Don’t Let This Tax Clawback Foil Your Estate Plan
In 2018, the basic exclusion amount (commonly called the “exemption”) for estate taxes doubled from $5 million to $10 million.1 Today, with an inflation adjustment, it sits at $12.92 million.2 But, absent an act of Congress, we believe this exemption will revert to an estimated $7.2 million in 2026, which is the former $5 million limit adjusted for inflation. Not surprisingly, many high-net-worth individuals are planning to use this exemption before they lose it. And while this can be a wise strategy, you should be aware that there is the potential for a tax clawback.
What is a clawback?
A clawback is when the IRS takes back a tax benefit that you have previously enjoyed. In 2019, the Treasury ruled that a decedent could use the greater of the exemption at the time of their death or the exemption applied toward their lifetime gifts,3 which effectively alleviated the clawback concern around estate taxes. However, the Treasury recently issued proposed regulations that may change this. There’s now a question as to whether someone who passes away in 2026 would benefit from the increased exemption during 2018–2025 or not.
The example below shows how the exemption works today and how a clawback could affect it. As you can see, if a decedent dies with a $5 million estate and made lifetime gifts of $10 million between 2018 and 2025, with the current exemption, the net taxable estate would be $2 million. However, if there was a clawback, there would be a $6 million change in the exemption applied to the lifetime gifts, and the net taxable estate would be $8 million.
|ESTATE TAX CALCULATION:
|DEATH PRIOR TO 2026
|DEATH IN OR AFTER 2026
|PLUS: Lifetime Gifts
|NET TAXABLE ESTATE
The proposed clawback regulations
The Treasury has proposed new regulations that effectively disallow the use of the excess exemption from the years 2018–2025 for certain types of gifts. For these specific situations, the decedent would utilize the exemption available at the time of their death rather than the exemption applied at the time of the gift. However, it is worth noting that an outright gift not included in the decedent’s estate would not be subject to this clawback rule.
Which gifts could be impacted?
The most common types of gifts we expect to be affected by the new proposed regulation are those included in the decedent’s estate or subject to special valuation rules (typically because the decedent maintained an ownership interest in the gift), such as:
- Grantor Retained Annuity Trusts (GRATS) are subject to the clawback if the gift represents more than 5% of the GRAT funding. So, zeroed-out GRATs would not be subject to this clawback rule.
- Qualified Personal Residence Trusts (QPRTS) are frequently subject to clawbacks, as the gift is typically more than 5% of the QPRT funding.
- Family Limited Partnerships (FLPs) are subject to the clawback if the decedent has too much control over the FLP.
- Preferred Freezes are subject to special valuation rules, so the clawback could apply.
- 18-Month and 3-Year Look-Backs could subject decedents to the clawback if they give up a power that would include a gift in their estate within three years of death. An 18-month look-back can apply to other types of transfers.
What’s our takeaway?
If you’re hoping to use the increased exemption prior to 2026, exercise caution if considering one of the gifting strategies listed above. It is also worth noting that some other wealth transfer strategies may be impacted by this new clawback rule. The risk of running afoul of this rule is that the property may not be included in the decedent’s estate, and the excess exemption used to shelter the gift prior to 2026 may not be available. Therefore, the entire value of the property may become taxable in the decedent’s estate.
We strongly recommend consulting your wealth and tax advisors about whether—and how best—to take advantage of the basic exclusion amount on your estate before it is set to change in 2026.
ABOUT THE AUTHOR
John Schuman, JD, CFP®
John is a Partner, Head of Wealth Transfer at Corient, based in our Columbus, OH, office. Previously, he was a Partner, Co-CEO and President of legacy firm Budros, Ruhlin & Roe. As a CERTIFIED FINANCIAL PLANNER™ certificant, licensed attorney and former Certified Public Accountant (CPA), he adds an exceptional perspective to the firm. John’s expertise includes estate planning and taxation, income tax, general business and succession planning, and charitable and retirement planning. He has been a featured speaker at conferences of the Columbus Bar Association, the Financial Planning Association (FPA), the National Association of Personal Financial Advisors (NAPFA), the Ohio CLE Institute, The Columbus Foundation and the International Association of Advisors in Philanthropy.
John holds a Bachelor of Science from The Ohio State University and a Juris Doctorate from Capital University Law School (summa cum laude). John is a member of the Financial Planning Association (FPA), the National Association of Personal Financial Advisors (NAPFA), and the Columbus, State of Ohio and American Bar Associations. He also serves as a member of the Professional Council of The Columbus Foundation.
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