Residential Real Estate Closings: Essentials of Practice ...
Estate Planning Essentials
217
Estate Planning Key Concepts Publish Date: July 2021
Transcript of Estate Planning Essentials
Estate Planning
Key Concepts
Publish Date: July 2021
2
Estate Planning - Key Concepts
By
Danny C. Santucci
The author is not engaged by this text, any accompanying electronic media, or lecture in the render-ing of legal, tax, accounting, or similar professional services. While the legal, tax, and accounting issues discussed in this material have been reviewed with sources believed to be reliable, concepts discussed can be affected by changes in the law or in the interpretation of such laws since this text was printed. For that reason, the accuracy and completeness of this information and the author's opinions based thereon cannot be guaranteed. In addition, state or local tax laws and procedural rules may have a material impact on the general discussion. As a result, the strategies suggested may not be suitable for every individual. Before taking any action, all references and citations should be checked and updated accordingly.
This publication is designed to provide accurate and authoritative information in regard to the sub-ject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert advice is required, the services of a competent professional person should be sought.
—-From a Declaration of Principles jointly adopted by a committee of the American Bar Association and a Committee of Publishers and Associations.
Copyright July 2021
Danny Santucci
i
TABLE OF CONTENTS
CHAPTER 1 - Estate Planning .................................................................. 1-1 Build, Preserve & Distribute ...................................................................................................................... 1-2 Legal Documents ....................................................................................................................................... 1-3 Estate Planning Team ................................................................................................................................ 1-4
Attorney ............................................................................................................................................... 1-5 Accountant ........................................................................................................................................... 1-5 Insurance Agents ................................................................................................................................. 1-6 Financial Planner .................................................................................................................................. 1-6
Estate Administration ................................................................................................................................ 1-6 Probate Court....................................................................................................................................... 1-6 Executor ............................................................................................................................................... 1-7 Internal Revenue Service (IRS) ............................................................................................................. 1-9 Trustee ................................................................................................................................................. 1-9 Family Members .................................................................................................................................. 1-9
Things to Be Done When Death Occurs ........................................................................................ 1-9 Estate Planning Techniques & Devices ...................................................................................................... 1-10
Transfers within Probate ..................................................................................................................... 1-10 Disposition of Property without a Will ......................................................................................... 1-10 Disposition of Property with a Will ............................................................................................... 1-11
Transfers Outside Probate ................................................................................................................... 1-12 Joint Tenancy with Right of Survivorship ...................................................................................... 1-13 Tenancy in Common ..................................................................................................................... 1-13 Retirement Plan & Individual Retirement Accounts ..................................................................... 1-13 Life Insurance ................................................................................................................................ 1-13 Gifts ............................................................................................................................................... 1-13 Payable on Death Accounts (POD) ................................................................................................ 1-14
Transfers Using a Trust ........................................................................................................................ 1-14 Special Planning Tools .......................................................................................................................... 1-14
Spending ....................................................................................................................................... 1-14 Annual Gift Tax Exclusion .............................................................................................................. 1-15 Applicable Exclusion Amount ....................................................................................................... 1-17
Spousal Portability of Unused Exemption Amount ................................................................. 1-17 2010 Special Election .............................................................................................................. 1-18
Unlimited Marital Deduction ........................................................................................................ 1-18 Family Business Deduction - Expired ............................................................................................ 1-18 Installment Payment of Estate Taxes - §6166............................................................................... 1-18 Private Annuities ........................................................................................................................... 1-19
Regs Restrict Private Annuity Tax Benefits ............................................................................. 1-19 Installment Sale to Family Member .............................................................................................. 1-19
Self-Canceling Installment Notes ............................................................................................ 1-19 Irrevocable Life Insurance Trust ................................................................................................... 1-19 Special Valuation of Farms and Businesses - §2032A ................................................................... 1-22 Crummey Trusts ............................................................................................................................ 1-22 Charitable Remainder Trusts ........................................................................................................ 1-22 Minor Trusts ................................................................................................................................. 1-23 Family Limited Partnerships ......................................................................................................... 1-23
ii
Grantor Retained Income Trusts .................................................................................................. 1-23 Qualified Personal Residence Trusts (QPRTs) ......................................................................... 1-23 Grantor Retained Annuity Trusts (GRATs) .............................................................................. 1-24 Grantor Retained Unitrusts (GRUTs) ....................................................................................... 1-24
