In proposed regulations, the IRS sought to block potential methods that might be used to extend the increased basic exclusion amount should it be allowed to drop back to a lower level after the end of 2025.[1]

The IRS had previously released what have been referred to as anti-clawback regulations in 2019. The regulations sought to prevent an estate from facing a tax bill if the basic exclusion amount (BEA) drops below amounts that have been gifted during life that were covered by the BEA applicable at the time of the gift, when the BEA has now dropped below the amount of those gifts. The regulations explain this as follows:

On November 26, 2019, the Treasury Department and the IRS published final regulations under section 2010 (TD 9884) in the Federal Register (84 FR 64995) to address situations described in section 2001(g)(2) (final regulations). The final regulations adopted §20.2010-1(c), a special rule (special rule) applicable in cases where the credit against the estate tax that is attributable to the BEA is less at the date of death than the sum of the credits attributable to the BEA allowable in computing gift tax payable within the meaning of section 2001(b)(2) with regard to the decedent’s lifetime gifts. In such cases, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based on the sum of the credits attributable to the BEA allowable in computing gift tax payable regarding the decedent’s lifetime gifts. The rule ensures that the estate of a donor is not taxed on completed gifts that, as a result of the increased BEA, were free of gift tax when made.[2]

However, the IRS was aware that it might be possible to use that special rule to make certain gifts during the period a higher BEA applied, but retain significant benefits past the date the new lower BEA took effect. To attempt to stop taxpayers from arranging transactions to make gifts with significant retained level of control to continue to benefit from the higher BEA the IRS has now issued these proposed changes:

The preamble to the final regulations stated that further consideration would be given to the issue of whether gifts that are not true inter vivos transfers, but rather are includible in the gross estate, should be excepted from the special rule, and that any proposal addressing this issue would benefit from notice and comment.[3]

Proposed Effective Date

The proposed regulations provide for the following effective date:

Once these regulations have been published as final regulations, it is proposed that these regulations be applicable to the estates of decedents dying on or after April 27, 2022. The special rule will not be needed until the basic exclusion amount has been decreased by statute; under current law, that is scheduled to occur for the estates of decedents dying after 2025. However, if such a decrease is enacted on or after April 27, 2022, but before the issuance of final regulations, the best way to ensure that all estates will be subject to the same rules is to make this proposed exception to the special rule applicable to the estates of decedents dying on or after April 27, 2022.[4]

Items Subject to the Special Rule

The regulations provide that the increase in the BEA under the special rule of Reg. §20.2010-1(c) does not apply to transfers includible in the gross estate, or treated as includible in the gross estate for purposes of IRC §2001(b). Such transfers will include, without limit, the following transfers:

Transfers includible in the gross estate pursuant to section 2035, 2036, 2037, 2038, or 2042, regardless of whether all or any part of the transfer was deductible pursuant to section 2522 or 2523;
Transfers made by an enforceable promise to the extent they remain unsatisfied as of the date of death;
Transfers described in Regs. §25.2701-5(a)(4) (Section 2701 interest) or §25.2702-6(a)(1) (indirect holding of interests under Section 2701); or
Transfers that would have been described in the prior three bullets but for the transfer, relinquishment, or elimination of an interest, power, or property, effectuated within 18 months of the date of the decedent’s death by the decedent alone, by the decedent in conjunction with any other person, or by any other person.[5]

Note that the regulation provides that the affected items includes those specific items. Thus, the list is not meant to be taken as an exclusive list of what would be covered by this rule. So if Congress adds other provisions to the law that are similar in nature, they would be caught by this rule even if the IRS doesn’t update the regulation.

