The Treasury Department is on the cusp of changing a taxpayer-friendly regulation regarding federal estate taxes, but there's no need to panic. As long as taxpayers can show that their gifts are truly gifts, they should not be affected by the revision.

The proposed amendment is designed to fix some loopholes in a 2019 regulation passed in response to the 2017 Tax Cuts and Jobs Act. The 2017 law doubled the value of the estate and gift tax exemption until December 31, 2025, when it goes from $12.06 million to $5.49 million. According to this recent article from Financial Advisor titled “Amending The IRS's Anti-Clawback Provision on Gifting,” the law generated concern among those who wanted to make large gifts to take advantage of the historically high federal estate and gift tax exemption.  Consultation with an experienced Estate Planning Attorney is critical.

The concern was whether the IRS would attempt to clawback the taxes, if the taxpayer died after 2025. This is when the estate tax reverts back to a much lower number. A regulation was issued in 2019 to reassure taxpayers and explain how they could take advantage of the high exemption as long as they made gifts before 2026, regardless of the exemption at the time of their death.

The IRS recognized this as a good step. However, it had a loophole and hence the new proposed amendment. The amendment provides clarity on what constitutes an actual gift. If the donor garners a benefit from the gift or maintains control over the gift, is it really a gift?  Consulting with an Estate Planning Attorney is important for interpretation of what is considered a gift.

Giving the gift of a promissory note worth $12.06 million to lock in the high exemption and leaving it unpaid until death, for instance, is not a gift. The person is not actually giving anything away until after death. Therefore, the note is part of the taxable estate and bound by the estate tax exemption amount in place at the day of death.

The same goes for a person who gives ownership interests in a limited liability company, while continuing to serve as the company's manager. Taxpayers must be very careful not to mischaracterize their gifts to stay on the right side of this regulation.

Another example: let's say a person puts a $12 million vacation home into an LLC, with clear directions for home to be kept in the family, and then makes gifts of the LLC ownership interests to the children. If the donor wants those gifts to max out the current $12.06 million exemption, rather than be subject to the lower exemption in place at the date of death, the owner should not be the manager of the LLC. The same goes for the owner living rent-free in any property he's gifted to anyone, if the wish is to take advantage of the gifting exemption.

In the same way, a mother who places money into a trust fund for a child may not serve as a trustee and control the assets and distributions, if she wishes to take advantage of the tax benefit.

If your estate plan uses grantor annuity trusts (GRATs), Grantor Retained Income Trusts (GRITs) and qualified personal residence trusts (QPRTs), speak with your estate planning attorney. If you die during the annuity period or term of the trust, your estate may lose the benefit of the anti-clawback regulation.

If the amendment is approved, which is expected in late summer, make sure your estate plan follows the new guidelines. If you are truly giving gifts before 2026, you will likely be able to take advantage of this substantial tax benefit and pass more of your estate to your heirs.

Call an Experienced Thousand Oaks Estate Planning Attorney with questions. Book a Call

Reference: Financial Advisor (May 27, 2022) “Amending The IRS's Anti-Clawback Provision on Gifting”