IRS proposes to protect wealth transfers with rules for estate and gift taxes

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The Internal Revenue Service’s recent proposal to extend gift and estate tax exemptions beyond 2025 could spur some large transfers of wealth.

Last month, the IRS and the Treasury Department issued proposed regulations saying individuals who take advantage of the increased gift and estate tax exclusion amounts in effect from 2018 to 2025 won’t have to worry about the time limits in the Tax Cuts and Jobs Act (see IRS proposes to extend bigger gift and estate tax exclusion amounts beyond 2025 and IRS sees no ‘clawback’ from higher estate and gift tax exemption). Under the proposed regulations, wealthy taxpayers won’t be negatively affected after 2025, when the exclusion amount is scheduled to drop to the old levels from before 2018, prior to the passage of the tax overhaul.

The Tax Cuts and Jobs Act effectively doubled the exclusion amount of assets that could be passed along to one’s heirs without triggering gift or estate taxes, to nearly $11.2 million for individual taxpayers and $22.4 million for couples. They go up even more after inflation adjustments for 2019, but then expire in 2025 when they go back to their old exclusion amount levels. They would then be taxed at 40 percent for amounts over the exclusion level.

While last December’s tax overhaul made large gifts exempt from the gift tax until 2025, some wealthy taxpayers and practitioners were concerned that making significant tax-free gifts now could trigger an estate tax bill for people who die after the rule expires. But under the proposed rules, people who worried about losing the benefits of the temporarily increased exemptions won’t face clawbacks when the exemption is scheduled to decline in 2025. On top of the release of the IRS’s increased estate and gift tax exemption amounts for 2019, taxpayers and practitioners are foreseeing a major gift and estate planning opportunity that could well trigger a wave of wealth transfers once the regulations are finalized.

Steve Saraisky, a member of the Tax, Trusts & Estates group at the law firm Cole Schotz, doesn’t believe the proposed regulations change the landscape all that much, but they do address some concerns.

“What they do is they answer one important question which people have been asking, which is whether there could be a so-called clawback if somebody uses the full exemption amount today, which is a bit over $11 million under the tax bill that was enacted at the end of 2017, and then the exemption amount comes down, as it’s scheduled to do in 2026,” he said. “Is there potential risk that person could have a clawback or could owe gift tax or potentailly estate tax as a result of the reduction in the exemption amount? And the proposed regs answer that by saying no, there wouldn’t be a clawback>

The proposed regs address some hypothetical examples of taxpayers who could be affected. “The IRS has given us certain situations and explained how the rules should work to clarify that there’s no clawback,” said Saraisky. “Probably the most important example is a scenario where someone makes gifts in the neighborhood of $11 million and then passes away, and has estate tax, and how the estate tax is calculated was an area of some uncertainty. The IRS has clarified that when you calculate the estate tax, that decedent won’t be penalized or won’t incur additional estate tax for the gift that they made.”

Some taxpayers had been concerned about the possibility of a clawback if they made gifts over the exclusion level. “It’s a real issue and it’s a question that people were uncertain about and so the proposed regs give clarity on that point,” said Saraisky. “It’s what we expected, but nonetheless it’s good to have clarity on a point that was uncertain.”

Wealthy taxpayers may now be encouraged to move ahead with the wealth transfers with the uncertainty now removed. However, Saraisky doesn’t see signs in the proposed regulations that the IRS is saying other individual tax breaks will last beyond 2025.

“I don’t think that there are assurances that you can count on the tax breaks continuing beyond 2025,” he said. “There is some concern that if we had a Democratic Congress and a Democratic president in the next election cycle, perhaps the law would be changed. But this idea right now of use it or lose it with respect to the increased exemption amount does kind of indicate for wealthy families to make gifts while they have the larger exemption amount and be sure they use it since it’s slated to go back to $5 million after 2025.”

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Estate taxes Tax reform Wealth management Wealth protection IRS