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IRS confirms “clawback” will not apply to gifts made under the increased estate and gift tax exemption

The estate and gift tax exemption is the amount that an individual can transfer to another individual tax-free either during lifetime or at death before a 40% transfer tax is imposed.

What is the current estate and gift tax exemption?

In 2017, the Tax Cuts and Jobs Act (TCJA) raised the base amount from $5 million to $10 million per person. The $10 million base is adjusted annually for inflation. The inflation-adjusted exemption amount for 2019 is $11.4 million for 2019 per person. It will increase in 2020 to $11.58 million per person.

The TCJA also doubled the amount of exemption that may be rolled over, or “ported,” from one spouse to another at the death of the first spouse.

What is the TCJA sunset provision?

The increased exemption amount is temporary and scheduled to sunset, or revert, to $5 million per person (adjusted for inflation) as of January 1, 2026.

The sunset provision created a question as to whether gifts of greater than the inflation-adjusted $5 million exemption made between 2018 and 2025 would be subject to estate tax if the donor died after January 1, 2026. Similarly, the sunset provision also created confusion as to whether amounts ported from one spouse to another in excess of the inflation-adjusted $5 million exemption would remain available to the surviving spouse after January 1, 2026.

What will happen under the regulation issued by the IRS?

On November 26, 2019, the Treasury Department and the Internal Revenue Service issued final regulations under IR-2019-189 confirming that individuals who take advantage of the increased gift tax exclusion or portability amounts in effect from 2018 to 2025 will not be adversely impacted when TCJA sunsets on January 1, 2026. This regulation was part of Treasury Decision 9884 which implemented changes made by the TCJA.

How will the estate tax be calculated after December 31, 2025?

The final regulations provide a special rule that allows the estate to compute its estate tax credit using the higher of the basic exclusion amount applied to gifts made prior to January 1, 2026, or the basic exclusion amount applicable on the date of death. A similar special rule applies to an exemption that is “ported” to the surviving spouse.

As a result, individuals planning to make large gifts between 2018 and 2025 can do so without concern that they will lose the tax benefit of the higher exclusion level once it decreases after 2025. Similarly, spouses who have the benefit of additional, “ported” exclusions made in this period will continue to have the benefit of those ported exclusions after 2025.

An example

In application, suppose an individual transfers $10 million into an irrevocable trust in 2020, makes no further gifts, and dies owning $3 million of other, taxable assets after January 1, 2026, when the estate tax exemption has reverted to an inflation-adjusted $5 million. Assume the inflation-adjusted exclusion amount is then $7 million. The estate tax would be calculated with an exclusion amount of $10 million, not $7 million, leaving only the $3 million of remaining assets exposed to estate tax.

The regulations set out a “use it or lose it” benefit. If an individual dies after 2025 and did not make gifts between 2018 and 2025 in excess of the sunsetted exclusion amount in effect at his/her death, the excess exclusion is lost.

Of course, this is a very simple example. Many situations will be much more nuanced. The final regulations provide a window for strategic gift planning that should be discussed with your estate planning attorney.

2020 Estate, Gift and GST tax exemptions announced by IRS
Effective in 2012, the amounts that a U.S. citizen or resident can transfer to another individual free of estate, gift or Generation-Skipping Transfer taxes (collectively, the “transfer taxes”) have been set at a base amount, which is subject to an annual adjustment for inflation.

What is the transfer tax exemption for 2020?

On November 6, 2019, the IRS announced that the 2020 transfer tax exemption amount is $11,580,000 ($10,000,000 base amount plus an inflation adjustment of $1,580,000).

The tax rate applicable to transfers above the exemption is currently 40%.

What is the gift tax annual exclusion amount for 2020?

The gift tax annual exclusion allows taxpayers to make certain gifts without eroding the taxpayer’s lifetime exemption amount. The gift tax annual exclusion in 2020 remains $15,000 per done.

What payments are excluded from the annual and lifetime gift tax exemption?

