Estate and Gift Tax Clawbacks: Taking Advantage of Current Laws Before the Law Changes Again

In 2017, when Congress passed the Tax Cuts and Jobs Act, it doubled the gift and estate tax exclusion amount, but that law is set to expire on December 31, 2025. How does this temporary change affect gifting strategies between now and 2026?

Taking Advantage of Current Laws Before the Law Changes Again

A Little Background

The federal estate and gift taxes are taxes on transfers of wealth. The estate tax (sometimes referred to as the “death tax”) is the tax levied on assets that are transferred at the time of your death. The gift tax, which is also calculated at the time of your death, is a tax levied on assets that you give away over the course of your lifetime.

Before the 2017 Tax Cuts and Jobs Act, most individuals were entitled to a $5 million unified gift and estate tax exemption (adjusted for inflation). This meant that the first $5.49 million dollars (in 2017) of transfers (either at death, or during one’s lifetime) were free of federal estate and gift taxes.

The Temporary Change

The Tax Cuts and Jobs Act of 2017 doubled the unified estate and gift tax exemption (meaning that in 2020, every individual has an exemption of $11.58 million), but the exemption is set to expire on December 31, 2025.

IRS Clarification: Use It or Lose It

Because the exemption increase is only temporary, many people have expressed concern over what this might mean if the estate tax exemption at the time of death is less than the gift tax exemption when lifetime gifts were made.

For example, if a person makes gifts totaling $11 million between 2018 and 2025, but passes away in 2026 after the exemption had returned to the original $5 million exemption, what taxes, if any, would that person’s estate owe? Might the IRS try to “clawback” funds into the estate in order to collect gift taxes on gifts that were made during a person’s life that now exceed the 2026 exemption amount?

Fortunately, the IRS clarified its position in November with final regulations providing that taxpayers who take advantage of the increased gift tax exemption from 2018 to 2025 will not be subject to any “clawback” if the exclusion amount has decreased at the time of death. Instead, the IRS provides a special rule in these cases that will allow an estate to compute the applicable tax exemption using the greater of exclusion amount at the times gifts were made or the exclusion amount at the time of death.

However, the final rule also clarifies that this special rule is a “use it or lose it” feature. It will only be available to estates of those who die on or after January 1, 2016 to the extent that the person actually used the increased exemption amounts by making gifts between the start of 2018 and the end of 2025.

This means that those who do not take advantage of the increased exemption while it is available, and who pass away after January 1, 2026, may end up paying unnecessary estate taxes at death.

What Should I Do About This Now?

Given the temporary nature of the current exemptions, many of our clients are asking what they can do to make sure they can take advantage of the tax savings now before exemption sunsets in 2025. Fortunately, there are a number of options available. Of course, each of these options should be considered carefully and we recommend discussing them with a Mesa estate planning attorney as well as with your other financial and tax advisors. Some of the strategies worth your consideration include:

1) Making Lifetime Gifts:

The most obvious way to take advantage of the increased unified tax exemption is to make lifetime gifts before the exclusion sunsets. Individuals can give up to $11.58 million and married couples can give up to $23.16 million in gifts before incurring any gift or estate tax. These gifts can be made outright to loved ones or can be gifted to a trust for their benefit. Gifting to a trust can be a particularly helpful strategy if you are also interested in obtaining asset protection for your loved ones.

2) Creating a Spousal Lifetime Access Trust (SLAT):

For married couples, there is at least one way to make immediate transfers while tax exemptions are at their highest, while still maintaining some of the benefits of those transferred assets during their own lifetimes. This can be done by creating through the creation of a spousal lifetime access trust (or “SLAT”). With careful planning and a properly drafted trust agreement, a married person can make a gift to a trust set up for the benefit of a spouse.

As long as the gift is properly executed, it will be a “completed gift” for tax law purposes and will qualify for the increased gift and estate tax exemption. Once the gift has been completed, the assets remain in a trust to be used for the benefit of the recipient spouse. By transferring assets that are likely to appreciate into such a trust, you can also ensure that any growth takes place outside of either spouse’s estate—thereby avoiding additional taxes that would otherwise be collected from the estate at the time of death.

In Arizona (just as in other community property states) preparing for this type of gift will require careful analysis and planning to ensure that the funds being gifted are the donor spouse’s separate property.

3) Gifting to a Grantor Trust

When gifting to a trust, it is also important to consider the income-tax treatment of the recipient trust. Assets in a grantor trust, for example, are reported on the grantor’s own tax return and the grantor can pay the income tax for income generated by the trust assets. This means that once the assets have been transferred into the trust, the trust’s beneficiaries can retain all the income and growth without any reductions that would otherwise be required to make income tax payments. Accordingly, the donor’s taxable estate is reduced not only by the amount of the initial gift, but also by the subsequent income tax payments paid on the trust’s assets.

We Are Here to Help

If you have questions or concerns about the current estate and gift tax laws, or if you want to ensure that you and your family can maximize tax savings during the current window of opportunity, let us help you.

The estate planning attorneys at Gunderson Law Group, P.C. are here to help you evaluate your options and design a plan that fits your family’s unique needs and circumstances. Contact us at 480-750-7337 to schedule a meeting today.

Gunderson Law Group, P.C.

Arizona Location
1839 S Alma School Rd #275
Mesa, AZ 85210

Office: (480) 750-7337

Nevada Location
3960 Howard Hughes Parkway #500-A
Las Vegas, NV 89169

Office: 702-990-3515