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“Use It or Lose It” – No Claw Back on Gifts

November 05, 2019

The unified federal gift and estate tax exemption is temporarily doubled under the Tax Cuts and Jobs Act. What does that mean for large gifts made from 2019 to 2025?

The IRS issued proposed regulations on November 20, 2018 to address the lingering concerns of using the increased gift tax exemptions on gifts made prior to 2026 – commonly referred to as the “Claw Back”. Fast forward to 2019, here’s what you need to know.

Tax Cuts and Job Act of 2017 – Sunset in 2025

In 2019, the gift, estate and GST exemptions are $11,400,000 per person. However, the current law will “sunset” on December 31, 2025 and the gift, estate and GST exemptions will revert back to $5,000,000, adjusted for inflation. There was concern that lifetime gifts above $5,000,000 would be includable in the taxable estate of the donor and be subject to a 40% federal estate and GST tax.

However, the new proposed regulations now provide that any gifts which were sheltered due to the use of the increased gift and GST tax exemptions will NOT be included or “Clawed Back” into the estate of the donor at his or her death.

More importantly, the new regulations will also apply if there is political change in Washington that reduces the lifetime exemptions before 2026.

S. 309 - For the 99.8% Tax Act

Democrats in Congress have introduced a bill, S. 309, that will reduce the lifetime estate and GST exemptions to $3,500,000, adjusted for inflation and reduce the lifetime gift tax exemption to $1,000,000, NOT adjusted for inflation. The tax rates will increase to 45%, 50% and 55% with a maximum rate of 77% above $1 Billion.

The bill also proposes that all assets in grantor trusts will be includable in the taxable estate, a minimum term of 10 years for GRATs and the elimination of valuation discounts. The bill is projected to raise over $2.2 Trillion over the next 15 years.

Estate Planning Strategies in 2019 – 2020

While the recent IRS proposed regulations “grandfather” all gifts made under the current lifetime exemptions of $11,400,000, it is important to recognize that the current GST lifetime exemption of $11,400,000 is NOT portable. While the gift and estate tax exemption can be passed to a spouse at death, the lifetime GST exemption is lost when the donor passes away.

Planning to use all existing estate planning strategies should be fully optimized, with specific focus on making gifts to children and grandchildren and allocating the current GST exemptions. There is no certainty that any particular strategy or use of current gift, estate and GST exemptions will be available after January 1, 2020 so this is truly a “use it or lose it” scenario.

Income Tax Rates for GST Trusts

Once a grantor passes away, GST trusts automatically become non-grantor trusts and will no longer receive the benefits of graduated income tax rates. As an example, unearned income from bond portfolios (interest) greater than $12,600 in 2019 will be taxed at the maximum rate of 40.8%, excluding state income taxes.

With a national debt approaching $20 Trillion and unfunded obligations of the US Government, including Social Security and Medicare, estimated to be more than $70 Trillion (WSJ 4/22/17), future top income tax rates are very unlikely to be lower and may actually be significantly higher. There are currently some proposals being discussed in Congress to raise the top income tax rates on income above $10,000,000 to 70% thereby impacting all GST trusts.

Therefore, tax-advantaged vehicles such as specially designed life insurance contracts, Roth IRAs and municipal bond portfolios that provide tax-free income but not subject to gift, estate and GST transfer taxes, will be very attractive for children and grandchildren in the years to come.

Questions? Contact any member of KLR Wealth Management, LLC.

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