A donor may exclude from his annual and lifetime gift tax exemption all gifts to his/her spouse as long as the spouse is a U.S. citizen, payments of tuition made directly to the donee’s educational institution and payments for medical expenses (including medical insurance) paid directly to the donee’s medical or medical insurance provider.

There is a separate gift tax annual exclusion for gifts to spouses who are not citizens of the United States: that amount is $157,000 in 2020.

Are the current high transfer tax thresholds permanent?

The Tax Cuts and Jobs Act, which was enacted in December 2017, provided that the current $10,000,000 base exemption amount for the estate, gift and Generation-Skipping Transfer taxes is effective through 2025, and reverts to the $5,000,000 base exemption amount established by the American Taxpayer Relief Act of 2012 on January 1, 2026.

How has the federal transfer tax exemption amount changed over the years?

The transfer tax exemptions (and the highest marginal transfer tax rates) have undergone several sweeping changes in the last two decades. The exemption amounts have been fully unified only since 2011.

Since 1997, the estate, gift tax and Generation-Skipping Transfer tax lifetime exemption amounts have changed as follows:
                                             Estate & Gift*                GST lifetime
                                             lifetime exemption:      exemption:
                    1997                  $600,000                        $1,000,000
                    1998                  $625,000                        $1,000,000
                    1999                  $650,000                        $1,010,000
                    2000                  $675,000                        $1,030,000
                    2001                  $675,000                        $1,060,000
                    2002                  $1,000,000                     $1,100,000
                    2003                  $1,000,000                     $1,120,000
                    2004–2005*      $1,500,000                      $1,500,000
                    2006–2008*      $2,000,000                      $2,000,000
                    2009*                $3,500,000                      $3,500,000
                    2010*                $5,000,000**                          ***
                    2011                  $5,000,000⁑                    $5,000,000
                    2012                  $5,120,000                      $5,120,000
                    2013                  $5,250,000                      $5,250,000
                    2014                  $5,340,000                      $5,340,000
                    2015                  $5,430,000                      $5,430,000
                    2016                  $5,450,000                      $5,450,000
                    2017                  $5,490,000                      $5,490,000
                    2018                  $11,180,000⁑⁑                $11,180,000
                    2019                  $11,400,000                    $11,400,000
                    2020                  $11,580,000                    $11,580,000

Notes:
* Between 2002 and 2010, the lifetime exclusion for gifts was capped at $1,000,000.
**In 2010, estates had the option to choose between a “no estate tax” system that afforded limited step-up in tax cost for the decedent’s assets, or a $5,000,000 federal estate tax exemption with full step-up in tax cost.
***In 2010, the GST tax exemption was $5,000,000, but the GST tax rate was 0.
⁑ The American Taxpayer Relief Act of 2012 set a base amount of $5,000,000, subject to inflation.
⁑⁑ The Tax Cuts and Jobs Act set a base amount of $10,000,000, subject to inflation; the Act provides that the base amount sunsets and reverts to prior law effective January 1, 2026.

What does this mean for you?

The changing landscape of the federal transfer taxes has led to challenges and opportunities in estate planning. In view of the recent changes and the scheduled sunsetting of the estate, gift and Generation-Skipping Transfer tax exemption amounts, please consult with your Nixon Peabody LLP attorney about your estate plan.
National Prescription Drug Take Back Day: A safe medication disposal option
It is important to plan for the safe disposal of medications. Many states are developing prescription drug return, reuse, and recycling laws. Take a look at the information on the National Conference of State Legislatures website for your state program.

Consider taking part in the National Prescription Drug Take Back Day on October 26, 2019, from 10:00 a.m. to 2:00 p.m. This program, brought to you twice a year (April and October) by the U.S. Department of Justice and Drug Enforcement Administration, is an opportunity to get it right on the correct disposal of your medications. Go to the DOJ DEA website and search by zip code or city/state to find a collection site near you.

