Background: In late 2017, Congress passed the 2017 Tax Cut and Jobs Act. One provision of the Act doubled the estate tax exclusion amount from $5 million to $10 million, adjusted for inflation. That increased amount is due to sunset at the end of 2025. To address taxpayer concerns that one could make a gift in the 2018-2025 period to take advantage of the higher exclusion and die after 2026, Congress directed the Department of Treasury to create regulations to address how the estate tax calculation would be handled. In November 2019, Treasury issued the “final anti-clawback regulations”. Treasury Reg 20.2010-1(c) provides that “if that exemption amount that applies to the decedent’s lifetime gifts exceeds the amount that’s available at the time of death, then the estate can use the higher exemption amount that applies to the decedent’s lifetime gift.” A person who makes a $10 million gift in 2020 can shield the entire $10 million gift from estate tax even if dying in 2026 or later.
In the preamble to the final anti-clawback regulations, Treasury discussed “anti-abuse rules” that could be enacted at a later date. The potential rule would prevent use of the increased exclusion amount on certain types of gifts that lock in the increased exclusion amount while retaining control over or benefit from the gifted property. As of October 2021, Treasury has not published any anti-abuse rules to the anti-clawback regulation.
BUT… As the Biden administration seeks new tax revenue to pay for its Build Back Better program, several House Ways and Means Committee tax proposals in the multi-trillion-dollar social infrastructure bill could have significant impact on estate and gift taxes. One provision would revert to the $5 million exclusion amount as of January 1, 2022, four years before the sunset date.
Another proposal would limit the use of grantor trusts to make lifetime transfers to reduce a potentially taxable estate at the death of the grantor. Some of these trusts have been on the Democrat chopping block for many years, including Spousal Lifetime Access Trusts (SLATs), Irrevocable Life Insurance Trusts (ILITs), Grantor Retained Annuity Trusts (GRATs), and Qualified Personal Residence Trusts (QPRTs). These restrictions would apply to trusts created after the effective date of the new legislation.
The House has also gone after “special valuations” or valuation discounts for lack of control, minority interest, etc. for nonbusiness assets held in a business entity. The tax proposal would eliminate the use of valuation discounts on nonbusiness assets held in a business entity, such as a family partnership or family limited liability company. It is likely that nonbusiness assets would mean assets not used in the active conduct of business, such as passive investment in real estate or equities held in a business entity. If enacted, the disallowance of valuation discounts could have significant impact on how the business entity sets the fair market value of the business under the buy-sell provisions of the entity’s governing documents.
Since these tax proposals would take effect as of January 1, 2022, current estate and gift planning can be modified to avoid unwanted tax consequences.
Of potentially greater significance to current estate and gift plans is the little-noticed comment in the Department of Treasury’s “2021-2022 Priority Guidance Plan” released in September 2021: “Regulations under §2010 addressing whether gifts that are includible in the gross estate should be excepted from the special rule of § 20.2010-1(c).” Translated into English, that means Treasury is considering how IRS could clawback tax on gifts made since 2018 when the 2017 tax act increased the exclusion amount. The Priority Guidance is an outline of the top tax issues Treasury plans to focus on during the fiscal year beginning in October 2021. Under current law, the clawback effort would take effect when the 2017 tax provisions sunset in 2026. However, if the House Ways and Means proposal becomes law, clawback could begin in just a few months, and could be retroactive to gifts made since 2018.
Treasury seems to be targeting “have your cake and eat it too” provisions of estate and gift planning as an abusive tax avoidance scheme, if a donor used the life-time gift tax exemption on gifts to move assets out of the donor’s estate at death but retained an interest in the gifted property.
What does IRS label as tax abuse to be subject to an anti-abuse rule? If IRS judges that a grantor has created a trust that appears to release control of gifted assets but retains control of how the assets are used, it is potentially abusive. Treasury is apparently preparing to target lifetime gifts to trusts that use the donor’s gift tax exclusion amount if the donor retains any beneficial interest in the gifted property. And is preparing to do so retroactively, targeting gifts made since 2018.