Background: The basic exclusion amount is an amount an individual can transfer, during life or at death, free of federal gift and estate tax. The Tax Cuts and Jobs Act doubled the basic exclusion amount (before taking into account inflation adjustments) from $5 million in 2017 to $10 million for 2018 to 2025. After 2025, the basic exclusion amount is scheduled to drop by about one-half to $5 million (indexed for inflation). This has raised a question that some people have been asking: If a person makes large taxable gifts using the increased basic exclusion amount during 2018 to 2025 and dies after 2025, will the person be penalized if the basic exclusion amount used during his or her life is greater than the lower basic exclusion amount available at death?
The IRS has released proposed regulations addressing recent changes to the basic exclusion amount. The proposed regulations, when finalized, would ensure that an individual who made taxable gifts using the increased basic exclusion amount during 2018 to 2025 would not be penalized if he or she died after 2025 when the basic exclusion amount is lower.
Note: To simplify the discussion, the basic exclusion amounts shown here are the base amounts prior to indexing for inflation. The basic exclusion amount, adjusted for inflation, is $11.18 million in 2018 and $11.4 million in 2019. (It was $5,490,000 in 2017.)
For example, assume an individual made a taxable gift of $10 million in 2018, when the basic exclusion amount was $10 million, and dies in 2026 with no taxable estate, when the basic exclusion amount is $5 million. Based on a literal interpretation of the statute, estate tax would be $2 million.
The gift tax payable on adjusted taxable gifts has been calculated using the $10 million basic exclusion amount in 2018. However the unified credit at death has been calculated using the $5 million basic exclusion amount available in 2026. The $2 million estate tax can be viewed as about a 40% tax on $5 million of adjusted taxable gifts that were originally protected by a higher basic exclusion amount when the gifts were made.
The proposed regulations would fix this by allowing the basic exclusion amount used to calculate the unified credit at death to equal the greater of (a) the sum of the basic exclusion amounts used in calculating the gift tax payable on the adjusted taxable gifts ($10 million) or (b) the basic exclusion amount at death ($5 million). Estate tax would then be equal to $0.
The proposed regulations should be effective on and after the date the regulations are made final.
First Bank & Trust as well as Broadridge Investor Communication Solutions, Inc. does not provide tax, or legal advice. The information presented here is not specific to any individual’s personal circumstances.
To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances.
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Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2018.