By: Patrick Ungashick
The IRS has recently proposed new regulations to resolve one of the lingering questions raised by the sweeping Tax Cuts and Jobs Act (TCJA), signed into law slightly more than a year ago.
TCJA presented business owners with a number of important tax changes that impact how you do tax planning today and how you design and implement your future exit plans. (Read more on these new tax provisions, including a helpful infographic.)
TCJA Creates Questions
Like many extensive tax legislative packages, TCJA created a few questions along the way, leaving it to the IRS and other agencies to interpret and clarify the laws where needed.
One of those questions was, “How would gifts and estates be taxed after 2026 for taxpayers who have taken advantage of the temporarily increased gift limits under TCJA?” Here’s the issue. Before TCJA, U.S. taxpayers could gift about $5 million of assets ($10 million for married couples filing jointly) before potentially triggering gift or estate taxes.
Under TCJA, this amount doubled, allowing taxpayers to gift about $10 million of assets (about $20 million for married couples filing jointly). Gifting more assets without triggering a tax is better — especially if you contemplate transferring some or all of your business to your children as part of your exit planning. Under the TCJA, however, this ability to gift twice as much without triggering taxes will expire (or “sunset”) in 2026.
This sunset raises a big question — what happens to taxpayers who take advantage of the new and higher gift limits before the end of 2025 but then die in the year 2026 or later when the limits are lower again? Would these taxpayers or their heirs have to pay additional taxes under the restored lower limits in what is colloquially known as a “clawback”? Experts have been debating this question since TCJA was passed.
How Does TCJA Impact Exit Planning?
Here’s an example of why this question impacts exit planning. Assume a married couple named Oliver and Orphelia Owner gift their company, ABC Co., to their son. The company is worth $20 million. Under the higher gift limits now available courtesy of TCJA, it is likely that no gift taxes would be owed.
Now assume Oliver and Orphelia die in 2026 or later when the higher gift limits have fallen back to only $5 million per person ($10 million for married couples). At their death, Oliver and Orphelia’s estate and heirs could face taxes on the amount they gifted in excess of $10 million under this clawback approach.
The risk of a clawback complicates exit planning for business owners, especially within family businesses. Therefore, the IRS had to take action. The IRS’s proposed solution involves creating a “use-it-or-lose-it” approach, where taxpayers are not at risk of a clawback in 2026 and beyond but must take advantage of the higher gift limits before they expire in 2026.
The IRS’s proposed regulations are being reviewed and should be finalized shortly. If implemented as proposed, this development reduces uncertainty for business owners and creates a need to act to avoid missing out on a tax-saving opportunity.
Review These Issues with Your Tax and Legal Advisors
Many family business owners hesitate to transfer ownership to their next generation for fear of losing control of the company or out of a need to preserve the income stream they enjoy from the company. However, it is possible to make large tax-free gifts of your company without surrendering control or cutting into your income. Ask us how to do this.
Any opportunity to implement business exit plans at potentially lower tax rates is good news. But, if the IRS’s proposed regulations are enacted, business owners cannot afford to miss this opportunity as it will expire. It is important to review these issues with your tax and legal advisors to determine the best course of action for you.