Buy-Sell Agreements ..................................................................................................................... 1-24 Estate Planning Facts ................................................................................................................................. 1-24
Family ................................................................................................................................................... 1-24 Property ............................................................................................................................................... 1-25
Domicile ........................................................................................................................................ 1-25 Objectives ............................................................................................................................................ 1-25 Existing Estate Plan .............................................................................................................................. 1-25
CHAPTER 2 - Estate & Gift Taxes ............................................................. 2-1 Federal Estate Tax...................................................................................................................................... 2-1
Changing Legislative Landscape ........................................................................................................... 2-2 Spousal Portability of Unused Exemption Amount - §2010(c)(2) ................................................. 2-3
Persons Subject to Federal Estate Tax ................................................................................................. 2-4 Applicable Exclusion Amount, Basic Computation & Rates ................................................................. 2-4
Progressive or Flat Rate ................................................................................................................ 2-4 2010 Special Election .................................................................................................................... 2-7
State Inheritance Tax ........................................................................................................................... 2-7 State Death Tax Credit Turns into Deduction – §2011 & §2058 ................................................... 2-7
Taxable Estate - §2051 ......................................................................................................................... 2-10 Gross Estate - §2031 ..................................................................................................................... 2-10
Owned Property - §2033 ......................................................................................................... 2-12 Interests Terminating At Death - Life Estates & Joint Tenancies ........................................ 2-12 Interests Created After Death............................................................................................. 2-13 Remainder Interests ........................................................................................................... 2-13
Dower & Curtsey - §2034 ........................................................................................................ 2-14 Community Property Comparison ...................................................................................... 2-14
Gifts within Three Years of Death - §2035 .............................................................................. 2-14 Transfers from Revocable Trusts ........................................................................................ 2-14
Retained Life Interest - §2036 ................................................................................................. 2-15 Retained Voting Rights ....................................................................................................... 2-16
Lifetime Transfers With Reversionary Interests - §2037 ......................................................... 2-16 Revocable Transfers - §2038 ................................................................................................... 2-17 Annuities - §2039 .................................................................................................................... 2-17 Joint Interests - §2040 ............................................................................................................. 2-18
Qualified Joint Interests Between Spouses - §2040(b) ....................................................... 2-18 Powers of Appointment - §2041 ............................................................................................. 2-19
Ascertainable Standard - The Safe Harbor Limitation ........................................................ 2-19 5/5 Power ........................................................................................................................... 2-20
Life Insurance - §2042 ............................................................................................................. 2-20 Incidents of Ownership ....................................................................................................... 2-22 Community Property Issue ................................................................................................. 2-22
Deductions from Gross Estate ...................................................................................................... 2-22 Estate Expenses & Claims - §2053 .......................................................................................... 2-24
Inclusion of Administrative Expenses on Non-Probate Assets ........................................... 2-24 Casualty & Theft Losses during Administration - §2054 ......................................................... 2-24 Charitable Transfers - §2055 (§170 & §2522) ......................................................................... 2-24
Immediate Contributions .................................................................................................... 2-25 Split-Interest Contributions ................................................................................................ 2-25
iii
Charitable Remainder Trusts .......................................................................................... 2-27 Charitable Lead Trusts .................................................................................................... 2-35
Insurance Related Contributions ........................................................................................ 2-35 Unlimited Marital Deduction - §2056 ..................................................................................... 2-35
Requirements ..................................................................................................................... 2-35 Net Value Rule .................................................................................................................... 2-36 Non-Citizen Spouse ............................................................................................................. 2-36
Qualified Domestic Trust ................................................................................................ 2-38 Gifts to Non-Citizen Spouses .......................................................................................... 2-39
Valuation .............................................................................................................................................. 2-40 IRS Valuation Explanation - §7517 ................................................................................................ 2-40 Alternate Valuation - §2032.......................................................................................................... 2-40 Special Valuation - §2032A ........................................................................................................... 2-41
Estate Tax Return & Payment - §6018 ................................................................................................. 2-41 Installment Payment of Federal Estate Taxes - §6166.................................................................. 2-41
