In 2017 when the Tax Cuts and Jobs Act (TCJA) was signed into law, it made significant changes to gift and estate transfer taxes. These changes were effective starting in 2018 and continue through 2025. One of the biggest changes was doubling the basic exemption amount—meaning how much can be transferred free of the gift, estate, and generation-skipping transfer taxes. This exemption went up from $5 million to $10 million. With adjustments for inflation, the 2019 exemption is $11.4 million for individuals and $22.8 million for married couples. Uncertainty was creeping in, however, as the TCJA will “sunset” on December 31, 2025. Starting on January 1, 2026, the basic exemption amount will revert to 2017 amounts and taxpayers have been unsure how the IRS will address lifetime gifts once the exemption amount falls back to a lower level.
The concern with making large gifts prior to the TCJA’s sunset was whether the IRS would attempt to “clawback” a portion of these gifts if the lifetime gift amounts exceeded the exemption amount in effect at the time of the gift-giver’s death. For example, if someone leaves a $3 million estate, makes $8 million in lifetime gifts during 2018 when the exemption amount is $11.4 million and passes away in 2019, no tax will be due. The calculation works like this: $3 million estate + $8 million lifetime gifts = $11 adjusted taxable estate. With an exemption of $11.4 million, there remains $400,000 of unused exemption amount and no tax is due. On the other hand, if the gift-giver was to pass away in 2026 when the exemption amount has reverted to $5 million (ignoring inflation adjustments for the purposes of this example), it was unknown whether the IRS would argue tax was due on the value of the estate that exceeded the $5 million exemption ($11 million taxable estate – $5 million exemption = $6 million the IRS might claw back as taxable).
In good news for taxpayers, Final Regulations became effective on November 26, 2019, that clarifies there will be no clawback of lifetime gifts that exceed the exemption amount in effect at the time of the gift-giver’s death. Thus, if you make $8 million in gifts today that are sheltered by the cumulative $10 million exclusion and pass away after 2025, these special rules will allow the basic exclusion amount to be equal to the amount you gifted ($8 million) instead of applying only the $5 million exemption available in 2026.
As such, the current exemption levels present a compelling opportunity for wealthy families to be proactive in making lifetime gifts. Gifting is an effective strategy to reduce the value of your estate during your lifetime while also providing for loved ones who may have meaningful uses for the gift. Because the TCJA will sunset in 2025, this is potentially also a “use it or lose it” opportunity. If you are interested in “using it” or learning more, please contact Kling Law Offices for a complimentary consultation on wealth preservation and transfer strategies.