However, the special rule (expansion of the BEA) will continue to apply to the following transactions (so they are exempted from the new rules meant to limit the applicability of the special rule):

Transfers includible in the gross estate in which the value of the taxable portion of the transfer, determined as of the date of the transfer, was 5 percent or less of the total value of the transfer (a de minimis rule); and
Transfers, relinquishments, or eliminations described in the last bullet point of the previous list effectuated by the termination of the durational period described in the original instrument of transfer by either the mere passage of time or the death of any person.[6]

The 18 month rule does provide for an option to terminate such interests if it becomes clear the donor is likely to pass away in the near, but not too near, future. However, it is clear this step would need to be taken to allow enough time for 18 months to pass before the decedent passed away, something that obviously can’t be assured at the time the interest is terminated. But it is important to note that 18 months is a shorter period than the three years that otherwise would apply to certain of these transactions to bring them back into the decedent’s estate.

IRS Examples of Applying the Proposed Regulations

The IRS provides the following examples of applying the newly proposed regulations:

Example 1, Reg. §20.2010-1(c)(3)(iii)

Individual A made a completed gift of A’s promissory note in the amount of $9 million. The note remained unpaid as of the date of A’s death. The assets that are to be used to satisfy the note are part of A’s gross estate, with the result that the note is treated as includible in the gross estate for purposes of section 2001(b) and is not included in A’s adjusted taxable gifts. Because the note is treated as includible in the gross estate and does not qualify for the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section, the exception to the special rule found in paragraph (c)(3) of this section applies to the gift of the note. 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). The result would be the same if A or a person empowered to act on A’s behalf had paid the note within the 18 months prior to the date of A’s death.

Example 2, Reg. §20.2010-1(c)(3)(iii)

Assume that the facts are the same as Example 1 except that A’s promissory note had a value of $2 million and, on the same date that A made the gift of the promissory note, A also made a gift of $9 million in cash. The cash gift was paid immediately, whereas the $2 million note remained unpaid as of the date of A’s death. The assets that are to be used to satisfy the note are part of A’s gross estate, with the result that the note is treated as includible in the gross estate for purposes of section 2001(b) and is not included in A’s adjusted taxable gifts. Because the $2 million note is treated as includible in the gross estate and does not qualify for the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section, the exception to the special rule found in paragraph (c)(3) of this section applies to the gift of the note. On the other hand, the $9 million cash gift was paid immediately, and no portion of that gift is includible or treated as includible in the gross estate. Because the amount allowable as a credit in computing the gift tax payable on A’s $9 million cash gift exceeds the credit based on the $6.8 million basic exclusion amount allowable on A’s date of death, the special rule of paragraph (c) of this section applies to that gift. The credit to be applied for purposes of computing A’s estate tax is based on a basic exclusion amount of $9 million, the amount used to determine the credit allowable in computing the gift tax payable on A’s $9 million cash gift.

Example 3, Reg. §20.2010-1(c)(3)(iii)

Assume that the facts are the same as in Example 1 except that, prior to A’s gift of the note, the executor of the estate of A’s predeceased spouse elected, pursuant to §20.2010-2, to allow A to take into account the predeceased spouse’s $2 million DSUE amount. Assume further that A’s promissory note had a value of $2 million on the date of the gift, and that A made a gift of $9 million in cash a few days later. The cash gift was paid immediately, whereas the $2 million note remained unpaid as of the date of A’s death. The assets that are to be used to satisfy the note are part of A’s gross estate, with the result that the note is treated as includible in the gross estate for purposes of section 2001(b) and is not included in A’s adjusted taxable gifts. Because A’s DSUE amount was sufficient to shield the gift of the note from gift tax, no basic exclusion amount was applicable to the $2 million gift pursuant to paragraph (c)(1)(ii)(A) of this section and the special rule of paragraph (c) of this section does not apply to that gift. On the other hand, the $9 million cash gift was paid immediately, and no portion of that gift is includible or treated as includible in the gross estate. Because the amount allowable as a credit in computing the gift tax payable on A’s $9 million cash gift exceeds the credit based on the $6.8 million basic exclusion amount allowable on A’s date of death, the special rule of paragraph (c) of this section applies to that gift. The credit to be applied for purposes of computing A’s estate tax is based on A’s $11 million applicable exclusion amount, consisting of the $2 million DSUE amount plus the $9 million amount used to determine the credit allowable in computing the gift tax payable on A’s $9 million cash gift.

