The first item of the guidance promised by Assistant Treasury Secretary David Kautter to be released by the end of January 2020 has been published. In TD 9884[1] the IRS finalized regulations on the anti-clawback rules that IRC §2001(g)(2) required the IRS to develop to prevent issues when the exclusions are scheduled to be reduced in 2026.

The problem is simple—generally a taxpayer’s estate tax is computed by combining his/her taxable estate at death with his/her lifetime taxable gifts. A gross tax is computed using that figure. It is then reduced by a credit based on the appropriate exclusion amount plus any gift tax actually paid on taxable gifts. If the exclusion amount at death is lower than it was when gifts were made, it’s possible that tax would be due at death with no assets available to pay the tax.

Example

Harry gave his son Wayne a gift of $11,000,000 in 2019, the only taxable gift Harry made during his lifetime. No gift tax is due in 2019, since the gift is less than the basic exclusion amount (BEA) in place at that date. In 2026 the exclusion is reduced back to the lower amount in place before the Tax Cuts and Jobs Act, adjusted for inflation. We will assume that amount would be computed to be $6,000,000. Harry has a zero taxable estate on hand at his death.

The total estate tax would be based on the $11,000,000 gift Harry made in 2019. However, only $6,000,000 of exclusion would be available to compute a credit, which would result in a tax due being shown on the Form 706 unless an anti-clawback rule is in place to solve this problem.

The final regulations adopt, with some clarifications, the proposed regulations issued last year.[2]

The final regulations provide at Reg. §20.2010-1(c) that the exclusion amount used in the computation will be the greater of the exclusion at the date in question or the total of gifts previously excluded from tax due to the use of the exclusion amount in place at the time of the transfer. Specifically, the regulation states:

If the total of the amounts allowable as a credit in computing the gift tax payable on the decedent’s post-1976 gifts, within the meaning of section 2001(b)(2), to the extent such credits are based solely on the basic exclusion amount as defined and adjusted in section 2010(c)(3), exceeds the credit allowable within the meaning of section 2010(a) in computing the estate tax, again only to the extent such credit is based solely on such basic exclusion amount, in each case by applying the tax rates in effect at the decedent’s death, then the portion of the credit allowable in computing the estate tax on the decedent’s taxable estate that is attributable to the basic exclusion amount is the sum of the amounts attributable to the basic exclusion amount allowable as a credit in computing the gift tax payable on the decedent’s post-1976 gifts.[3]

The regulation provides the following computational rules:

In determining the amounts allowable as a credit:
- The amount allowable as a credit in computing gift tax payable for any calendar period may not exceed the tentative tax on the gifts made during that period; and
- The amount allowable as a credit in computing the estate tax may not exceed the net tentative tax on the taxable estate.
In determining the extent to which an amount allowable as a credit in computing gift tax payable is based solely on the basic exclusion amount:
- Any deceased spousal unused exclusion (DSUE) amount available to the decedent is deemed to be applied to gifts made by the decedent before the decedent's basic exclusion amount is applied to those gifts;
- In a calendar period in which the applicable exclusion amount allowable with regard to gifts made during that period includes amounts other than the basic exclusion amount, the allowable basic exclusion amount may not exceed that necessary to reduce the tentative gift tax to zero; and
- In a calendar period in which the applicable exclusion amount allowable with regard to gifts made during that period includes amounts other than the basic exclusion amount, the portion of the credit based solely on the basic exclusion amount is that which corresponds to the result of dividing the basic exclusion amount allocable to those gifts by the applicable exclusion amount allocable to those gifts.
In determining the extent to which an amount allowable as a credit in computing the estate tax is based solely on the basic exclusion amount, the credit is computed as if the applicable exclusion amount were limited to the basic exclusion amount.[4]

The IRS provides the following two examples to illustrate the application of this provision to a taxpayer who has never been married.

Example 1 - Reg. §20.2010-1(c)(2)

Individual A (never married) made cumulative post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by the cumulative total of $11.4 million in basic exclusion amount allowable on the dates of the gifts. The basic exclusion amount on A's date of death is $6.8 million. A was not eligible for any restored exclusion amount pursuant to Notice 2017-15. Because the total of the amounts allowable as a credit in computing the gift tax payable on A's post-1976 gifts (based on the $9 million of basic exclusion amount used to determine those credits) exceeds the credit based on the $6.8 million basic exclusion amount allowable on A's date of death, this paragraph (c) applies, and the credit for purposes of computing A's estate tax is based on a basic exclusion amount of $9 million, the amount used to determine the credits allowable in computing the gift tax payable on A's post-1976 gifts.

Example 2 – Reg. §20.2010-1(c)(2)

Assume that the facts are the same as in Example 1 of paragraph (c)(2)(i) of this section except that A made cumulative post-1976 taxable gifts of $4 million. Because the total of the amounts allowable as a credit in computing the gift tax payable on A's post-1976 gifts is less than the credit based on the $6.8 million basic exclusion amount allowable on A's date of death, this paragraph (c) does not apply. The credit to be applied for purposes of computing A's estate tax is based on the $6.8 million basic exclusion amount as of A's date of death, subject to the limitation of section 2010(d).