Computation ........................................................................................................................... 2-41 Eligibility & Court Supervision............................................................................................. 2-42
Closely Held Business .............................................................................................................. 2-42 Acceleration of Payment ......................................................................................................... 2-42
Flower Bonds ................................................................................................................................ 2-43 Tax Basis for Estate Assets - §1014 ...................................................................................................... 2-45
Community Property Cost Basis ................................................................................................... 2-46 Basis of Property Under the 2010 Special Election ....................................................................... 2-46
Property to Which the Modified Carryover Basis Rules Apply ................................................ 2-46 Limited Basis Increase for Certain Property ............................................................................ 2-47
GST Tax - §2601 ......................................................................................................................................... 2-48 Predeceased Parent Exception ..................................................................................................... 2-49 Exemption ..................................................................................................................................... 2-50
Allocation ................................................................................................................................ 2-50 Retroactive Allocation ........................................................................................................ 2-52
Gift Taxes - §2501 to §2524 ....................................................................................................................... 2-54 Gift Tax Computation ........................................................................................................................... 2-54 Calculation Steps .................................................................................................................................. 2-54 Applicable Exclusion............................................................................................................................. 2-55 Application ........................................................................................................................................... 2-55
Entity Rule ..................................................................................................................................... 2-55 Valuation .............................................................................................................................................. 2-55
Real Property ................................................................................................................................ 2-56 Stocks & Bonds ............................................................................................................................. 2-56 Annuities, Life Estates, Terms for Years, Remainders, & Reversions ............................................ 2-56
Split Gifts - §2513 ................................................................................................................................. 2-56 Community Property States.......................................................................................................... 2-57
Annual Exclusion .................................................................................................................................. 2-57 Per Donee/Per Year ...................................................................................................................... 2-58 Gifts in Excess of the Annual Exclusion ......................................................................................... 2-58 No Gift Tax .................................................................................................................................... 2-58 Gifts within 3 Years of Death ........................................................................................................ 2-58 Uniform Gifts to Minors Act ......................................................................................................... 2-59 Exception for Minor’s Trusts - §2503(b) & (c) ............................................................................... 2-59
Medical & Tuition Exclusion - §2503(e) ............................................................................................... 2-62 Qualifying Transfers ...................................................................................................................... 2-62
Interest-Free or Below-Market Loans .................................................................................................. 2-62 Gift Tax Marital Deduction ................................................................................................................... 2-62
iv
Nondeductible Terminable Interests ............................................................................................ 2-62 Gift Tax Charitable Deduction .............................................................................................................. 2-63
Partial Interests ............................................................................................................................. 2-64 Selecting Gift Property ......................................................................................................................... 2-65 Gift Advantages .................................................................................................................................... 2-65 Gift Disadvantages ............................................................................................................................... 2-66 Gift Tax Returns ................................................................................................................................... 2-66 Includibility of Gifts in the Estate ......................................................................................................... 2-66 Shifting Income & Gain ........................................................................................................................ 2-68
Gifts before Sale ........................................................................................................................... 2-68 Transfers into Trust Prior to Sale ............................................................................................ 2-68
Installment Obligations ................................................................................................................. 2-68 Transfer to Obligor at Death ................................................................................................... 2-69 Income in Respect of a Decedent ........................................................................................... 2-69
Reporting of Foreign Gifts - §6039(f) ............................................................................................ 2-70
CHAPTER 3 - Wills & Probate .................................................................. 3-1 What Is A Will? .......................................................................................................................................... 3-1
Provisions & Requirements .................................................................................................................. 3-1 Specific & General Bequests ......................................................................................................... 3-2 Residual Bequests ......................................................................................................................... 3-2 Conditional Bequests .................................................................................................................... 3-2 Executor ........................................................................................................................................ 3-2 Guardian ....................................................................................................................................... 3-3
