IRS Raises Impetus to Make Gifts Now With Proposed Regulations Protecting Gifts From Double Tax

by Brent W. Nelson and Rachel M. Sass

On November 23, 2018, the Internal Revenue Service (“IRS”) proposed new regulations that prevent individuals who make a gift of more than $5,000,000 before 2026 from being double taxed on those gifts if they die after 2026.¹ The Tax Cuts and Jobs Act (“TCJA”) increased the federal gift and estate tax exclusion from $5,000,000 per individual (indexed for inflation) to $10,000,000 per individual (indexed for inflation) (the “Exclusion Amount”), plus any excess exclusion amount an individual may have from a deceased spouse (so called “DSUEA” or “portability”). The current inflation adjusted Exclusion Amount is $11,180,000 per individual or $22,360,000 for married couples. The Exclusion Amount allows individuals to avoid paying any immediate gift tax on gifts made during their lifetime that exceed the annual exclusion amount ($15,000 per donee in 2018). Instead, gifts in excess of the annual exclusion amount will reduce the individual’s Exclusion Amount. 

The increased Exclusion Amount, however, sunsets in 2026, when it reverts back to its pre-2018 $5,000,000 level. Some practitioners had argued that if a person made a gift of the extra Exclusion Amount granted under the TCJA before 2026, and then died after 2026, due to the way the federal estate tax is calculated, the extra gift could be subject to estate tax. If that were the case, the extra gift would effectively be subjected to double taxation (i.e. subject to gift tax during life and then estate tax at death).  

The IRS has now addressed that issue in its recent proposed regulations by ensuring the individual dying in 2026 or beyond is not double taxed on their prior gifts. This proposed change would close the loop on uncertainty that remained under the TCJA. It has implications for individuals in three categories: (1) those with a net worth above the current Exclusion Amount (“Ultra High Net Worth Individuals”), (2) those with a net worth between the current and pre-2018 Exclusion Amount (“High Net Worth Individuals”), and (3) those with a net worth below the pre-2018 Exclusion Amount (“Ordinary Individuals”).

Ultra High Net Worth Individuals

Ultra High Net Worth Individuals and families should consider making use of the additional Exclusion Amount now as there is little upside to waiting to make these gifts. Gifting now ensures that the individual can make use of the extra Exclusion Amount (before it is gone) and that future appreciation, including appreciation occurring before 2026, is also going to be excluded from federal estate tax at their death. Although the Exclusion Amount is indexed for inflation, the investment performance of the individual’s assets may outpace inflation, meaning that retaining the asset and gifting it in the future may require more of the individual’s Exclusion Amount to shelter the gift from gift tax than it would have taken had the individual immediately made the gift. In addition, uncertainty over the future composition of the federal legislative and executive branches means there is no guarantee the extra Exclusion Amount will still be available through 2026, or that if it is revoked in the future, taxpayers will be granted enough warning to plan for its revocation. As a reminder, the TCJA was passed on December 22, 2017, and some provisions taking effect that year had retroactive elements that made planning difficult or impossible. The bottom line is Ultra High Net Worth Individuals are likely better off not waiting until closer to 2026 to act.  

Ultra High Net Worth Individuals and families should consider making these gifts into trusts that would be federal estate and generation-skipping transfer tax exempt for their families and also offer creditor protection. They should discuss their goals and family circumstances to create a plan that maximizes the tax savings offered in the extra Exclusion Amount, as well as advancing their vision of how to manage their family wealth for future generations. This includes careful consideration for how the extra Exclusion Amount can be used to structure family businesses that may undergo a change of control as principal owners retire or die before 2026.

High Net Worth Individuals

High Net Worth Individuals and families should also consider whether they would be best served to plan as though they will survive until 2026. In that instance, their estate plans need to be updated to include additional flexibility to take into account widely different estate tax results that could occur if they died before 2026 or after 2025. They may also consider whether their assets are likely to grow in excess of their available Exclusion Amounts. Even if gift or estate tax is not a concern, High Net Worth Individuals and families should consider whether to take advantage of income tax planning, such as planning for income tax basis in appreciated assets, the benefits of the 20 percent pass-through income deduction (created under the TCJA), and charitable planning. They may also want to focus on adjusting their estate plans to take advantage of financial management and creditor protection for future generations.

Ordinary Individuals

Ordinary Individuals and families, who may still have significant wealth relative to the country and world at large, may not have gift or estate tax concerns, but they should still take a fresh look at their estate plans. They may be better served to strip out estate tax specific planning and focus more on income tax planning, creditor protection, and incapacity planning—all of which can still provide significant tax and wealth management benefits.