Proposed Regulations Take Aim at Estate and Gift Basic Exclusion

Written by Dalton Bradshaw, CPA

In 2017, the passage of the Tax Cuts and Jobs Act (TCJA) brought about numerous provisions aimed at benefiting taxpayers, including within the estate and gift tax arena. Most notably, the TCJA provided for the basic exclusion amount (BEA) for estates and lifetime gifts to increase to $10 million from $5 million, adjusted for inflation. Although the TCJA has brought significant tax savings to many estates since its passing, the benefits will be short-lived as the increased exclusion is set to expire and revert to pre-TCJA levels on January 1, 2026, sometimes referred to as the “sunset.”

The sunset on the BEA has presented an unprecedented situation for estate planners.  This scheduled reduction in the BEA will be the first reduction since the passage of the Tax Reform Act of 1976, which created the current unified estate and gift tax framework. Since the enactment of the TCJA, advisors have grappled with planning estates with lifetime gifts in excess of the reduced BEA, for fear of these gifts being pulled back into a decedent’s taxable estate if they die after the sunset, referred to as the “clawback.”

The IRS attempted to dispel this confusion, in part, in 2019 when final regulations were passed which ensured gifts that utilized the temporarily increased BEA would not be “clawed back” into the estate of a decedent that is subject to a reduced BEA (deaths after December 31, 2025). While these regulations provided assurance that true completed inter vivos (during lifetime) gifts would be shielded from a clawback scenario, they did not address the reduced BEA’s implications on special rule gifts (gifts made during the lifetime but included in a decedent’s estate).

On April 26, 2022, nearly three years after the initial regulations had been finalized, the IRS issued proposed regulations (REG-118913-21) that provided an exception to the 2019 regulations for special rule gifts. The proposed regulations specifically address the following special rule gifts:

• Gifts within three years of death (§2035)
• Life estate (§2036)
• Certain transfers effectuated at death (§2037)
• Revocable transfers (§2038)
• Certain life insurance proceeds (§2042)
• Gifts made by enforceable promise
• Freeze partnerships (§2701)
• GRATs, GRUTs, and QPRTs (§2702)
• Transfers that would have been described in the preceding bullet points but for the transfer, relinquishment, or elimination of an interest, power, or property, effectuated within 18 months of the date of the decedent’s death

The special rule from 2019 would continue to apply, and be exempt from the clawback, to transfers whose taxable amount is five percent or less of the total amount of the transfer, valued on the date of transfer. These exceptions to the special rule have been proposed in response to a perceived abuse of the 2019 regulations in which a taxpayer would be able to give away property for estate and gift tax purposes but retain the right to use them (incomplete gift).

Additionally, there is no mention in the proposed regulations of clawing back any portion of a deceased spouse’s unused exclusion (DSUE) that was ported to his/her surviving spouse during the increased BEA period.

The proposed regulations would apply to the estates of decedents dying on or after the date that the regulations are published as final. We will continue to monitor developments surrounding these proposed regulations and communicate any updates as they occur. Although the application of these proposed regulations to detailed, alternative scenarios is beyond the scope of this article, please contact your trusted BMSS advisor if you have any questions or would like to discuss how these proposed regulations may affect your estate plan at (833) CPA-BMSS.