Types of Wills ....................................................................................................................................... 3-3 Title Implications .................................................................................................................................. 3-4
Individual ...................................................................................................................................... 3-4 Joint Tenancy ................................................................................................................................ 3-5 Tenants in Common ...................................................................................................................... 3-7 Tenants by the Entirety................................................................................................................. 3-7 Community Property .................................................................................................................... 3-7
Tax Basis Advantage ................................................................................................................ 3-7 Untitled Assets .............................................................................................................................. 3-8
Changes to a Will ................................................................................................................................. 3-8 Advantages of a Will .................................................................................................................................. 3-8
Intestate Succession ............................................................................................................................ 3-9 Periodic Review .................................................................................................................................... 3-10 Continuing Business Operations .......................................................................................................... 3-11
Simple Will ................................................................................................................................................. 3-12 Probate ...................................................................................................................................................... 3-13
Advantages .......................................................................................................................................... 3-14 Disadvantages ...................................................................................................................................... 3-14 Probate Avoidance ............................................................................................................................... 3-15
Joint Tenancy ................................................................................................................................ 3-15 Community Property .................................................................................................................... 3-15 Totten Trust Accounts .................................................................................................................. 3-17 Life Insurance & Employee Benefits ............................................................................................. 3-17 Living Trusts .................................................................................................................................. 3-17
CHAPTER 4 - Trusts ................................................................................. 4-1 What is a Trust? ......................................................................................................................................... 4-1
v
Why a Trust? .............................................................................................................................................. 4-1 Types of Trusts ........................................................................................................................................... 4-3
Common Elements ............................................................................................................................... 4-3 Revocable Trust ................................................................................................................................... 4-3 Irrevocable Trusts ................................................................................................................................ 4-3 Testamentary Trust .............................................................................................................................. 4-4 Foreign Trusts - §679 ........................................................................................................................... 4-4 Family Trusts ........................................................................................................................................ 4-4 Medicaid Trust ..................................................................................................................................... 4-5 Living Trust ........................................................................................................................................... 4-5
Reversion ...................................................................................................................................... 4-5 Advantages of a Living Trust ......................................................................................................... 4-5 Disadvantages ............................................................................................................................... 4-6 Priority .......................................................................................................................................... 4-6
Pour-Over Will ......................................................................................................................... 4-6 Trust Taxation ............................................................................................................................................ 4-6
Income Tax ........................................................................................................................................... 4-6 Grantor Trusts - §671 to §678 ...................................................................................................... 4-6
Grantor Retained Income Trust .............................................................................................. 4-8 Revocable Trusts Included in Estate - §646 & §2652(b)(1) ........................................................... 4-9
Election for Income Tax Purposes ........................................................................................... 4-9 Irrevocable Trust Taxation ............................................................................................................ 4-10
Throwback Rules ..................................................................................................................... 4-10 Capital Gains ................................................................................................................................. 4-11 Deduction of Estate Planning Expenses ........................................................................................ 4-11 Deductibility of Death Expenses ................................................................................................... 4-11
Gift Tax ................................................................................................................................................. 4-11 Estate Tax ............................................................................................................................................. 4-13
Unlimited Marital Deduction ........................................................................................................ 4-14 Outright to Spouse .................................................................................................................. 4-14 Marital Deduction Trust .......................................................................................................... 4-14 Qualified Terminable Interest Property (QTIP) Trust .............................................................. 4-14
