For estate planning professionals, one of the major changes presented by the 2010 Tax Act was the increase of the lifetime gift tax exemption from $1 million to $5 million (in 2012, it increased to $5.12 million). This substantial increase to the amount that an individual could gift during their lifetime posed what many consider to be an “once-in-a-lifetime” opportunity to gift large portions of a person’s assets during their lifetime. And with this increase in effect until December 31, 2012, a sense of urgency spread amongst advisors.
But just as quickly as this opportunity presented itself, tax professionals began to question if this was really the great planning tool it appeared to be. Specifically, some began to worry that utilizing the full lifetime gift tax exemption may eventually lead to a claw back of a portion of the gift when the donor dies.
The premise of the claw back relates to interplay between lifetime gifting and the calculation of estate taxes at a person’s death. When an estate ‘s executor calculates the taxable value of an estate, he or she must account for taxable gifts (gifts in excess of the annual gift tax exclusion) made by the decedent during their lifetime. The more taxable gifts that are made, the smaller amount that can pass at your death free of estate tax.
The concern is because the current estate and gift tax exemptions are $5.12 million and both are set to reduce to $1 million, the IRS may impute a portion of a gift made before the end of 2012 into a future calculation of estate tax. By way of example, if a claw back exists and an individual with a $6 million estate gifts the full $5.12 million before the end of 2012, then $4.12 million of that gift will be clawed back and used to calculate their estate taxes.
The main argument for the existence of a claw back is that under the current statutory interpretation, when calculating an estate tax, a tax preparer uses the constructive gift tax that would be due in the year that a gift is made. Therefore, where that amount is low as it would be in years with a high exemption, the credit against the estate tax would be high and reduce the estate tax by less. There has yet to be dispositive word from the IRS one-way or the other on this interpretation.
For those who don’t believe that the claw back is a problem, the primary argument against the application of a claw back is the intent of the 2010 Tax Act. There was clearly no intention on the part of Congress to allow for large-scale gifts only to eventually recapture the lost tax revenue at a later date. In addition, the nature of the gift and estate tax system is to tax gifts at the time they are made, not at death. A claw back would be inconsistent with this.
There is also a political argument against the claw back. While the gridlock in Washington makes any action before the end of 2012 unlikely, it is in neither party’s interest to apply a claw back. Further, the 2010 Act was supported by both a Democrat President and Congress who would be more likely to support purported tax increases than their Republican counterparts. It seems unlikely that they will support matters that would counter their previously passed laws.
Claw back or not, making a large gift before the exemptions expire at the end of 2012 still make sense for those with the means to make them. For people with appreciable assets, shifting those assets to a younger generation now will remove the appreciation from their estates. Further, for business owners looking to transfers their business in a tax efficient manner, this may be the best time to make those transfers while incurring less taxes than they will incur in future years.
Large scale gifting always comes with a degree of risk from a tax perspective. The fear of a claw back may turn out to be real or imaginary, but in the end, it should not be the deciding factor in determining whether making a large gift is right for you.
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