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In response to a perceived potential abuse of the ‘anti-clawback’ regulations released in 2019, on April 27 the IRS published Proposed Regulation sec. 20.2010-1(c)(3).
Federal tax reform enacted in 2017 increased the basic exclusion amount (gift and estate tax exemption) from $5 million to $10 million (adjusted for inflation) for gifts made and decedents dying after December 31, 2017 and before January 1, 2026. The basic exclusion amount is scheduled to revert to $5 million (adjusted for inflation) on January 1, 2026.
On November 26, 2019, the IRS published Final Regulation sec. 20.2010-1(c) (known colloquially as the ‘anti-clawback’ regulations), which addressed instances where the credit related to the basic exclusion amount applicable at the time of death for estate tax purposes is less than the credit allowable in computing the gift tax payable with respect to the gifts that the decedent made during their lifetime. The intention of the regulations was to avoid imposing an additional estate tax in situations where the exemption at death was lower than the exemption at the time of the completed gift.
The recently proposed regulation would impose some limits on the anti-clawback regulations issued in 2019. The regulation, when finalized, is proposed to apply to estates of decedents dying on or after April 27, 2022. Comments on the proposed regulations are due by July 26, 2022.
The IRS states that the goal of the proposed regulation is to ensure that bona fide inter vivos transfers are treated as gifts for both gift and estate tax purposes, and therefore, by contrast, they are subject to the values, gift tax rates, and exclusions applicable as of the date of the gift, by contrast, a gift of property that remains includible in the donor’s estate would be subject to the values, estate tax rates, and exclusions applicable at the date of death.
In general, the federal estate and gift tax exemption is ‘unified,’ meaning that at death, any taxable gifts (made after 1976) are added back in calculating the estate tax. Thus, gifts that utilized the gift tax exemption are added back so that the taxpayer’s estate tax exemption is reduced accordingly.
When the exemption was significantly increased by the tax reform measures in 2017 but scheduled to revert after 2025, some concerns arose that if the estate exemption was lower at death than at the time gifts were made utilizing a higher gift exemption, those gifts would be ‘clawed back’. To address this concern, the IRS and Treasury released regulations known as ‘anti-clawback’ regulations.
In 2019, Treasury Regulation sec. 20.2010-1(c) (anti-clawback regulations) addressed the concern described above by creating a special rule that permits a decedent’s estate to use the unified credit equal to the basic exclusion amount in effect during the year of the decedent’s prior adjusted taxable gifts.
Observation: The special rule allows the decedent’s estate to receive a credit for the higher basic exclusion amount at the time of gift. This higher credit would then offset the tax on the adjusted taxable gifts included in the estate, resulting in no additional estate tax as a result of the prior gift, as the decedent would have anticipated at the time of gift.
However, the special rule under Treasury Regulation sec. 20.2010-1(c) does not distinguish between two types of transfers. The first transfer consists of completed gifts that are treated as adjusted taxable gifts and not included in the donor’s gross estate (or ‘adjusted taxable gifts’) while the second transfer consists of completed gifts that are treated as testamentary transfers and included in the donor’s gross estate (or ‘includible gifts’). The IRS and Treasury perceived a potential for abuse in not differentiating between these types of transfers, and in response they released the current proposed regulations.
The proposed regulations describe includible gifts as follows:
These type of transfers include, but are not limited to, the following:
Observation: As a result of the lack of differentiation between adjusted taxable gifts and includible gifts, an individual could make transfers in a way that would allow for the increased basic exclusion amount at the time of the gift to be available against the decedent’s estate tax. This could be the case despite the fact that the individual could retain the beneficial use of or the control of the transferred property. It was this potential abuse that the IRS sought to close with the new proposed regulation.
The proposed regulation states that the anti-clawback rule would not apply to transfers that are includible in the gross estate, or treated as includible in the gross estate for purposes of IRC section 2001(b). These transfers include the aforementioned includible gifts.
Furthermore, the exception would still be applicable to transfers that would have been classified as includible gifts, if not for the transfer, relinquishment, or elimination of an interest, power, or property, effectuated within 18 months of the decedent’s date of death by the decedent alone, by the decedent and any other person, or by any other person.
Under the proposed regulations, the anti-clawback rule would continue to apply to the following transfers:
Observation: This proposed exception to the anti-clawback rule should not affect completed gifts that are out of the taxpayer’s estate ‒ i.e., standard defective grantor trusts and other estate planning techniques. It could affect failed Qualified Personal Residence Trusts and other situations where the exemption at the time of the gift was higher than the exemption at the time of death, and the gift/transfer is pulled back into the taxpayer’s estate.
Personal Financial Services Leader, PwC US
Partner, PwC US
Irene C. Estrada
Managing Director, Private Company Services, PwC US