IRS Announces 2019 Exemption Amounts and Confirms Increased Exemption is “Use It or Lose It”

By Jeffrey K. Eisen

Just before Thanksgiving, IRS made two key pronouncements concerning the estate tax and gift tax.

1.    In Revenue Procedure 2018-57, the IRS announced that for gifts made in 2019 or deaths occurring in 2019, the combined gift tax/estate tax exemption amount will be $11,400,000 per person (or $22,800,000 per couple with proper planning). This is up from $11,180,000 per person in 2018 (or $22,360,000 per couple).  These exemption amounts also apply to the generation-skipping transfer tax.

The “annual exclusion” (the amount each donor can give as many people he or she wants in one year without using up any of his or her exemption) will be $15,000 in 2019, the same as in 2018.

2.    The IRS’ second pronouncement concerned a very technical but important topic, and served as a reminder that under current law, the current lofty exemption amount of $10,000,000 plus inflation (which yields the figures discussed above) expires on January 1, 2026, absent legislation to make them permanent. At that point, the exemption drops back to $5,000,000 plus inflation from 2011 (which probably will result in an exemption in the neighborhood of $6,000,000 to $6,500,000).   Any of the increased exemption not used before the reduction will be lost permanently, an important fact of which the second pronouncement reminds us.  In other words, the increased exemption amount is “use it or lose it.”

The estate tax is calculated by adding back to the decedent’s taxable estate all lifetime gifts in excess of the annual exclusion, and then restoring the decedent’s “full” exemption to apply against this combined total.  This means that gifts made between January 1, 2018 and December 31, 2025 in excess of the 2026 exemption, but sheltered by the current higher exemption, could be subject to estate tax, even though the gift itself was not subject to gift tax.

Example:  Jane is unmarried. She makes a gift of $10,000,000 to her sister in 2019.  No gift tax is due because this gift is less than Jane’s $11,400,000 exemption amount.  Jane dies in 2028, when the exemption is $6,000,000, with assets totaling $7,000,000.  Her taxable estate is $17,000,000 ($7,000,000 assets at death plus $10,000,000 of gifts).  However, her exemption is only $6,000,000.  Jane’s estate would owe 40% estate tax on $11,000,000—the $7,000,000 of her assets at death, plus the $4,000,000 by which her 2019 gift exceeded the reduced exemption of $6,000,000.  The total estate tax would be $4,400,000.

However, in the Tax Cuts and Jobs Act, Congress authorized the IRS to issue regulations to prevent the estate tax from applying, after the exemption decreases, to gifts which were sheltered from gift tax by the increased exemption when made.

On November 20, 2018, the IRS issued Proposed Regulations on this subject.  If the Proposed Regulations become final, then for purposes of computing the estate tax for decedents dying after 2025, gifts which were sheltered by the increased exemption from 2018-2025 will not be subject to estate tax.  In essence, the increased exemption needed to shelter the original gift from gift tax also will apply against the estate tax.  In Jane’s case, this would mean that only $7,000,000 (the assets actually owned by her at death) would be subject to estate tax, for a total tax of $2,800,000.  The $1,600,000 reduction in tax is 40% of the $4,000,000 by which Jane’s gift exceeded the reduced exemption.

But the Proposed Regulations also make clear that the full exemption doesn’t apply after 2025; only the exemption needed to shelter 2018-2025 gifts actually made will apply.  Therefore, because the increased exemption amount is “use it or lose it,” people with the means to make gifts up to the full exemption amount should do so before 2025 (or earlier, if elections in 2020, 2022 or 2024 result in legislation making the decreased exemption take effect before 2026).

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