Final Estate Regs Address Application of Increased TCJA Basic Exclusion Amount

(Parker Tax Publishing December 2019)

The IRS issued final regulations under Code Sec. 2010(c)(3) adopting a special rule in cases where the portion of the credit against the estate tax that is based on the basic exclusion amount (BEA) is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable under Code Sec. 2001(b)(2). The final regulations provide that the portion of the credit against the net tentative estate tax that is attributable to the BEA is based on the greater of those two amounts in order to ensure that the estate of a decedent is not inappropriately taxed with respect to gifts that were sheltered from gift tax by the increased BEA under the Tax Cuts and Jobs Act of 2017. T.D. 9884.

Background

The Tax Cuts and Jobs Act of 2017 (TCJA) amended Code Sec. 2010(c)(3) to provide that, for decedents dying and gifts made after December 31, 2017, and before January 1, 2026, the basic exclusion amount (BEA) is increased by $5 million to $10 million, as adjusted for inflation (increased BEA). On January 1, 2026, the BEA will revert to $5 million.

In computing the amount of federal gift tax to be paid on a gift or the amount of federal estate tax to be paid at death, the gift and estate tax provisions apply a unified rate schedule to the taxpayer's cumulative taxable gifts and taxable estate on death to arrive at a net tentative tax. The net tentative tax then is reduced by a credit based on the applicable exclusion amount (AEA), which is the sum of (1) the basic exclusion amount (BEA) under Code Sec. 2010(c)(3) and, if applicable, (2) the deceased spousal unused exclusion (DSUE) amount under Code Sec. 2010(c)(4). The credit is applied first against the gift tax, on a cumulative basis, as taxable gifts are made. To the extent that any credit remains at death, it is applied against the estate tax.

When the BEA was temporarily increased under TCJA, questions arose regarding a potential for inconsistent tax treatment or double taxation of transfers. Specifically, practitioners wondered whether, for estate tax purposes, a gift made during the increased BEA period that was sheltered from gift tax by the increased BEA would inflate a post-2025 estate tax liability. This would be the case if the estate tax computation failed to treat such gifts as sheltered from gift tax, in effect reversing the benefit of the increased BEA available for those gifts. This issue would arise in the case of estates of decedents who both made gifts during the increased BEA period that were sheltered from gift tax by the increased BEA in effect during those years, and die after 2025. The concern was that the estate tax computation would treat the gifts made during the increased BEA period as post-1976 taxable gifts not sheltered from gift tax by the credit on the BEA, given that the post-2025 estate tax computation is based on the BEA in effect at the decedent's death rather than the BEA in effect on the date of the gifts.

Proposed Regulations

In 2018, the IRS issued proposed regulations (REG-106706-18) providing a special rule to prevent individuals who take advantage of the increased BEA in effect from 2018 to 2025 from being adversely impacted after 2025 when the BEA is scheduled to drop to pre-2018 levels. The proposed regulations provided a special rule in cases where the portion of the credit as of the decedent's date of death that is based on the BEA is less than the sum of the credit amounts attributable to the BEA allowable in computing gift tax payable within the meaning of Code Sec. 2001(b)(2). In that case, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based upon the greater of those two credit amounts. The proposed regulations required the determination of a credit equal to the tentative tax on the AEA as in effect on the date of the decedent's death, where the BEA included in that AEA is the larger of (1) the BEA as in effect on the date of the decedent's death under Code Sec. 2010(c)(3), or (2) the total amount of the BEA allowable in determining the gift tax payable.

Thus, for example, if a decedent had made cumulative post-1976 taxable gifts of $9 million, all of which were sheltered from gift tax by a BEA of $10 million applicable on the dates of the gifts, and if the decedent died after 2025 when the BEA was $5 million, under the proposed regulations the credit to be applied in computing the estate tax would be based on the $9 million of BEA that was used to compute the gift tax payable.

Final Regulations

In November 2019, the IRS issued final regulations in T.D. 9884 adopting the special rule in the proposed regulations, with certain clarifications and additional examples in response to practitioners' comments.

First, the final regulations clarify the effect of annual inflation adjustments to the BEA by including examples that reflect hypothetical inflation-adjusted BEA amounts. The IRS also made clear that the increased BEA is a "use or lose" benefit and is available to a decedent who survives the increased BEA period only to the extent the decedent "used" it by making gifts during the increased BEA period. Thus, the final regulations include an example to demonstrate that the application of the special rule is based on gifts actually made, and does not apply to a decedent who did not make gifts in excess of the date of death BEA as adjusted for inflation. In addition, the final regulations confirm that a decedent dying after 2025 will not benefit from post-2025 inflation adjustments to the BEA to the extent the decedent made gifts in an amount sufficient to cause the total BEA allowable in the computation of gift tax payable to exceed the date of death BEA as adjusted for inflation.

With respect to the calculation of the DSUE, the final regulations include examples confirming that even if the amount of BEA that is allowable under Code Sec. 2010(c)(3) decreases after 2025, a DSUE amount elected during the increased BEA period will not be reduced as a result of the sunset of the increased BEA. In addition, the IRS explained that it received several questions concerning the calculation of the credit amount solely attributable to the BEA in computing gift tax payable where the AEA upon which the credits are based consists of amounts other than the BEA. In response, the final regulations clarify how to determine the extent to which a credit allowable in computing gift tax payable is based solely on the BEA.

Finally, the IRS addressed comments suggesting that the proposed regulations exceeded the authority granted by Congress. These comments suggested that the special rule would violate the reconciliation rules under which the TCJA was passed because it would increase the impact of the deficit beyond 2025, and therefore could not have been what Congress intended when it granted regulatory authority to the IRS. The IRS disagreed and reasoned that Code Sec. 2001(g) addresses the effect of changes in tax rates and exclusion amounts on the computation of the estate tax and that the plain language of Code Sec. 2001(g)(2) addresses circumstances that can occur only after December 31, 2025.

For a discussion of the calculation of the basic exclusion amount, see Parker Tax ¶227,201.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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