Proposed Regs Address TCJA Increase to Basic Exclusion Amount for Estate and Gift Tax

(Parker Tax Publishing May 2022)

The IRS issued proposed regulations relating the effect of the increase to the basic exclusion amount (BEA) enacted by the Tax Cuts and Jobs Act of 2017 for years 2018-2025 and the special rule in Reg. Sec. 20.2010-1(c) which ensures that the estate of a donor is not taxed on completed gifts that, as a result of the increased BEA, were free of gift tax when made if the donor's death occurs after a reduction in the BEA. In keeping with the statutory distinction between completed gifts that are treated as adjusted taxable gifts and completed gifts that are treated as testamentary transfers, the proposed regulations generally deny the benefit of the special rule to gifts that are included in the donor's gross estate. REG-118913-21.

Background

The Tax Cuts and Jobs Act (Pub. L. 115-97) (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) applicable to the computation of federal estate and gift taxes is increased by $5 million to $10 million as adjusted for inflation (increased BEA). Under the TCJA, on January 1, 2026, the BEA will revert to $5 million as adjusted for inflation. The TCJA also added new Code Sec. 2001(g)(2), which authorizes the IRS to issue regulations that carry out Code Sec. 2001 and address any difference between the BEA applicable at the time of a decedent's death and the BEA applicable with respect to any gifts made by the decedent.

In 2019, the IRS published final regulations (T.D. 9884) to address situations described in Code Sec. 2001(g)(2) (final regulations). The final regulations adopted Reg. Sec. 20.2010-1(c), a special rule (special rule) applicable in cases where the credit against the estate tax that is attributable to the BEA is less at the date of death than the sum of the credits attributable to the BEA allowable in computing the gift tax payable within the meaning of Code Sec. 2001(b)(2) with regard to the decedent's lifetime gifts. In such cases, the portion of the credit against the net tentative estate tax that is attributable to the BEA is based on the sum of the credits attributable to the BEA allowable in computing gift tax payable regarding the decedent's lifetime gifts. The rule ensures that the estate of a donor is not taxed on completed gifts that, as a result of the increased BEA, were free of gift tax when made.

The special rule currently does not distinguish between: (1) completed gifts that are treated as adjusted taxable gifts for estate tax purposes and that, by definition, are not included in the donor's gross estate; and (2) completed gifts that are treated as testamentary transfers for estate tax purposes and are included in the donor's gross estate (includible gifts). The Code and the regulations, however, do distinguish between these two types of transfers. Code Sec. 2001(b) excludes from the term "adjusted taxable gifts" gifts that are includible in the gross estate. Code Sec. 2701(e)(6) and Reg. Sec. 25.2701-5 similarly remove from adjusted taxable gifts those transfers includible in the gross estate that previously were subject to the special valuation rules of Code Sec. 2701.

The preamble to the final regulations stated that further consideration would be given to the issue of whether transfers made during the increased BEA period that are not true inter vivos transfers, but rather are includible in the gross estate (e.g., transfers subject to a retained life estate or other retained powers or interests), should be excepted from the special rule. As was noted in the preamble, the purpose of the special rule is to ensure that bona fide inter vivos transfers are not subject to inconsistent treatment for estate tax purposes and, arguably, the possibility of inconsistent treatment does not arise with regard to transfers that are treated as part of the gross estate for estate tax purposes, rather than as adjusted taxable gifts.

Proposed Regulations

On April 27, the IRS published proposed regulations (REG-118913-21) relating to the BEA that, in keeping with the statutory distinction between completed gifts that are treated as adjusted taxable gifts and completed gifts that are treated as testamentary transfers, generally deny the benefit of the special rule in Reg. Sec. 20.2010-1(c) to gifts includible in an estate. Specifically, the proposed regulations add Prop. Reg. Sec. 20.2010-1(c)(3) to provide an exception to the special rule for transfers that are includible in the gross estate or are treated as includible in the gross estate.

Such transfers include, for example:

(1) gifts subject to a retained life estate or subject to other powers or interests as described in Code Sec. 2035 through Code Sec. 2038 and Code Sec. 2042, regardless of whether the transfer was deductible under Code Secs. 2522 or 2523;

(2) gifts made by enforceable promise to the extent they remain unsatisfied as of the date of death;

(3) other amounts that are duplicated in the transfer tax base, including a Code Sec. 2701 interest within the meaning of Reg. Sec. 25.2701-5(a)(4) and a Code Sec. 2702 interest within the meaning of Reg. Sec. 25.2702-6(a)(1); and

(4) transfers that would be described in items (1) through (3) above but for the transfer, elimination, or relinquishment within 18 months of the donor's date of death of the interest or power that would have caused inclusion in the gross estate, effectively allowing the donor to retain the enjoyment of the property for life.

The proposed regulations also provide a de minimis rule under which the special rule in Reg. Sec. 20.2010-1(c) continues to apply to transfers includible in the gross estate when the taxable amount of the gift is not material - that is, the taxable amount is 5 percent or less of the total amount of the transfer, valued as of the date of the transfer.

Example: When the BEA was $11.4 million, Albert gratuitously transferred his enforceable $9 million promissory note to his child. The transfer constituted a completed gift of $9 million. On Albert's death, the assets that are to be used to satisfy the note are part of his gross estate, with the result that the note is treated as includible in the gross estate. Thus, the $9 million gift is excluded from adjusted taxable gifts in computing the tentative estate tax under Code Sec. 2001(b)(1). Nonetheless, if Albert dies after a statutory reduction in the BEA to $6.8 million, Prop. Reg. Sec. 20.2010-1(c)(3) provides that the credit to be applied in computing the estate tax is the credit based on the $6.8 million of the BEA allowable as of the date of Albert's death.

Example: Assume the same facts as in the above example, except Albert's promissory note has a value of $2 million and, on the same date that Albert made the gift of the promissory note, he also made a gift of $9 million in cash. The cash gift was paid immediately, whereas the $2 million note remained unpaid as of the date of Albert's death. The assets that are to be used to satisfy the note are part of Albert's gross estate, with the result that the note is treated as includible in the gross estate and is not included in Albert's adjusted taxable gifts. Because the $2 million note is treated as includible in the gross estate and does not qualify for the 5 percent de minimis rule, Prop. Reg. Sec. 20.2010-1(c)(3) applies to the gift of the note. On the other hand, the $9 million cash gift was paid immediately, and no portion of that gift is includible or treated as includible in the gross estate. Because the amount allowable as a credit in computing the gift tax payable on Albert's $9 million cash gift exceeds the credit based on the $6.8 million BEA allowable on Albert's date of death, the special rule of Reg. Sec. 20.2010-1(c) applies to that gift. The credit to be applied for purposes of computing Albert's estate tax is based on a BEA of $9 million, the amount used to determine the credit allowable in computing the gift tax payable on Albert's $9 million cash gift.

Applicability Date

The proposed regulations provide that, once they have been published as final regulations, they will apply to the estates of decedents dying on or after April 27, 2022. The IRS noted that the special rule will not be needed until the BEA has been decreased by statute; under current law, that is scheduled to occur for the estates of decedents dying after 2025. However, the IRS said that if such a decrease is enacted on or after April 27, 2022, but before the issuance of final regulations, the best way to ensure that all estates will be subject to the same rules is to make this proposed exception to the special rule applicable to the estates of decedents dying on or after April 27, 2022.

For a discussion of the special rule in Reg. Sec. 20.2010-1(c), see Parker Tax ¶221,110.

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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