The Tax Cuts and Jobs Act (TCJA) of 2017 added many new provisions to the tax code. Taxpayers with larger estates initially saw a benefit from the change to the lifetime exclusion for gift and estate taxes. It increased the amount for each taxpayer from $5 million to $11 million, adjusted for inflation. (For 2019, the indexed amount is $11.4 million.) However, tax practitioners saw a catch: after 2025, the provision will sunset and the lifetime exclusion per taxpayer will revert back to $5 million. Worse yet, it was unclear what would happen to taxpayers who gave gifts that make up this extra $5 million provided by the TCJA. Thankfully, the IRS has finalized Regulation 106706-18, which provides more clarity around gifts and estate transfers. Let's take a look at what you should know if you're worried about being taxed for your generosity.

How Do Taxes On Gifts And Estate Transfers Work?

The taxation of lifetime gifts and estate transfers on death is unlike regular income taxes. For starters, the tax on gifts and estate transfers is levied on the individual who gives away the money or other assets; the recipient is not liable for any tax on directly gifted or inherited property. Additionally, gifts are tracked over a lifetime and a unified tax structure is applied to all transfers. As a parallel, imagine that current income tax brackets were unified like gift taxes are. You could be filing tax returns for years and years, but only later in life would the bill come due – and it wouldn’t be cheap!

Tracking And Calculating Taxes on Lifetime Gifts

Taxpayers are required to file gift tax returns for any year in which they give a gift larger than the annual exclusion to any single recipient (for 2019, this is $15,000). When they file it, the tax is calculated on any gifts given, and then the lifetime exclusion (the $11.4 million from above) is applied to the resulting tax in the form of a credit. Only if the cumulative amount of gifts over the taxpayer’s lifetime exceeds the exclusion is tax actually owed.

Because of this, taxpayers are required to track all gift tax returns filed during their lifetime – but the tax law can change, and change often, during one’s lifetime. What happens if the exclusion is reduced to an amount that you have already exceeded? Are you restricted from giving further gifts that are not taxed? Or worse, do you now have to pay taxes on gifts for which you’ve already filed a gift tax return and paid no tax?

Final Regulation 106706-18 Explained

The proposed regulations answer these questions and more. By making rules regarding the enforcement of Internal Revenue Code Sections 2010 and 2502, the regulations clarify that of the two amounts in question (the applicable lifetime exclusion used for the giving of lifetime gifts, and the applicable lifetime exclusion at the date of the taxpayer’s death), the higher will be used to calculate the tax.

For example, if an unmarried taxpayer gives $8 million in gifts this year, but dies after 2025 when the rates sunset, the lifetime exclusion applicable to the taxpayer’s estate will be $8 million, not the $5 million that would ordinarily apply. The taxpayer doesn’t get to take advantage of the unused amount before the sunset, but nonetheless, this is welcome news to taxpayers and practitioners.

Protect Yourself With Proper Tax And Estate Planning

Even though these regulations simplify the gift and estate tax compliance process, there are still many pitfalls and obstacles to consider. You owe it to yourself to engage in proper tax and estate planning to ensure that your beneficiaries are taken care of, and MRPR stands ready to assist you every step of the way.