How to Avoid the Estate Tax Clawback

How to Avoid the Estate Tax Clawback

Regulations proposed in 2018 (but not yet finalized) stipulate that individuals who make large gifts in 2018 through 2025 and benefit from the historically generous unified federal estate and gift tax exemptions for those years will not be penalized if the exemptions revert to the pre-TCJA amounts after 2025.

Under the proposal, a decedent’s federal estate tax exemption would be the greater of:

  • The TCJA exemption amount that was used to shelter earlier gifts, or
  • The exemption amount that’s allowed in the post-TCJA year of death.

For example, let’s suppose that in 2019, when the unified federal estate and gift tax exemption is $11.4 million, Andy makes $9 million of taxable gifts. (These gifts are in excess of the $15,000 per donee annual gift tax exclusion for 2019.)

When Andy passes away in 2026, assume the unified exemption is only $6 million, and he leaves a $4 million estate. What federal estate tax liability does Andy leave behind?

To calculate the tax liability for Andy’s estate, the $9 million of taxable gifts made in 2019 is added back to his $4 million date-of-death estate, resulting in a gross estate of $13 million.

According to the proposed regulations, the estate tax liability would be calculated using a $9 million unified exemption. His estate would owe federal estate tax on $4 million ($13 million – $9 million). So, the $9 million of taxable gifts made while the $11.4 million unified exemption was in place under the TCJA wouldn’t increase the 2026 federal estate tax liability of the estate.

What would have happened if Andy had given away $11.4 million in 2019 instead? Under this scenario, his remaining estate in 2026 would be only $1.6 million ($13 million – $11.4 million).

To calculate the 2026 federal estate tax liability for the estate, the $11.4 million of taxable gifts made in 2019 is added back to Andy’s $1.6 million date-of-death estate, resulting in a gross estate of $13 million.

According to the proposed regulations, the estate tax liability would be calculated using an $11.4 million unified exemption. His estate would owe federal estate tax on $1.6 million ($13 million – $11.4 million). So, the $11.4 million of taxable gifts made while the $11.4 million unified exemption was in place wouldn’t increase the 2026 federal estate tax liability of the estate.

The first situation is good news for high-net-worth individuals. But the second scenario produces even better results for Andy’s estate.

Questions? Contact Brady Ware’s Estate Planning experts.

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