“A-B” Format................................................................................................................................. 4-16 “A-B-C” (QTIP) Format .................................................................................................................. 4-18 Valuation & Tax Basis .................................................................................................................... 4-19 Alternate Valuation....................................................................................................................... 4-21
Fundamental Provisions - Revocable Living Trust ..................................................................................... 4-21 Identification Clause ............................................................................................................................ 4-21 Recital Clause ....................................................................................................................................... 4-21 Property Transfer Clause ..................................................................................................................... 4-21 Income & Principal Clause ................................................................................................................... 4-21 Revocation & Amendment Clause ....................................................................................................... 4-22 Trustee Clause ...................................................................................................................................... 4-22
Trustee’s Acceptance .................................................................................................................... 4-22 Choice of a Trustee ....................................................................................................................... 4-22 Factors for Corporate Trustees ..................................................................................................... 4-22 Factors for Individual Trustees ..................................................................................................... 4-23
Trust Termination Clause ..................................................................................................................... 4-23
CHAPTER 5 - Post-Mortem Planning & Tax Return Requirements ........... 5-1 After Death Planning ................................................................................................................................. 5-1
Alternate Valuation Election ................................................................................................................ 5-1
vi
Special Use Valuation ........................................................................................................................... 5-1 Election to Defer Payment ................................................................................................................... 5-1 Final Medical Expenses ........................................................................................................................ 5-2 Administration Expenses ..................................................................................................................... 5-2 QTIP Election ........................................................................................................................................ 5-2 Disclaimers ........................................................................................................................................... 5-2
Federal Returns ......................................................................................................................................... 5-3 Form 1040 - Decedent’s Income Tax ................................................................................................... 5-3 Form 1041 - Estate’s Income Tax ......................................................................................................... 5-3 Form 706 - Decedent’s Estate Tax ....................................................................................................... 5-3 Carryover Basis Election & Information Return For 2010 .................................................................... 5-3
Decedent’s Estate Tax - Form 706 ............................................................................................................. 5-4 Filing Requirements ............................................................................................................................. 5-4 Paying the Estate Tax ........................................................................................................................... 5-5
Section 6161 ................................................................................................................................. 5-5 Section 6166 ................................................................................................................................. 5-6 Section 6163 ................................................................................................................................. 5-6
Overview of the Form 706 ................................................................................................................... 5-7 Definitions ..................................................................................................................................... 5-9
Preparing Form 706 ............................................................................................................................. 5-9 Form 706, Part 1, Page 1 - Decedent & Executor ......................................................................... 5-9 Form 706, Part 3, Page 2 - Elections by the Executor ................................................................... 5-9 Form 706, Part 4, Pages 2 & 3 - General Information ................................................................... 5-10 Schedule A, Page 5 - Real Estate ................................................................................................... 5-10 Schedule A-1, Pages 6 thru 9 - Section 2032A Valuation .............................................................. 5-10 Schedule B, Page 10 - Stocks and Bonds ....................................................................................... 5-11 Schedule C, Page 11 - Mortgages, Notes, and Cash ...................................................................... 5-11 Schedule D, Page 12 - Insurance on Decedent’s Life .................................................................... 5-11 Schedule E, Page 13 - Jointly Owned Property ............................................................................. 5-11 Schedule F, Page 14 - Other Miscellaneous Property .................................................................. 5-12 Schedule G, Page 15 - Transfers During Decedent’s Life .............................................................. 5-12 Schedule H, Page 15 - Powers of Appointment ............................................................................ 5-12 Schedule I, Page 16 - Annuities ..................................................................................................... 5-12 Schedule J, Page 17 - Funeral and Administration Expenses ........................................................ 5-12 Schedule K, Page 18 - Debts of Decedent, and Mortgages and Liens ........................................... 5-13 Schedule L, Page 19 - Net Losses During Administration and Expenses Incurred in Administering Property Not Subject to Claims .......................................................................................................................... 5-13 Schedule M, Page 20 - Bequests to Surviving Spouse................................................................... 5-14 Schedule O, Page 21 - Charitable Gifts and Bequests ................................................................... 5-14 Schedule P, Page 22 - Credit for Foreign Death Taxes .................................................................. 5-14 Schedule Q, Page 22 - Credit for Tax on Prior Transfers ............................................................... 5-14 Schedules R & R-1, Pages 23 thru 27 - Generation-Skipping Transfer Tax ................................... 5-14 Old Schedule T Gone - Qualified Family-Owned Business Interest .............................................. 5-14 Schedule U, Page 28 - Qualified Conservation Easement Exclusion ............................................. 5-14 Form 706, Part 5, Page 3 - Recapitulation .................................................................................... 5-15 Form 706, Part 6, Page 4 - Portability of Deceased Spousal Unused Exclusion (DSUE) ................ 5-15 Form 706, Part 2, Page 1 - Tax Computation ................................................................................ 5-15 Schedule PC, Pages 29 - 31 - Protective Claim for Refund ............................................................ 5-15