Billions of left over drugs are thrown into the trash, flushed, or consigned to medical cabinets each year. The FDA has a list of medicines that may be flushed. It is a good idea to take the time each year to go through your medicine cabinets and look at expiration dates and at medicine that you no longer need, and then be responsible as to their disposal.

If you miss National Prescription Drug Take Back Day, visit your local pharmacy to ask for their assistance with the disposal of your unneeded or unwanted medications. They may have pre-addressed envelopes to mail unwanted medications for incineration.

Alternatively, as of 2018, 38 states (plus Guam) have enacted laws for donation and re-use of drugs.

Most importantly, always handle medications with care and dispose responsibly.
What happens to uncashed checks at death?
CNN recently reported that Aretha Franklin died with nearly $1 million dollars of uncashed checks. While the majority of people do not have this magnitude of uncashed checks at death, there will likely be a few uncashed checks at hand.

Uncashed checks issued prior to death in a decedent’s name alone which are still negotiable (typically 180 days) can be negotiated by the executor of the decedent’s estate.

Uncashed checks issued prior to death in a decedent’s name alone that are no longer negotiable will need to be handled one of two ways. The executor of the decedent’s estate should contact the payor to request the issuance of a new replacement check and then negotiate the new check. If the payor has already deposited the uncashed check with the state’s Abandoned Property division (typically after three years), then the executor will need to follow the state’s procedure for collection of the abandoned funds.

Uncashed checks issued in joint names, such as John and Jane Smith, can be negotiated by the survivor. If the decedent is the survivor of the payees named, then the decedent’s executor can negotiate the check.

Refund checks issued after death in the decedent’s name alone for unearned premiums and service refunds can be negotiated by the executor of the decedent’s account.

Whether a check issued prior to the decedent’s death, a refund check issued after the decedent’s death or check issued for the proceeds of abandoned property, the executor should keep in mind that these funds are includible in the decedent’s probate estate as well as the decedent’s gross estate for estate tax purposes.
What is a distributee and what do they mean for your estate plan?
A distributee is your legal heir that will inherit your estate, by law, if you do not have a valid will. A distributee may also be referred to as an “heir-at-law” or “next-of-kin.”

In New York, distributees are defined under EPTL § 4-1.1 to be (1) your spouse and/or children, (2) your parents, (3) your siblings/nieces and nephews/grandnieces and grandnephews, (4) your grandparents/aunts and uncles/first cousins or (5) your first cousins once-removed.

In New York, when you probate a will, you are required to give notice to a decedent’s distributees. Since distributees are the “natural” heirs of a decedent’s estate, this notice gives them an opportunity to dispute the validity of your will, if they believe there was any wrongdoing.

There could be many reasons why you choose to not leave your estate to your distributees —perhaps your closest living relative is someone whom you have never met, maybe you don’t get along with your family or maybe you simply want to contribute your estate to charity upon your death. Whatever the reason, it is important to speak with an estate planning attorney to make sure your wishes are documented and the proper steps are taken now, to avoid time delays and expenses after death.
What estate planning attorneys “need to know” about family dynamics
When Tom Petty died at the age of 66 from an accidental overdose, he had been considered a “success story” in the realm of celebrity estate planning as he had a full estate plan in place at his death.

For example, he apparently had a trust that disposed of his artistic property upon his passing through instructions to the successor trustee (his wife from a second marriage) to form a California limited liability company (“LLC”) to hold and deal with such property. As he had children from a first marriage, his trust apparently further provided that they should “participate equally” in the management of such LLC.

While such provisions seem to be well-meaning, they have apparently been the source of disagreement between Petty’s wife and children and have unsurprisingly resulted in recent litigation. From an estate planning perspective, they also call into question the extent to which family dynamics may have been taken into account in the planning process, especially when it is reported that Petty’s wife and children may have had a strained relationship during his life.

What can be done to avoid a family dynamics issue?

