2019 final regulations
In 2019, the U.S. Department of the Treasury and the IRS issued final regulations under Treasury Regulation Section 20.2010-1(c). The regulations added a special rule that applies to situations in which the credit against estate tax that is attributable to the BEA at the date of death is less than the sum of the credits attributable to the BEA allowable in computing gift tax payable with regard to the decedent’s lifetime gifts. The special rule prevents the estate of a donor from being subject to estate tax on wholly completed gifts that, as a result of the higher BEA, were free of gift tax when made.
Under the 2019 final regulations, the special rule does not differentiate between a completed gift that is treated as an adjusted taxable gift for estate tax purposes and is not included in the donor’s gross estate and a gift that is treated as testamentary transfer for estate tax purposes and is included in the donor’s gross estate for estate tax purposes. As a result, decedents could make tax-free gifts due to the higher BEA but be subject to the lower BEA in effect on the donor’s date of death. Examples of such gifts include busted IRC Section 2701 partnership freezes, gifts subject to a life estate under IRC Section 2036, gifts of qualified terminable interest property income triggering gift of trust corpus, and grantor retained annuity trusts (GRATs) and qualified personal residence trusts (QPRTs) in which the grantor fails to survive the specified term.
2022 proposed regulations
On April 27, Treasury and the IRS issued proposed regulations that would limit the special rule to completed gifts. Under Proposed Regulation Section 20.2010-1(c)(3), the following transfers that are includible in the gross estate would be excluded from the special rule:
- Transfers subject to a retained life estate or subject to other powers or interests under IRC Sections 2035-2038 or IRC Section 2042, whether any part of or all of the transfer was deductible under IRC Section 2522 or 2523
- Transfers made by an enforceable promise or other amounts duplicated in the transfer tax base, to the extent they remain unsatisfied as of the date of death
- An IRC Section 2701 applicable retained interest under Treasury Regulation Section 25.2701-5(a)(4), such as a freeze partnership, or an inter vivos transfer under Treasury Regulation Section 25.2702-6(a)(1), such as a GRAT or QPRT
- Transfers that would have been described in the previous examples but for the transfer, relinquishment, or elimination of an interest, power, or property, effectuated within 18 months of the donor’s death by the decedent, by the decedent and a third party, or by a third party
The 2022 proposed regulations also clarify that even though the special rule is limited in certain cases, it will continue to apply to the following transfers:
- Transfers includible in the gross estate in which the value of the taxable portion of the transfer, determined as of the date of the transfer, was 5% or less of the total value of the transfer
- Transfers, relinquishments, or eliminations described in the last category of transfers listed earlier effectuated by the termination of the durational period described in the original instrument or transfer by the mere passage of time or the death of any person
Review current estate planning
Taxpayers who have used estate planning techniques involving gifts treated as testamentary transfers, such as individuals who have GRATs or QPRTs but who might not survive the set term of years, should consult their tax adviser about the potential implications of the 2022 proposed regulations and review and possibly revise their planning. While the fate of TCJA provisions that are scheduled to sunset in 2026 remains uncertain, these recent proposed changes are likely to be finalized and should be considered in the meantime.