Example 4, Reg. §20.2010-1(c)(3)(iii)

Individual B transferred $9 million to a grantor retained annuity trust (GRAT), retaining a qualified annuity interest within the meaning of §25.2702-3(b) of this chapter valued at $8,550,000. The taxable portion of the transfer valued as of the date of the transfer was $450,000. B died during the term of the GRAT. The entire GRAT corpus is includible in the gross estate pursuant to §20.2036-1(c)(2). Because the value of the taxable portion of the transfer was 5 percent or less of the total value of the transfer determined as of the date of the gift, the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section is met and the exception to the special rule found in paragraph (c)(3) of this section does not apply to the gift. However, because the total of the amounts allowable as a credit in computing the gift tax payable on B’s post-1976 gift of $450,000 is less than the credit based on the $6.8 million basic exclusion amount allowable on B’s date of death, the special rule of paragraph (c) of this section does not apply to the gift. The credit to be applied for purposes of computing B’s estate tax is based on the $6.8 million basic exclusion amount as of B’s date of death, subject to the limitation of section 2010(d).

Example 5, Reg. §20.2010-1(c)(3)(iii)

Assume that the facts are the same as in Example 4 except that B’s qualified annuity interest is valued at $8 million. The taxable portion of the transfer valued as of the date of the transfer was $1 million. Because the value of the taxable portion of the transfer was more than 5 percent of the total value of the transfer determined as of the date of the gift, the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section is not met and the exception to the special rule found in paragraph (c)(3) of this section applies to the gift. The credit to be applied for purposes of computing B’s estate tax is based on the $6.8 million basic exclusion amount as of B’s date of death, subject to the limitation of section 2010(d).

Example 6, Reg. §20.2010-1(c)(3)(iii)

Assume that the facts are the same as in Example 4 except that B’s qualified annuity interest is valued at $2 million. The taxable portion of the transfer valued as of the date of the transfer was $7 million. B survived the term of the GRAT. Because B survived the original unaltered term of the GRAT, no part of the value of the assets transferred to the GRAT is includible in B’s gross estate, and the exception to the special rule found in paragraph (c)(3) of this section does not apply to the gift. Moreover, because the amount allowable as a credit in computing the gift tax payable on B’s $7 million gift exceeds the credit based on the $6.8 million basic exclusion amount allowable on B’s date of death, the special rule of paragraph (c) of this section applies to the gift. The credit to be applied for purposes of computing B’s estate tax is based on a basic exclusion amount of $7 million, the amount used to determine the credit allowable in computing the gift tax payable on B’s transfer to the GRAT.

Example 7, Reg. §20.2010-1(c)(3)(iii)

Individual C transferred $9 million to a grantor retained income trust (GRIT), retaining an income interest valued at $0 pursuant to section 2702(a)(2)(A). The taxable portion of the transfer valued as of the date of the transfer was $9 million. C died during the term of the GRIT. The entire GRIT corpus is includible in C’s gross estate pursuant to section 2036(a)(1) because C retained the right to receive all of the income of the GRIT. Because the transferred assets are includible in the gross estate and do not qualify for the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section, the exception to the special rule found in paragraph (c)(3) of this section applies to the gift. The credit to be applied for purposes of computing C’s estate tax is based on the $6.8 million basic exclusion amount as of C’s date of death, subject to the limitation of section 2010(d).

[1] REG-118913-21; 87 F.R. 24918-24923, April 27, 2022, https://www.taxnotes.com/research/federal/proposed-regulations/proposed-regs-limit-application-of-higher-basic-exclusion-amount/7df65 (retrieved July 27, 2022)

[2] REG-118913-21; 87 F.R. 24918-24923, April 27, 2022, Supplementary Information, Background

[3] REG-118913-21; 87 F.R. 24918-24923, April 27, 2022, Supplementary Information, Background

[4] REG-118913-21; 87 F.R. 24918-24923, April 27, 2022, Supplementary Information, Background

[5] Proposed Reg. §20.2010-1(c)(3)(i)

[6] Proposed Reg. §20.2010-1(c)(3)(ii)