Since 2011, a surviving spouse has been able to make use of a deceased spouse unused exclusion amount (DSUE) if the estate of the deceased spouse made the appropriate election. The application of the anti-clawback rules where a DSUE is involved is outlined in the following examples in the regulations.

Example 3 – Reg. §20.2010-1(c)(2)

Individual B's predeceased spouse, C, died before 2026, at a time when the basic exclusion amount was $11.4 million. C had made no taxable gifts and had no taxable estate. C's executor elected, pursuant to §20.2010-2, to allow B to take into account C's $11.4 million DSUE amount. B made no taxable gifts and did not remarry. The basic exclusion amount on B's date of death is $6.8 million. Because the total of the amounts allowable as a credit in computing the gift tax payable on B's post-1976 gifts attributable to the basic exclusion amount (zero) is less than the credit based on the basic exclusion amount allowable on B's date of death, this paragraph (c) does not apply. The credit to be applied for purposes of computing B's estate tax is based on B's $18.2 million applicable exclusion amount, consisting of the $6.8 million basic exclusion amount on B's date of death plus the $11.4 million DSUE amount, subject to the limitation of section 2010(d).

Example 4 – Reg. §20.2010-1(c)(2)

Assume the facts are the same as in Example 3 of paragraph (c)(2)(iii) of this section except that, after C's death and before 2026, B makes taxable gifts of $14 million in a year when the basic exclusion amount is $12 million. B is considered to apply the DSUE amount to the gifts before applying B's basic exclusion amount. The amount allowable as a credit in computing the gift tax payable on B's post-1976 gifts for that year ($5,545,800) is the tax on $14 million, consisting of $11.4 million in DSUE amount and $2.6 million in basic exclusion amount. This basic exclusion amount is 18.6 percent of the $14 million exclusion amount allocable to those gifts, with the result that $1,031,519 (0.186 x $5,545,800) of the amount allowable as a credit for that year in computing gift tax payable is based solely on the basic exclusion amount. The amount allowable as a credit based solely on the basic exclusion amount for purposes of computing B's estate tax ($2,665,800) is the tax on the $6.8 million basic exclusion amount on B's date of death. Because the portion of the credit allowable in computing the gift tax payable on B's post-1976 gifts based solely on the basic exclusion amount ($1,031,519) is less than the credit based solely on the basic exclusion amount ($2,665,800) allowable on B's date of death, this paragraph (c) does not apply. The credit to be applied for purposes of computing B's estate tax is based on B's $18.2 million applicable exclusion amount, consisting of the $6.8 million basic exclusion amount on B's date of death plus the $11.4 million DSUE amount, subject to the limitation of section 2010(d).

Thus, if a person dies before 2026 and a DSUE election is made to transfer the unused exclusion to the surviving spouse, that higher DSUE will survive the reduction in the basic exclusion amount (BEA) in 2026 if the surviving spouse dies after that date. The preamble to the final regulations state:

The regulations in §§20.2010-1(d)(4) and 20.2010-2(c)(1) confirm that the reference to BEA is to the BEA in effect at the time of the deceased spouse’s death, rather than the BEA in effect at the death of the surviving spouse. A DSUE election made on the deceased spouse’s estate tax return allows the surviving spouse to take into account the deceased spouse’s DSUE amount as part of the surviving spouse’s AEA. Section 2010(c)(5); §20.2010-2(a). AEA is the sum of the DSUE amount and the BEA. Section 2010(c)(2). A decrease in the BEA after 2025 will reduce the surviving spouse’s AEA only to the extent that it is based upon the BEA, but not to the extent that it is based on the DSUE amount. Therefore, the sunset of (or any other decrease in) the increased BEA has no impact on the existing DSUE rules and the existing regulations governing DSUE continue to apply.[5]

Although the IRS declined to have these regulations directly address generation skipping transfer tax (GST) issues, the preamble contained the following guidance on the impact on GST issues:

Several commenters asked for confirmation that, during the increased BEA period, donors may make late allocations of the increase in GST exemption to inter vivos trusts created prior to 2018. An increase in the BEA correspondingly increases the GST tax exemption, which is defined by reference to the BEA. Section 2631(c). The effect of the increased BEA on the GST tax is beyond the scope of this rulemaking.

A commenter requested confirmation and examples showing that allocations of the increased GST exemption made during the increased BEA period (whether to transfers made before or during that period) will not be reduced as a result of the sunset of the increased BEA. There is nothing in the statute that would indicate that the sunset of the increased BEA would have any impact on allocations of the GST exemption available during the increased BEA period. However, this request is beyond the scope of this project.

[1] TD 9884, November 26, 2019 publication date in Federal Register, https://s3.amazonaws.com/public-inspection.federalregister.gov/2019-25601.pdf (retrieved November 23, 2019)

[2] REG–106706–18, published November 23, 2019, https://www.govinfo.gov/content/pkg/FR-2018-11-23/pdf/2018-25538.pdf

[3] Reg. §20.2010-1(c)

[4] Reg. §20.2010-1(c)(1)

[5] TD 9884, Summary of Comments and Explanation of Revisions, Section 3