Regardless of a person’s celebrity, it is important that his or her estate plan take into account family dynamics as they may be when he or she is alive and in good health, as well as upon his or her death or in the event of a serious, long-term illness.

In particular, attention should be paid to family dynamics in the case of “blended” families where there is frequently tension between the spouse from a subsequent marriage and children of a first marriage. However, equal attention should be paid to all other types of family situations, such as adult children of the same marriage, as there is frequently tension in these situations too.

It is important to have an honest and open discussion with your estate planning attorney about how family members have traditionally gotten along and how you think they would get along when you are no longer there. It may be helpful also to discuss how family members have handled stress or grief, about how they have traditionally handled finances and whether you think that they are actually up for handling additional responsibilities, such as taking care of you or managing your finances. You should also think about whether it would be better for a few family members to work together or one family member to be in charge.

Finally, you should inform your estate planning attorney of any significant relationship or marital issues between family members, of any mental illness or of any substance abuse issues, so that your estate planning attorney may tailor his or her recommendations to achieve your estate planning goals and hopefully provide your loved ones with a more harmonious structure upon your incapacity or passing.
Joint ownership in real property — What happens at death?

There are three ways to own title to real property between two or more individuals—as tenants in common, joint tenants or tenants by the entirety. How you hold title to real property with another individual is important when it comes to your estate plan and knowing what will happen after death.

Tenants in common: Each owner has a separate interest in the property. If the type of ownership is not expressly stated in the deed, and the parties are not husband and wife, this creates ownership by tenants in common. Upon the death of an owner, his or her share passes pursuant to the deceased’s will, or if there is no will, to the deceased’s heirs via intestacy laws.

Joint tenants: A joint tenancy must be specifically declared in a deed. Upon the death of a joint tenant, his or her interest automatically passes to the surviving joint tenant. This tenancy may also be referred to as “joint tenants with right of survivorship.”

Tenants by the entirety: This type of ownership is unique to married persons. Upon the death of a spouse, the property becomes owned in full by the surviving spouse. The deed should state that ownership is by “tenants by the entirety” or between “husband and wife,” although if it is silent and the parties are legally married at the time, the ownership will be automatic. Alternatively, married persons can own property as joint tenants or tenants in common, provided it is expressly stated in the deed.

Unclaimed funds — What are they and how do I collect?
Unclaimed assets are funds in an individual’s name such as bank accounts, stocks, federal or state income tax refunds, uncashed dividends, insurance premium refunds, etc. that have not been accessed or collected [a year or more after issuance] that will eventually escheat to the state as “Abandoned Property.”

We commonly see the following types of Abandoned Property: uncollected dividends, forgotten bank accounts, uncashed checks and contents of safe deposit boxes.

If unclaimed funds are located in your name, only you, your spouse (or other family member if none) or your estate is entitled to collect the money from your state’s unclaimed funds depository.

There is no central federal source to research unclaimed funds specific to you. However, the National Association of Unclaimed Property Administrators website has helpful information on each state and provides instructions on how to search for unclaimed money in your name and corresponding state.

We recommend you search the Abandoned Property website of each state in which you have resided annually. The collection process is relatively simple and most times can be done online through the National Association of Unclaimed Property Administrators, Office of the New York State Comptroller Unclaimed Funds, Massachusetts Unclaimed Property Division and Illinois State Treasurer’s Unclaimed Property websites.
The importance of elective share statutes in “I love you not” wills
It is common for a married individual to fully provide for a spouse under his or her estate plan and to execute what is called an “I love you” will.” However, it sometimes happens that the married individual does not bequeath property for his/her spouse, often because he or she has children from a previous marriage and wants to leave family property to them. State laws generally do not favor disinheriting a spouse and may allow the surviving spouse to claim a portion of the decedent spouse’s property despite the provisions of the will. Absent a pre- or post-nuptial agreement addressing parties’ interests in each other’s property at death, “Elective Share” statutes can prevent a spouse from being disinherited under the decedent’s estate plan. A recent Massachusetts Supreme Judicial Court opinion underscores the importance of elective share statutes when individuals do not provide for a surviving spouse.

