Recent developments in estate planning.

• Author: Ransome, Justin
• Position: Part 2

This article is the second of two parts of an annual update on recent developments in trust, estate, and gift taxation. The first part in the October issue covered trust and gift tax issues. This second part covers developments in estate and generationskipping transfer (GST) taxation, as well as inflation adjustments.

Estate tax

Basic exclusion amount

The IRS issued final regulations (1) addressing the effect that changes made by the law known as the Tax Cuts and Jobs Act (TCJA) (2) have on the basic exclusion amount used in computing federal estate and gift taxes. The final regulations affect donors of gifts made after 2017 and the estates of decedents dying after 2025.

In general, to compute liability for federal gift tax or federal estate tax, the Code applies a unified rate schedule to the taxpayer's cumulative taxable gifts and taxable estate and arrives at a net tentative tax, which is then reduced by a credit based on the applicable exclusion amount. The applicable exclusion amount is the sum of (1) the basic exclusion amount (BEA) under Sec. 2010(c) (3); and (2) the deceased spousal unused exclusion (DSUE) amount under Sec. 2010(c)(4), if any; and (3) in some cases, a restored exclusion amount under Notice 2017-15. (3) The TCJA amended Sec. 2010(c)(3) by doubling the BEA from $5 million to $10 million, adjusted for inflation, for decedents dying and gifts made during calendar years 2018-2025.

The regulations first set forth how gift tax is calculated in a seven-step computation under Sees. 2502 and 2505. The seven steps are:

1. Determine a tentative tax on the sum of all taxable gifts made in the current year or in prior periods;

2. Determine a tentative tax on the sum of all taxable gifts made in all prior periods;

3. Determine the net tentative gift tax on the current-year gifts by subtracting the tentative tax determined in Step 2 from the tentative tax determined in Step 1;

4. Determine a credit equal to the applicable credit amount under Sec. 2010(c);

5. Determine the sum of all of the amounts allowable as a credit to offset the gift tax on gifts the donor made in all preceding calendar periods;

6. Subtract the total credit allowable for prior periods determined in Step 5 from the credit for the current period determined in Step 4; and

7. Subtract the credit amount determined in Step 6 from the net tentative gift tax determined in Step 3.

   The regulations next set forth how estate tax is calculated in a five-step computation under Sees. 2001 and 2010:

1. Determine a tentative tax on the sum of the taxable estate and the adjusted taxable gifts (i.e., all taxable gifts made after 1976 other than those included in the gross estate).

2. Determine a hypothetical gift tax on all post-1976 taxable gifts. Under Sec. 2502(c), the credit amount allowable for each gift year is the tentative tax on the applicable exclusion amount for that year but may not exceed the tentative tax on gifts made during that year. The applicable exclusion amount equals the sum of: (1) the BEA in effect for the year in which the gift was made; (2) any DSUE amount as of the date of the gift as computed under Regs. Sec. 25.2502-2; and (3) any restored exclusion amount as of the gift date as computed under Notice 2017-15.

3. Determine the net tentative estate tax by subtracting the gift tax payable determined in Step 2 from the tentative tax determined in Step 1.

4. Determine a credit amount (which may not exceed the net tentative estate tax) equal to the tentative tax on the applicable exclusion amount in effect on the date of death.

5. Subtract the credit amount determined in Step 4 from the net tentative estate tax determined in Step 3 (Sec. 2010(a)).

   To address concerns over what the tax consequences would be if a taxpayer were to gift between $5 million and $10 million during calendar years 2018-2025 and die in 2026 or later, when the BEA is only $5 million, the proposed regulations (4) provided a special rule that would allow the estate to compute its estate tax credit using the higher of: (1) the BEA applicable to gifts made during the decedent's life, or (2) the BEA applicable on the date of the decedent's death. The final regulations adopt the special rule from the proposed regulations so that a decedent's estate is not inappropriately taxed on gifts that were sheltered from gift tax by the increased ($10 million) BEA when the gifts were made. The final regulations also make clarifications and address additional comments made by commentators.

   Inflation adjustments: Examples provided in the final regulations reflect hypothetical inflation-adjusted BEA amounts not included in the proposed regulations. The preamble notes that the increased BEA as adjusted for inflation is a use-it-or-lose-it benefit that is available to a decedent who lives beyond the increased BEA period if the decedent used the benefit by making gifts during the increased BEA period.

