeds 105% of the exclusion amount available on the date of death. In addition, at certain taxable estate levels, it can produce a confiscatory marginal New York estate tax rate that is substantially in excess of 100%. As a result, the New York estate tax exclusion only fully benefits individuals whose New York taxable estates (including taxable gifts made within three years of death) fall below the New York exclusion amount in effect on the date of death. In addition, the New York estate tax exemption is not portable to spouses for lifetime gifting or for use on the survivor’s New York estate tax return, in sharp contrast to the federal estate tax exemption.

As a result of the dramatic spread between the federal and New York estate tax exemptions ($11.58 million federal versus $5.85 million for New Yorkers dying in 2020), decedents whose estates are below the federal estate tax exemption amount may still owe significant New York estate tax if their estates exceed the New York estate tax exemption amount. In addition to confirming that Will provisions can fully soak up the New York estate tax exemption of the first spouse to die (including via an executor’s decision not to make a QTIP election for property in trust), New Yorkers may consider gifting an amount that would bring her taxable estate below the New York estate tax exemption amount. If such person dies more than three years after making the gift, the New York estate tax can be completely eliminated on the first spouse’s death.  Depending upon the circumstances, the total combined New York estate tax savings for a married couple can potentially exceed $1 million. Such a gifting strategy, however, needs to be carefully balanced against the income tax consequences that would result from the fact that gifted property would not be eligible to receive a “step-up in basis” generally to fair market value as of the decedent’s death. So, a careful analysis of the income tax basis of the property to be gifted would be required, with strategies including borrowing to fund gifts and the swapping of assets held in IDGTs (to substitute into the IDGT high-basis assets in exchange for low-basis assets of equivalent value), depending upon the circumstances.

One very practical strategy could involve transforming New York property into non-New York property by purchasing real or tangible property that is located in a state other than New York (such as Florida or New Jersey) that does not impose an estate tax.  Significantly, New York does not impose estate tax on real or tangible property that is located outside of New York.  Because there is no gift, New York’s addback for taxable gifts made within three years of death would not apply, and there would not be any loss of the step-up in basis upon death.  

Kevin Matz, JD, Esq., CPA, LLM, is a partner at the law firm of Stroock & Stroock & Lavan LLP in New York City. His practice is devoted principally to domestic and international estate and tax planning, advising family offices and qualified opportunity zone funds, and he is a Fellow of the American College of Trust and Estate Counsel and a co-chair of the Tax Committee of the Trusts and Estates Law Section of the New York State Bar Association. Mr. Matz is also the Secretary/Treasurer of the NYSSCPA and a past president of the Foundation for Accounting Education’s (FAE) Board of Trustees, for which he also currently chairs the FAE Curriculum Committee, and writes and lectures frequently on estate and tax planning topics. He can be reached at kmatz@stroock.com or 212-806-6076.

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