What are Elective Share statutes?

Elective share statutes generally allow a surviving spouse who has been disinherited by the deceased spouse to claim a fixed portion of the decedent’s estate (elective share), and in so doing, circumvent the decedent’s wishes. The purpose of elective share statutes is to allow a measure of financial protection to the surviving spouse, saving him or her from destitution.

Each state sets its own rules, and many states provide that the size of the elective share depends upon whether the decedent left issue (i.e., children, grandchildren) or parents. For example, New York allows a surviving spouse to claim the greater of $50,000 or 1/3 of the estate while Illinois allows a surviving spouse to claim 1/2 of the estate if the deceased did not leave issue but only 1/3 if the deceased left issue. In comparison, Massachusetts sets out a complicated matrix that depends on the degree of kinship of the other surviving relatives and the type of property left by the decedent. Some elective share statutes, such as Illinois’s, limit a surviving spouse’s claim to probate property; others, such as that of Massachusetts, include certain non-probate property, such as a decedent’s revocable trust.

Massachusetts’ Elective Share Statute

Where a decedent leaves issue, the Massachusetts elective share statute allows the surviving spouse to claim an interest in 1/3 of the deceased’s personal and real property. To the extent that the value of the 1/3 exceeds $25,000, the electing spouse will receive $25,000 outright and an interest in the remainder of the 1/3 share.

In a case decided in January 2019, Cianci v. MacGrath, SJC-12531 (Mass. Jan. 8, 2019), Massachusetts’ highest court determined the exact nature of the surviving spouse’s interest in that remainder of the 1/3 share. In this case, the decedent’s family consisted of a wife and adult children from an earlier marriage and his property consisted of three parcels of real estate. The case does not mention whether the couple had established a pre- or post-nuptial agreement, which could have determined the parties’ interests in each other’s property at death. The husband’s will made no provision for his wife and his real estate was bequeathed to his children. Not surprisingly, the wife elected against the will and then sought to force the sale of the real estate. Not surprisingly, litigation followed. The ultimate ruling was a toss-up: the Massachusetts Supreme Judicial Court determined that the wife has a life estate in the real estate subject to the 1/3 share, that she can seek division (partition) of the property to settle her share and that she is entitled to compensation for the value of her interest in any property that had already been sold.

What if you do not wish to fully provide for your spouse under your estate plan?

You should not assume that you can disinherit your spouse. If your estate plan does not provide at least as much for your spouse as your state’s elective share statute provides, your spouse could have a state-sanctioned override. You should consult with your estate planning attorney to determine your options and your spouse’s rights.
Proposed IRS regulations issued to address when lifetime exemption differs from estate exemption
The Tax Cuts and Jobs Act of 2017 (TCJA) provided for a substantial increase in the estate and gift tax exclusion amount, effective for the years 2018 to 2025. The TCJA did not specify whether taxpayers who made gifts during this eight-year period would enjoy the benefit of the higher exemption levels after 2025, or clarify other technical issues.

On November 21, 2018, the IRS issued proposed regulations that provide that there will be no “clawback” imposed upon taxpayers.

What would happen under the proposed regulations?

Under the TCJA, the exclusion amount used to compute federal and estate gift taxes increased to $10,000,00 (as adjusted annually for inflation; $11,400,000 in 2019) and will revert to $5,000,000 (as adjusted for inflation) on January 1, 2026.

The proposed regulations provide that gifts made during 2018 through 2025 in excess of the reversion amount are sheltered from the estate tax. There are other technical corrections sheltering certain pre-2018 gifts. 

What is the plan for the proposed regulations?

IRS has invited public comments on the proposed regulations and has scheduled a public hearing on March 13, 2019.

The proposed regulations will not take effect until the final regulations are issued.
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