Estate Tax "claw-back" concern could become "use it or lose it."

On November 20, 2018, the IRS issued proposed regulations on the estate and gift tax. A little back-story will help explain why these proposed regulations are big news. The estate and gift taxes do not affect most people at the current exemption levels, but you aren’t the only who is worried about it. You and others you know will still more than likely need estate planning, so you can to the bottom of this post. For those curious about what’s going on, let’s dive in.

The estate and gift taxes are long-time boogeymen in estate planning. Twenty years ago, they were much more prominent in the planning landscape because the exemptions were in the $600,000 range per person. If you were a middle-class American with a nice home and a decent retirement account giving you more than $600,000 to your name, you were potentially subject to the estate tax on the assets above that exemption amount you owned at your death. If you chose to gift away your assets before death, you still don’t escape the tax: your large gifts are counted in determining whether your total estate (gifts plus assets kept) exceeds the exemption amount.

With the tax rate at 55% (in the 90s) for those assets over the exemption, it made for quite the incentive to do your estate planning. Since then there’ve been some big jumps in the exemption amounts (and the rate has been lowered to 40%). The most recent change took the exemption from $5,000,000 per person to $10,000,000 per person, with those numbers to be adjusted for inflation each year (the $10,000,000 is adjusted to $11,400,000 for 2019).

However, the $10,000,000 exemption hike is only temporary and is scheduled to revert to the $5,000,000 mark on January 1, 2026. This potential drop in the exemption has caused concern among the estate planners for clients with estates above the $5,000,000 mark because it raises the question of what will happen if you make gifts while the exemption is high, but then die after the exemption is lowered? While the exemption is high, a taxpayer could make a gift and pay no gift taxes because he or she hadn’t used up the exemption amount. But if the exemption drops before death and the total estate (gifts plus assets kept) exceeds the lower exemption, is the formerly tax-free gift going to cause an estate tax at death? This “claw-back,” or taxing of formerly tax-free gifts, caused quite a bit of controversy and cries of unfairness in the law.

The November 20 proposed regulation will put an end to the controversy, which is why it is big news. The IRS’s proposed regulation eliminates the claw-back possibility but also makes clear that if you don’t use the exemption while it exists, you can’t try to claim it when the exemption drops. In shorter terms, the IRS is saying, “use it or lose it.”

While this news will not affect more than 99% of the US population, the concerns about the estate and gift taxes are a frequent topic. If the estate tax rules concern you, please drop me a line so we can discuss your options. If you know someone who is worried about the gift or estate taxes and doesn’t know how much they can pass tax-free, share this with your friend! Send them a link to Trailheadep.com, and ask that person to get in touch (They most likely need planning for a different reason, but this may be a good starting point for a discussion). Finally, if you want to get more granular about the estate tax calculations and how this proposed regulation affects the tax, click here.

See you on the trail.

Post by Peter Harrison