Differences between how the chained consumer price index and the standard CPI are published may complicate estate tax planning by forcing taxpayers to rely on estimated adjustments.
The Tax Cuts and Jobs Act (P.L. 115-97) has permanently changed the measure for inflation adjustments under 46 code sections — including the estate tax exemption — from standard to chained CPI, which is expected to slow dollar adjustments in the code.
During a February 6 American Law Institute Continuing Legal Education webinar, Kimberly E. Cohen of Ropes & Gray LLP said that while standard CPI is reported monthly and those reports do not change, chained CPI is estimated annually, in February, with final values published one year later.
Having to rely on those estimates will make it difficult for taxpayers to use up the exact amount of the gift and estate tax exclusion without resorting to a formula gift, according to Cohen. While the IRS has accepted formula gifts in some situations, like for the marital deduction, it often can be hostile to such planning, she said.
“This raises the question as to whether gifts tied to an individual’s remaining basic exclusion amount will be valid,” Cohen said. Because individual taxpayers will have few alternatives in this context when trying to make gifts in a particular year, she expects that those formulas will be respected, she added.
Further, an estate could have to pay the estate tax before the inflation adjustment for the exclusion amount has been finalized, Cohen said. Presumably, using the estimate when the final number turns out to be different will not result in a penalty, she said.
Jeffrey N. Pennell of Emory University School of Law agreed that it would be “cheeky for the government to come down on you for using a formula when it’s Congress that has made it so impossible to actually know the precise numbers that you want to use.”
Cohen said she expects formula planning to become more popular.
Larry Katzenstein of Thompson Coburn LLP said that because the exclusion now exceeds $11 million per donor, it might be simpler to just err on the high side and pay the small amount of gift tax. With the doubling of the exemption, the gift and estate taxes now only affect taxpayers with substantial estates, so risking a small amount of gift tax by slightly overshooting the eventual inflation-adjusted exemption is probably good planning, he said.
Pennell said it is not yet clear what will happen to taxpayers who use nearly the full amount of the temporarily doubled exclusion for gifts if Congress allows the increase to expire. He compared the situation to the uncertainty around the estate tax between 2010 and 2012.
The idea that the government could force taxpayers who made gifts under the temporarily increased exclusion pay tax on those gifts as though there had never been an increase if the taxpayers die after the increase expires is known as “clawback,” Pennell said.
The TCJA added section 2001(g), directing Treasury to promulgate regulations regarding any difference between the exclusion amount at the time of a gift and at the time of death.
Pennell said he thinks Congress’s intent in section 2001(g) is for Treasury to make clear that there will be no clawback attempts. Because the exclusion has only ever increased since the 1930s, Treasury might have to rethink an approach it has used for nearly a century, he said.
Kathleen R. Sherby of Bryan Cave LLP said it is not yet clear how or when the IRS and Treasury will address the issue. She added that they have until 2025 to come up with a solution.
Pennell said he does not expect an answer until closer to that time because Treasury and the IRS are not likely to look at the problem until it seems likely that Congress will allow the temporary doubling of the exclusion to expire.