It has been just over a year since Public Law 115-97, more informally known as the “Tax Cuts and Jobs Act” (“TCJA”), was enacted. With it came sweeping changes to our tax code, but it also left many issues for the regulators to resolve. One open item related to the potential for the so‑called “clawback” of the TCJA’s increased exclusion from the gift and estate tax. Taxpayers can take comfort that the Treasury Department issued proposed regulations in November under Internal Revenue Code § 2010 (the “Anti-Clawback Regulations”).
The TCJA doubled the “Basic Exclusion Amount” or “BEA” from $5 million to $10 million per taxpayer. The BEA is effectively the amount any taxpayer can transfer free of gift and estate tax to his or her beneficiaries (with the excess taxed at a current rate of 40 percent) and is adjusted for inflation from calendar year 2010. In 2019, the BEA is $11.4 million per taxpayer ($22.8 million for married couples). However, the provision doubling the BEA sunsets at the end of 2025, meaning the BEA is scheduled to return to $5 million (adjusted for inflation) beginning in 2026. As such, many practitioners have concerns about the potential for clawback—the idea that if a taxpayer currently utilizes the increased BEA, there could be adverse estate tax consequences if the taxpayer dies after the BEA is scheduled to decrease in 2026. These are not new concerns as the potential for a sharp decline in a prior version of the BEA existed at the end of calendar year 2012 only to be resolved by last minute Congressional action. However, the magnitude of the potential clawback is much greater this time around. In response, the Treasury Department proposed the Anti‑Clawback Regulations, which would prevent clawback. Thus, assuming the Anti‑Clawback Regulations are finalized, the question arises: should taxpayers act now?
Historically, what is now the BEA has been significantly lower ($1 million as recently as 2003), and estate tax rates have been significantly higher (55 percent through 2001). The lower exclusions and higher rates often presented a significant impediment to a taxpayer passing the desired, or even necessary, quantum of wealth to his or her intended beneficiaries. As such, many wealth transfer plans focused almost exclusively on estate tax mitigation, which included passing as much tax-free as possible, as soon as possible, to allow the buildup of value to occur outside of the taxpayer’s estate. But does this laser focus on early-and-often wealth transfers remain necessary?
Perhaps for some, full utilization of the increased BEA remains the most efficient and appropriate wealth transfer tactic. However, according to the Tax Policy Center’s estimates, less than one-tenth of one percent of deaths will result in an estate tax obligation. There is also a potential benefit to holding onto assets through death: assets achieve a basis step-up and any capital gain would be wiped out. And, of course, there is always the possibility that Congress will extend the increased BEA beyond its scheduled sunset. Those that remain subject to the estate tax may now find themselves pondering whether they should, or even can, give the maximum away. It may be wise for these individuals to take a step back and review their broader goals rather than reflexively transferring the increased BEA.
Of course, the starting point in determining how much an individual can transfer is calculating how much that individual needs to retain in order to maintain his or her lifestyle for the remainder of life. Perhaps surprisingly, many wealthy individuals were not forced to grapple with this issue when the BEA was lower (for example, giving away $1 million did not affect the balance sheet all that much). With the increase to the BEA, these individuals will need to evaluate whether they can transfer the increased BEA without limiting their lifestyle and ability to meet their needs.
A review of current annual spending—from the everyday mundane items such as food, medicine, and primary home maintenance and property taxes, to the more discretionary expenditures like exotic travel and the caretaker for that West Texas ranch—would be recommended. Family goals such as education payments for children or grandchildren, or perhaps a vacation property acquisition or enhancement, should be considered. Maybe that special building or program at the alma mater needs endowing. After all of these goals are established and the sufficiency of the estate is confirmed, planning for the true excess portion of an estate can commence.
Maybe an individual’s estate more than provides for a complete lifetime of goals and the likelihood of an estate tax under almost any circumstance is certain. Perhaps the excess is so great that it is readily determinable that an immediate transfer of the increased BEA is the best course of action. However, it is also entirely possible that the projected remainder of the estate is short of the increased BEA, even in circumstances where there are plenty of assets to provide for a lifetime of goals. In this case, it could be a mistake to make gifts that are too large too soon as retaining significant assets until death and achieving basis step-up would be the better method to achieve wealth transfer.
Lastly, regardless of the increased BEA, wealthy individuals should consider what their excess sufficiency means to their beneficiaries, what they might like to achieve for their family and future generations as they consider the long-term usage of their accumulated estates. Many have reservations about fully passing on the maximum amount and should give themselves permission to utilize their wealth in other ways. Regardless, blindly utilizing the increased BEA may no longer be appropriate for numerous taxpayers.
Nolan A. Moullé, III is a senior vice president and senior wealth adviser at Northern Trust. He provides insight and guidance on wealth planning and tax issues of interest to clients, their businesses, and their advisors.