Discharge from Personal Liability......................................................................................................... 5-16 Estate Income Tax Return - Form 1041 ..................................................................................................... 5-18
Filing Requirements ............................................................................................................................. 5-18 Schedule K-1 ................................................................................................................................. 5-19
Tax Computation .................................................................................................................................. 5-19
vii
Exemption Deduction ................................................................................................................... 5-20 Contributions ................................................................................................................................ 5-20
Statute of Limitations........................................................................................................................... 5-20 Accounting Methods ............................................................................................................................ 5-20 Taxable Year ......................................................................................................................................... 5-20 Double, Split & Solo Deductions .......................................................................................................... 5-20
Decedent’s Final Income Tax Return - Form 1040 ..................................................................................... 5-23 Preceding Year Return ......................................................................................................................... 5-23 Filing Requirements ............................................................................................................................. 5-23
Refund .......................................................................................................................................... 5-23 Form 1310 ..................................................................................................................................... 5-23 Joint Return with Surviving Spouse .............................................................................................. 5-24
Request for Prompt Assessment.......................................................................................................... 5-24 Included Income .................................................................................................................................. 5-24
Partnership Income ...................................................................................................................... 5-25 S Corporation Income ................................................................................................................... 5-26 Self-Employment Income.............................................................................................................. 5-26 Community Income ...................................................................................................................... 5-26 Interest & Dividend Income .......................................................................................................... 5-26
Exemptions & Deductions .................................................................................................................... 5-27 Medical Expenses ......................................................................................................................... 5-27
Election for Decedent’s Expenses ........................................................................................... 5-27 Making the Election ............................................................................................................ 5-27 AGI Limit ............................................................................................................................. 5-28
Medical Expenses Not Paid By Estate ..................................................................................... 5-28 Insurance Reimbursements .................................................................................................... 5-28
Deduction for Losses..................................................................................................................... 5-28 At-Risk Loss Limits ................................................................................................................... 5-28 Passive Activity Rules .............................................................................................................. 5-29
Gift Tax Return - Form 709 ........................................................................................................................ 5-31 Penalties ............................................................................................................................................... 5-31 Filing ..................................................................................................................................................... 5-31
Extension of Time to File .............................................................................................................. 5-32 Extension of Time to Pay .............................................................................................................. 5-32
Split Gifts .............................................................................................................................................. 5-32 Special Applications & Traps ................................................................................................................ 5-33
Bargain Sales ................................................................................................................................. 5-33 Below Market Loans ..................................................................................................................... 5-33
Exception ................................................................................................................................. 5-34 Net Gifts ........................................................................................................................................ 5-34 Promises to Make a Gift ............................................................................................................... 5-34 Checks ........................................................................................................................................... 5-35 Stock Certificates .......................................................................................................................... 5-35 Promissory Notes .......................................................................................................................... 5-35 Powers of Appointment ................................................................................................................ 5-35
viii
Learning Objectives
After reading Chapter 1, participants will be able to:
1. Identify basic estate planning elements recognizing the importance of well-drafted legal documents and specify the key team participants including their roles in the estate plan-ning process.
