US gift tax – final regulations protect large gifts from future tax

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Individuals taking advantage of the increased gift and estate tax exclusion amounts in effect from 2018 to 2025 enacted under the Tax Cuts and Jobs Act (TCJA) will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop to pre-2018 levels. Treasury and IRS confirmed the estate tax treatment of large gifts after 2025 in final regulations that take effect on and after November 26, 2019.

Final Regulations Protect Large Gifts from Future Tax

The TCJA doubled the basic exclusion amount (BEA) used to compute federal estate and gift taxes to $10 million ($11.58 million in 2020 as adjusted for inflation) for transfers from decedents and gifts made after December 31, 2017, and before January 1, 2026. On January 1, 2026, the basic exclusion amount will revert to $5 million as adjusted for inflation. It was unclear whether taxpayers who made a gift covered by the BEA in effect from 2018 through 2025 and who died after 2025, when the lower BEA takes effect, faced the prospect of having a portion of the gift clawed back into their taxable estate.

The final regulations allow taxpayers to avoid this scenario by permitting an estate to compute its estate tax credit using the greater of the BEA applicable to gifts made during life, or the BEA applicable on the date of death. As a result, estates of decedents who died after 2025 and made gifts between 2018 and 2025 can apply the higher credit available during that period rather than the lower credit that takes effect after 2025.

For example, if a single individual makes a $7 million gift in 2020, and dies in 2026, the $2 million in excess of the $5 million BEA would still be exempt from estate and gift tax under the final regulations. This is because the estate would be allowed to use the higher credit ($10 million adjusted for inflation) that was available in 2020 when the gift was made rather than the lower credit that took effect in 2026 ($5 million).

The final regulations also include an example relating to the deceased spousal exclusion (DSUE) amount. This example makes clear the BEA referenced in the definition of the DSUE amount under Internal Revenue Code Sec. 2010(c)(4) refers to the BEA in effect at the time of the deceased spouse’s death, rather than the BEA in effect when the surviving spouse passes away. In other words, if the first spouse dies while the BEA is the inflation-adjusted $10 million amount and the deceased spouse’s estate elected to allow the surviving spouse to take the deceased spouse’s exclusion amount, that amount is assumed by the surviving spouse regardless of what the BEA amount is at that surviving spouse’s death.

The Takeaway

The final regulations make an important clarification to the estate and gift tax treatment of gifts made from 2018 through 2025. Those benefiting from the temporarily increased BEA can rest assured that their estates will not be adversely impacted by a lower credit amount after 2025. But it is important to remember that a key element of effective estate planning is planning for the unexpected. Just as the TCJA provided a temporary benefit by doubling the BEA, it is possible for subsequent legislation to make significant changes. Prepare for this by regularly reviewing your plan with a knowledgeable tax advisor.

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