It is possible the proposed clawback regulations from the Treasury may undermine the estate planning you’ve done to address the reduction in estate tax exemptions coming on January 1, 2026. These proposed regulations are not as severe as initially feared, but they do pose a threat to some estate planning, according to a recent article titled “Proposed Clawback Regs May Undermine Some Estate Planning” from Wealth Management.com.
On a positive note, if your estate plan includes a SLAT (Spousal Lifetime Access Trust) or a Self-Settled Domestic Asset Protection Trust (DAPT), the proposed regs shouldn’t prevent you from securing those exemptions, as long as they work with the other aspects of the planning. The proposed regulations are complex and may change the anticipated results of several other estate planning strategies.
When the Tax Cuts and Jobs Act of 2017 was passed, the federal estate tax exemption doubled from $5 million to $10 million, adjusted for inflation until January 1, 2026, when it ends. Some taxpayers made transfers, usually to irrevocable trusts, to secure the temporarily higher gift, estate, and generation-skipping (GST) exemptions. However, what’s not clear is what happens if the taxpayer who made these gifts dies after the higher exemption ends and the new exemption is considerably lower.
In most, but not all, cases, such gifts won’t be subject to a clawback. However, there are exceptions in the proposed new regulations.
The Treasury is concerned about gifts made where the taxpayer continues to retain control over assets. One example is funding a Grantor Retained Interest Trust (GRIT) so the gift would be deemed made of the entire amount transferred with no reduction for the interest retained because the value of the retained remainder would be zero.
A Preferred Partnership could also be structured that intentionally violated requirements under IRC regulations, so the equity the donor received in the entity would be valued at zero. The taxpayer would have retained a preferred interest and the trust would be set up so the entire value would be treated like a gift when family members acquired the common interests. The gift exemption would be secured and the Preferred Partnership interest would be included in the taxpayer’s estate, but the exemption would be preserved.
These types of transactions are the targets of the proposed regulations. Several types of transfers won’t benefit from the anti-clawback rule, so the lower exclusion at death and not the higher exclusion that was thought to have been secured will still be available.
Your estate planning attorney has been following the efforts of the Treasury to provide anti-abuse regulations. A review of your estate plan is always a good idea, but with these changes coming, it would be wise to evaluate your estate plan to see if any planning needs to be revised. There may be newer, better options.
Reference: Wealth Management.com (May 3, 2022) “Proposed Clawback Regs May Undermine Some Estate Planning”