2. Determine the major steps in the probate process, identify ways to make transfers out-side the probate system including the use of a trust, specify estate tax techniques that save death taxes while retaining maximum control, and identify estate-planning facts.
1-1
CHAPTER 1
Estate Planning
Everyone needs to do estate planning. Whether a person is a business owner or an employee, young or retired, wealthy or poor, people should plan their estate. Even those without assets need to deal with old age, possible conservatorship, health care directives, and funeral arrangements. Estate plan-ning is for everyone.
Since death is uncertain, everyone, young or old, should be ready for the contingency of death at any time. Even with the great advances in modern medicine, not everyone is lucky enough to grow old gracefully. None of us can, with certainty, predict the timing of our deaths. In estate planning, to-morrow may instantly become today.
Estate planning is more than just planning for death. It includes building an estate during a lifetime, then seeing that those assets are protected in an estate that can be passed to the next generation. It allows you the opportunity to control your success both during life and on death.
Thus, estate planning has three economic elements:
(1) Building the estate;
(2) Preserving the estate; and
(3) Distributing the estate.
1-2
Build, Preserve & Distribute
Estate planning is designing a program for effective wealth building, preservation, and disposition of property at the minimum possible tax cost. This process is much more than just planning for death. It is a commitment to yourself and your family.
Estate planning tries to encourage wealth building for everyone. Building an estate throughout life is part of estate planning.
When you start building an estate, you must preserve it at the same time. Preservation is the process of looking at the income and gift tax to minimize the overall tax burden for the total family unit.
Finally, once you have made and preserved an estate, you must determine how to distribute it to your heirs with the least possible death tax cost.
1-3
Legal Documents
For an estate plan to be effective, suitable and proper legal documents must be executed. The im-portance of well drafted legal documents cannot be overemphasized. Poor drafting and improper documentation will destroy any estate plan.
1-4
Legal instruments must be drafted by a competent attorney who knows estate planning techniques. Not all attorneys are qualified for estate planning work. For example, a specialist in real estate may not be knowledgeable on the latest estate planning developments.
Estate planning documents must be periodically reviewed due to tax and legal changes and to ascer-tain whether they continue to express the objectives of the estate owner. Such a review could bring about a modification in the plan that would produce significant benefits to the estate owner, while the neglect of such a review could be very costly.
Estate Planning Team
In estate planning, many professional skills are useful and a team effort will work best. Normally, the professionals most often involved in the estate planning process are:
(1) The attorney,
(2) The accountant,
(3) The insurance agent, and
(4) The financial planner.
There is one goal - the development of a comprehensive plan to accomplish the client’s financial and family objectives. Each member of the team has a job to do.
Estate Planning Team Assignments
Action Qualified Persons
Convincing a person to do estate planning
You (i.e., client or individual)
Spouse\
Attorney
Accountant
Financial Planner
Insurance Agent
Family Members
Friends
Analysis of Assets
Attorney
Accountant
You
Review of Present Plan
Attorney
Accountant
Financial Planner
Insurance Agent
Action Qualified Persons
Tax Analysis
Attorney
Accountant
Insurance Agent
1-5
Liquidity Requirements
Attorney
Accountant
Financial Planner
Insurance Agent
Legal Consequences Attorney
Changes in Estate Plan
You
Attorney
Accountant
Financial Planner
Insurance Agent
Putting Plan into Effect
Attorney
Accountant
Financial Planner
Insurance Agent
Follow Up
You
Attorney
Accountant
Financial Planner
Insurance Agent
Attorney
The attorney should decide whether suggestions, recommendations, and phases in the plan have legal substance and merit. A competent attorney must draft the legal documents that are the frame-work of an effective estate plan. Only a lawyer may legally practice law.
