Because of the recent tax law changes, there is an interesting proposal on the table that will be voted on in March of 2019. It is expected to pass with little opposition. If it does pass, there will be some interesting “opportunities” for people between now and 2026. This is the window where you will be able to take advantage of the “Clawback” opportunity.
Let’s investigate and analyze this a bit further so you can see if it will apply to you or someone in your family. Here are the “legal basics” we have in place today.
Where We Are Today...
First, each person has a permanent exclusion amount of $5 million, which they can give during life or at death, which is adjusted for inflation. The Tax Cuts and Jobs Act doubled that exclusion for years 2018 through 2025. This means that in 2018, adjusted for inflation, the exclusion was temporarily doubled to be $11.18 million. NOTE: In Washington, Oregon and many other states, there is also an inheritance tax that is separate and additional to the US Estate tax…this discussion does not address the STATE estate tax.
Shortly after passage of the Tax Cuts and Jobs Act, questions began arising regarding hypothetical taxpayers who might utilize the “doubled U.S. estate tax exclusion” during their lifetimes. Where this became a hot topic for discussion was if they passed away in 2026 or later when the exclusion reverts back to the standard $5 million (or possibly a lower amount), adjusted for inflation. How would this be treated under the new Tax Act?
In other words, will people under this scenario have “two bites at the apple” as some have called it? This is a very legitimate (and impactful) question since prior taxable gifts ordinarily are included when determining the estate tax and then the exclusion is applied. Let’s look at how this could affect you personally with an example.
An Example to Clarify How This Can Affect You
Mary owns $14.18 million in assets…her net worth. She decides to give away $11.18 million of those assets in 2018, the maximum she is allowed under the new Tax Act. She believes she should use the entire increased gift exemption amount under the new law so she can maximize her benefits. If she does, she will be able to live comfortably on her interest income from the $3 million. This, combined with social security and a pension, would be enough to pay her living expenses after the gift. By giving her assets away in 2018 she wouldn’t owe any gift tax with the $11.18 million exclusion in 2018.
If we assume Mary then dies in 2026 (or any time after the tax law reverts back to the $5 million exclusion and is adjusted by inflation to $6 million) she will still have her $3 million in assets at the time of her death in 2026 and beyond. However, she still has to account for the prior taxable gifts of $11.18 million. So her “grossed up” estate would still be $14.18 million.
Here's the Critical Question...
Will Mary owe tax on the amount above the “exclusion in effect” at her death, which would be $8.18 million ($14.8 million minus inflation adjusted $6 million for the new exclusion that took effect after 2026)? If this is the case, then her estate would owe 40% tax on the amount above $6 million, which would be $8.18 million. The tax on that amount would total over $3 million! This is a sizeable amount of taxes and would be taken up entirely by the $3 million remaining in her estate after giving away her $11.18 million earlier.
Here's Some Good News...
The Treasury Department and the IRS have just issued Proposed Regulations which addresses this so-called “clawback” issue. Those regulations provide that there will not be a tax on assets that were gifted when the exclusion covered the gift. This is great news for Mary.
In Mary’s situation, she wouldn’t owe tax on the amount she had already gifted and only owe taxes on the remaining exclusion. In this case she would only owe tax on the $3 million remaining in her estate, or $1.2 million. This would allow Mary to leave $1.8 million to her surviving beneficiaries rather than having that amount be used to cover the taxes that would be charged on her entire estate.
The Bottom Line...
The Proposed Regulations are quite favorable to the taxpayer. There will be a public hearing on these Proposed Regulations at the IRS building in Washington, DC, on March 13, 2019. It’s doubtful there will be many in opposition to this ruling so it is expected to pass. If the Proposed Regulations are finalized, this will confirm the benefit for higher net worth taxpayers to utilize the doubled exclusion for gifts prior to the sunset at the end of 2025.
It is important to examine your own situation and see how this may change your decisions between now and 2026. For some, like Mary, it could mean the difference between leaving your loved ones a nice nest egg instead of paying it all to the government in taxes. If you don’t have an estate attorney, give me a call and I can give you some insights into your situation. Or you can schedule a meeting and we can dive into your personal situation in detail and get you some concrete answers and solutions. Either way, I don’t want you to miss out on this opportunity to lower your taxes and give more to your loved ones. If you do, I can guarantee you and your loved ones will have NO.MORE.TEARS.