An Uncertain Future: How the Potential Clawback Muddies the Estate and Gift Tax Waters

• Publication year: 2018
• Author: By Robin L. Klomparens and Kristin N. Capritto

An Uncertain Future: How the Potential Clawback Muddies the Estate and Gift Tax Waters1

By Robin L. Klomparens and Kristin N. Capritto²

EXECUTIVE SUMMARY

The Tax Cuts and Jobs Act³ (the "Act") was signed by the president on December 22, 2017. Despite simplification of the tax code being one of the Act's stated purposes, many of its provisions add complexity and ambiguity for both practitioners and taxpayers. This is particularly evident with respect to the Act's changes to the estate and gift tax scheme. Thus, clarification on several issues would be helpful. This includes the potential for additional estate tax due because of lifetime gifts made by the donor.

Specifically, the possible sunset in 2026 of the increased estate and gift tax exemption amount leads to uncertainty and insecurity that the possibility that a gift previously made by a decedent will be "clawed back" into his or her estate if death occurs in a year in which the exemption amount is less than it was in the year the gift was made. Conversely, a concern for practitioners and taxpayers involves the loss of a credit against estate tax on a donee's death with respect to previous gift tax paid by the donor during his or her lifetime when exemption amounts are increasing. Additional issues arise relative to the ordering of credit amount used—if an individual makes a gift in a year with a higher credit amount and then the credit amount subsequently decreases, does that individual still have unified credit remaining? The answer depends on whether the credit amount is reduced from the top down or the bottom up.

The Act added an additional provision to Internal Revenue Code section 2001(g)(1), to specifically address these issues as it mandates the Department of Treasury to prescribe regulations as may be necessary or appropriate to address any difference in the basic exclusion amount at the time of a gift and at the time of death. Contrary to the current law, any type of clawback is inconsistent with related regulations and contrary to current law. Hence, Treasury should address the above circumstances to provide that no additional estate tax should arise due to changing exemption amounts, but at minimum resolve ambiguities relating to potential differences in the exclusion amount on lifetime gifts and on death.

I. BACKGROUND

A. The Unified Credit and Applicable Exemption Amount

Calculating estate and gift tax is far less intuitive than one might think. The Code⁴ allows all taxpayers a unified credit on lifetime gifts and transfers on death.⁵ This unified credit offsets tax owed on these transfers, which is calculated using the applicable estate and gift tax rates in effect at the time of the transfer. This is referred to as the exemption amount. In simplified terms, to determine the amount of estate tax due on a decedent's death, the entirety of the decedent's gross taxable estate is determined (assets less liabilities and administrative expenses), then lifetime gifts are added in, at which point the estate tax due is calculated. Then, any gift tax previously paid by the decedent (as the donor of a gift made in excess of the applicable unified credit exemption amount in the year the gift was made), is credited back. What remains is the amount of estate tax due. Thus, variances (whether increases or decreases between the time of a gift and the donor's death) in the amount of the unified credit amount can vastly affect the estate tax owed on a donor's death. This causes uncertainly for taxpayers and difficulty for tax practitioners who are attempting to advise clients in connection with their estate tax liability on death.

B. The Unified Credit Under The Tax Cuts and Jobs Act of 2017

Formally called "An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018," the Tax Cuts and Jobs Act ("Act") represents the most dramatic overhaul to the nation's tax law since the Tax Reform Act of 1986. In terms of estate and gift tax, the Act provides taxpayers the ability to increase gifts during both life and bequests on death without gift or estate tax by doubling the exemption amount. Specifically, the new provisions under the Act increase the basic exclusion amount provided in Section 2010(c)(3) from $5 million to $10 million indexed for inflation occurring after 2011. The indexed amount for 2018 is $11.18 million but unfortunately, this may be fleeting. Under the Act, the transfer tax provisions relative to estate and gift tax are only effective for eight years (from January 1, 2018 to December 31, 2025) in the absence of congressional action.⁶ After 2025, these new provisions sunset and beginning in 2026, the prior law returns.

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Certainly, the increased unified credit amount decreases the need for many taxpayers to even consider the effects of lifetime gifts on post mortem transfers of property. Much like the confusion and uncertainty experienced by taxpayers attempting to plan for wealth transfers in 2012; however, these sunset provisions create significant insecurity for taxpayers whose...