   Example 1 of Regs. Sec. 20.2010-1(c)(2)(i) in the final regulations confirms that a decedent dying after 2025 would not benefit under the special rule from post-2025 inflation adjustments to the BEA to the extent the decedent made gifts large enough to cause the total BEA allowable in the computation of gift tax payable to exceed the date-of-death BEA as adjusted for inflation. To compute estate tax, the preamble notes, the BEA is first applied against the decedent's gifts as taxable gifts were made; to the extent any BEA remains at the time of death, that remainder applies against the decedent's estate. Therefore, a decedent who made gifts in a large enough amount to cause the total BEA allowable in the gift tax computation to equal or exceed the date-of-death BEA, no BEA would remain available to be applied to reduce the estate tax. The IRS notes that the special rule does not change (1) the five-step estate tax computation or (2) that only the credit remaining after computing gift tax payable may be applied against the estate tax.

   DSUE response: Regs. Sees. 20.2010-1(d)(4) and 20.2010-2(c)(1) confirm that a DSUE amount elected during the increased BEA period will not be reduced, even if the BEA amount decreases after 2025. Reference to "BEA" means the BEA in effect at the time that the deceased spouse dies as opposed to the BEA in effect when the surviving spouse dies. 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 applicable exclusion amount, the preamble explains. Ultimately, the sunset of the $10 million BEA, or any other decrease in the $10 million BEA, will not affect the existing DSUE rules or the existing regulations governing the DSUE. Examples 3 and 4 of Regs. Sees. 20.2010-1(c)(2)(iii) and (iv) address this point.

   BEA computations: The final regulations provide guidance for determining the extent to which a credit allowable in computing gift tax payable is based solely on the BEA. Specifically, the regulations specify that:

1. The credit may not exceed the amount necessary to reduce the gift tax for the period to zero;

2. Any DSUE amount available to the decedent for the calendar period is deemed applied to the decedent's gifts before any of the decedent's BEA is applied to the gifts;

3. In a calendar period in which the applicable exclusion amount allowable for gifts made during the period includes both a DSUE and a BEA, the allowable BEA may not exceed the amount necessary to reduce the tentative gift tax to zero after applying the DSUE amount; and

4. In a calendar period in which the applicable exclusion amount allowable for gifts made during the period includes both a DSUE and a BEA, the portion of the credit based solely on the BEA for the period equals the BEA allocable to those gifts divided by the applicable exclusion amount allocable to those gifts.

   GST tax: The preamble states that an increase in the BEA correspondingly increases the GST exemption because it is defined by reference to the BEA. However, issues concerning the late allocation of the increase in the GST exemption to inter vivos trusts created before 2018 and whether the allocation of the increased GST exemption will be affected by the sunsetting of the increased BEA are beyond the scope of the regulation project. The preamble does include a footnote citing the Joint Committee on Taxation's Blue Book of the TCJA that indicates a late allocation of the GST exemption (increased by the increase in the BEA) may be made.

   Regulatory authority: One of the commentators noted that the special rule in the regulations would exceed the scope of congressionally granted authority because the rule is not limited to the treatment of transfers during calendar years 2018-2025. The preamble states this assertion is inconsistent with both Sec. 2001(g)--addressing the effect of changes in tax rates and exclusion amounts in the computation of the estate tax--and Sec. 2001(g)(2)--addressing circumstances that can occur only after Dec. 31, 2025, when the BEA increase sunsets and drops to $5 million. The preamble states that the impact of the sunset of the increased BEA as of Jan. 1, 2026, was the exact reason Congress granted it regulatory authority under Sec. 2001(g)(2) to resolve the issue and to ensure that there would be no imposition of estate tax on inter vivos gifts that were sheltered from gift tax by the increased BEA in effect when the gifts were made.

   The problem resolved by the proposed regulations is the same one that many practitioners feared when the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 (5) increased the BEA from $1 million to $3.5 million but was supposed to sunset and return the BEA from $3.5 million to $1 million. The estate tax calculation does not take into account changes in the BEA that may take place during the taxpayer's life, whereas the calculation of gift tax does take those changes into consideration by effectively giving the...