Chipman Mazzucco Emerson Estate Planning and Elder Law

In our post entitled Two Year Planning Window of Opportunity for Large Gifts we invited you to come here for the legal reasoning behind the conclusion that there will be no tax clawback with respect to the estates of clients who die after 2012 and who make large gifts in 2011 or 2012.

We can take no credit for the brain work involved in reaching this conclusion. Rather, we must give credit to Dan Evans who published a newsletter on the topic via the fabulous resources of Leimberg Information Services (http://www.leimbergservices.com/blogwatch.cfm#). That conclusion has been confirmed via Paul Caron, editor of the TaxProf Blog, reporting on the opinions of tax experts participating in a BNA Tax & Accounting Webinar scheduled for February 10, 2011.

Nevertheless, we closely examined the rationale presented by Mr. Evans before being able to agree with his conclusions and the conclusions of other experts.

This is the rationale.

Section 304 of the legislation enacted in December by Congress (bearing the name of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (TRUIRJCA)) says:

Section 901 of the Economic Growth and Tax Relief Reconciliation Act of 2001 shall apply to amendments made by this section [sic: title].

Section 901 (Sunset of Provisions of Act) of EGTTRA says:

(a) IN GENERAL.—All provisions of, and amendments made by, this Act shall not apply—

(1) …

(2) In the case of title V, to estates of decedents dying, gifts made, or generation skipping transfers, after December 31, 2010.

(b) APPLICATION OF CERTAIN LAWS.—The Internal Revenue Code of 1986…shall be applied and administered to years, estates, gifts, and transfers described in subsection (a) as if the provisions and amendments described in subsection (a) had never been enacted.

Accordingly, after 2012 the provisions of EGTRRA do not apply and the provisions of the Internal Revenue Code must be applied as if EGTRRA were never enacted. We will refer to the law as if EGTRRA were never enacted as Pre-EGGTRA law.

Although we will describe the calculation in more detail below, keep in mind that the U.S. estate tax is computed by adding the value of the estate to the value of taxable gifts to arrive at a Tentative Tax Base. The Tentative Estate Tax is determined based on the Tentative Tax Base. To determine the U.S. estate tax, the Tentative Estate Tax is then reduced: (1) by the gift tax obligation related to the gifts that were made; (2) the unified credit against the estate tax (this is the credit that results in what we refer to as the estate tax exemption); and (3) a credit for state estate taxes paid (other credits also may be available for special situations).

At issue when discussing the possibility of an estate tax clawback is how to compute the reduction for the gift tax obligation referred to above in red.

The gift tax obligation is a function of the unified credit and the gift tax rates. The unified credit after 2012, according to Pre-EGTRRA law, is $345,800 (resulting in what is often referred to as a $1,000,000 estate and gift tax exemption). As mentioned above, the unified credit is applied against a Tentative Estate Tax (and gift tax) to arrive at the actual tax due. Under pre-EGGTRA law, the tentative gift tax on a $5,000,000 taxable gift would be $2,390,800. To arrive at the tax due, the unified credit of $345,800 (the credit which would apply if EGTRRA had not been enacted) would be applied against the tentative gift tax to arrive at the gift tax of $2,045,000. This is the tax that would have been due if the rules were applied as if EGTRRA were never enacted. Of course, if the gift is made in 2011 or 2012 there would be no actual gift tax to pay because the exemption in those years is actually $5,000,000.

In computing the estate tax on the estate of the client who dies in 2013 after making a gift of $5,000,000 in 2012, the tentative estate tax is computed on the sum of the taxable estate and the taxable gifts. In this case such sum would be $10,000,000 which is referred to as the tentative tax base.

The tentative tax on a tentative tax base of $10,000,000 is $5,140,000.

Section 2001(b)(2) of the Internal Revenue Code says that in determining the estate tax the tentative tax is reduced by “the aggregate amount of tax which would have been payable under chapter 12 [the gift tax chapter] with respect to gifts made by the decedent after December 31, 1976, if the modifications described in subsection (g) had been applicable at the time of such gifts.”

The modifications described in subsection (g) are modifications enacted as part of TRUIRJCA and would have been applicable at the time of the 2012 gift. Accordingly, for purposes of computing the reduction under 2001(b)(2), the reduction is the gift tax that would have been payable, not the gift tax actually paid.

The estate tax is being calculated in 2013 (the assumed year of the client’s death) after the provisions of TRUIRJCA have sunsetted. Because Section 304 of TRUIRJCA says that the sunset rules of Section 901 of EGTRRA apply, the pre-EGTRRA law applies to both the estate and gift tax calculations.

The final calculation therefore looks like this:

(1) The Taxable Estate of $5,000,000 and the Taxable Gift of $5,000,000 would be added together to arrive at the Tentative Tax Base of $10,000,000.

(2) The U. S. Tentative Estate Tax on a Tentative Tax Base of $10,000,000 would be $5,140,800.

(3) To arrive at the U. S. estate tax, the Tentative Estate Tax is reduced by the U.S. gift tax that would have been incurred according the law as it would be if EGTRRA were never enacted in 2001. The gift tax that would have been incurred is $2,045,000.

(4) In addition, the Tentative Estate tax is reduced by the Unified Credit available according to the law that would be if EGTRRA were never enacted. Such a Unified Credit is $345,800. The Unified Credit shelters assets having a value of $1,000,000 from U.S. estate and gift taxes according to the law that would have existed if EGTRRA were never enacted.

(5) The Tentative Estate Tax is reduced further by the Credit for N.Y. estate tax which would be $391,600.

(6) The result of the calculations described above is a U.S. Estate Tax equal to $2,358,400.

As Dan Evans points out, the result is what you would expect if gift tax policies of the past were consistently applied to the current gift tax. He explains that past policy dictated that lifetime gifts were made a part of the estate tax calculation only for the purpose of determining the estate tax brackets to be applied to the estate that remains after lifetime gifts were made. The calculation methodology was never intended to be used as a way to subject lifetime gifts to additional tax.

In the example above, if the policy is properly applied, you would expect that the estate tax on the taxable estate of $5,000,000 would be 55% or $2,750,000. This is exactly the result achieved above when the U.S. estate tax and the New York estate tax are added for a total of $2,750,000.

Posted on 2/9/2011 by Richard S. Land, Member, Chipman, Mazzucco, Land & Pennarola, LLC.

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Notice: To comply with U.S. Treasury Department rules and regulations, we inform you that any U.S. federal tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction, tax strategy or other activity.

This entry was posted on February 9, 2011 at 8:00 pm and is filed under Estate Tax and Estate Planning Developments. You can subscribe via RSS 2.0 feed to this post's comments.

Tags: estate planning, estate tax, estate tax exemption, estate tax repeal, step up in basis, wills