As we discussed in several prior Newsletters, the 2017 Tax Act temporarily doubled the exemption from the Estate and Gift Taxes, known as the Basic Exclusion Amount (BEA). Each person is given a BEA equal to $5 million indexed for inflation, and this BEA was temporarily doubled by the 2017 Tax Act to $10 million indexed for inflation until the end of 2025. The BEA in 2022, as indexed for inflation, is $12,060,000.

In our November 2020 Newsletter, we discussed the best ways to utilize the temporarily doubled BEA before it is reduced either by new legislation or by the end of 2025. This was and remains important for wealthier individuals and married couples who may end up with a potentially significant Estate Tax liability at death. At the end of our November 2020 Newsletter, we also discussed two important considerations before undertaking any such Gift Tax planning strategies. Of key importance was the possibility of future IRS “anti-abuse” Regulations.

On April 27, 2022, the IRS issued such “anti-abuse” clawback Proposed Regulations. The purpose of this Newsletter is to discuss the issue, the initial “anti-clawback” Regulations, and the new “anti-abuse” clawback Proposed Regulations.

A. Issue.

Does a taxable gift made to take advantage of a currently higher BEA amount lock in this higher BEA for Estate Tax purposes at your death even if the BEA is lower at that time?

B. “Anti-Clawback” Regulations.

On November 26, 2019, the IRS issued taxpayer friendly, “anti-clawback” Regulations that gave taxpayers assurance that their current use of the higher BEA would effectively lock in this higher BEA amount (to the extent it was used with taxable gifts) for Estate Tax purposes. However, as we discussed in our November 2020 Newsletter, they stated that they may issue further rules to prevent a perceived abuse where a transfer was made to technically create a taxable gift, but which was structured to cause Estate Tax inclusion at death. This structure was presumably a perceived abuse since it enabled taxpayers to lock in the temporary portion of the BEA without really giving up too much as to the control and access to their gifted property.

C. New “Anti-abuse” Clawback Proposed Regulations.

As of April 27, 2022, the new IRS Proposed Regulations generally provide that transfers which are taxable gifts, but which will be included in the taxable estate for Estate tax purposes will not lock in the use of the temporary portion of the BEA. These Proposed Regulations also provided that the creative strategy discussed in our prior Newsletter of gifting an IOU (promissory note) in return for “good” but not “valuable” consideration would likewise not lock in the temporary portion of the BEA.

Based on these new Proposed Regulations, the taxable gifting strategies discussed in Paragraph G of our November 2020 Newsletter that should no longer be undertaken include:

4: Gift “naked Note” to grantor trust.

5: Utilize a defective IRS Section 2701 preferred partnership or defective IRC Section 2702 Grantor retained annuity or income trust.

6: Utilize an E-GRIT.

7: Trigger IRC Section 2519 with an existing QTIP trust.

D. Important miscellaneous comments.

1. These new “anti-abuse” Regulations are Proposed.

The IRS will follow Proposed Regulations, but taxpayers are not required to do so by law. However, it would be risky to ignore these Regulations since they will likely get finalized substantially in their current form at some point in the future. The Proposed Regulations state that they are to be effective as soon as they are finalized retroactively to their publication date of April 27, 2022.

2. These types of taxable gifts can still be used when utilizing the permanent portion of the BEA.

Since these Regulations only apply to disallow the locking in of the temporary portion of the BEA, they do not prevent taxpayers from making taxable gifts to utilize the permanent portion of the BEA. This would include the $5 million indexed for inflation (assuming Congress does not later lower the permanent BEA) amount and, for married couples, the deceased spouse’s unused exemption (DSUE) amount where a portability election was made after the first spouse’s death.

3. These “anti-abuse” clawback Proposed Regulations include two exceptions.

1. 1. Taxable gift portion of the transfer is 5% or less.
      This is a de minimis rule exception. The types of transfers at issue under the Proposed Regulations are structured to maximize the amount of the taxable gift.
   2. The completed gifting transfer is effectively modified thereafter to avoid Estate tax inclusion at least 18 months before date of death.

This exception permits the correcting of a transfer to lock in the temporary portion of the BEA if the cause of the likely Estate Tax inclusion is removed at least 18 months before date of death. For example, an outstanding loan can be fully paid off, or retained powers over or access to assets in trust can be eliminated. Of course, care must be taken in this regard since this will likely significantly limit or eliminate any further access to or control over the transferred assets. The tax implications of taking such actions must also be considered.

4. Previous taxable gift still permanently uses BEA even if the Proposed Regulations prevent locking in temporary portion of BEA.

As was discussed in our November 2020 Newsletter, one potentially significant downside of using one of the more creative taxable gifting strategies is the opportunity cost if the IRS later decides that the type of taxable gifting transfer completed was ineffective in locking in the temporary portion of your BEA. In other words, you will not be able to use the already used BEA for any other purpose even though its prior use provided you with no effective Estate Tax benefit.

If you would like to learn more about this important and timely topic, please call our offices at (678) 720-0750 or e-mail us at info@morgandisalvo.com to schedule an estate planning consultation to discuss your particular situation.