Note: Many people mistakenly believe that the attorney named in the estate planning documents must be used as the estate attorney at death. Even if the estate planning documents name an at-torney, most states deem this only a suggestion and not a requirement. There’s no reason to hire a lawyer if he or she is not the best choice.
Accountant
The accountant should know the financial affairs of the taxpayer, recognize the client’s need for po-tential estate planning1, and be knowledgeable with respect to income and estate tax laws. The ac-countant should also be able to advise on valuation problems and family income needs.
An accountant should file the final income tax return on behalf of the decedent. In addition, the estate will generally require an income tax return, as will any trusts formed under the estate plan. These are important functions for a good accountant.
1 The accountant is often the person on the team who has the responsibility to initiate the estate process.
1-6
Insurance Agents
Insurance agents are great motivators in getting persons involved in the estate planning process and can provide excellent advice and ideas. The agent should have specialized knowledge of the many forms of life insurance and know what various policies can and cannot do.
Financial Planner
The financial planner should be able to advise on investment return, asset management, and cash flow analysis. The financial planner should also know enough about insurance, estate taxes, and law to suggest possible solutions for the client to discuss with his or her accountant and attorney.
Estate Administration
There are other players in the total process of estate planning besides the “estate planning team.” These other participants can include:
(1) The Probate Court,
(2) An executor,
(3) The Internal Revenue Service, and
(4) A trustee.
Probate Court
The probate court is an important participant. It functions to:
(i) Oversee the executor and conserve the decedent’s assets,
(ii) Interpret the will, and
(iii) If there is no will, apply the laws of intestate succession.
The "probate estate" refers to any property subject to the authority of the probate court. Often it is good planning to avoid probate and there are several estate planning devices to do so.
Note: When one dies without a will, this is called dying intestate and the state writes a will for you by statute. Thus, under intestate succession, the probate estate is distributed to heirs based on a statutory distribution scheme.
Intestacy vs. Will
Intestacy Will
No expense of a will Appointment of guardian for mi-nors
No need to think about death Appointment of executor
Expense of a probate proceeding with an administrator
Potential expense of probate with an executor
Potential litigation Allocation of death taxes to heirs
1-7
Assignment of powers to executor to carry on business, sell assets
and make tax decisions
Elimination of bond for executor
Creation and exercise of powers of appointment
Bequests to relatives, heirs, and charities
Establishment of a testamentary trust
Can be used together with a living trust to avoid probate
Executor
An executor (man) or executrix (woman) is designated by the will to manage the assets and liabilities of the decedent. Normally, the executor is the surviving spouse or a close relative.
Being an executor is time consuming and often complex. The job may last from nine months up to several years. The duties of the executor include searching for assets, publishing notices to creditors, filing estate and income tax returns, paying expenses and liabilities, and distributing remaining assets (if any) to the beneficiaries. The executor is only in control of the probate assets.
1-8
1-9
Internal Revenue Service (IRS)
Obviously, the Internal Revenue Service is an interested participant. As many as four federal tax re-turns may be required after a person dies:
(1) An income tax return (Form 1040),
(2) An estate tax return (Form 706),
(3) An estate income tax return (Form 1041), and
(4) A gift tax return (Form 709).
Note: The tax departments of your state or local government may also have a role, depending on the inheritance tax laws of your domicile.
Trustee
If a trust has been created during the decedent’s lifetime (called inter vivos) or at death (called tes-tamentary), there will be a trustee named in the trust agreement to carry out the terms of the trust.
Family Members
The most immediate duties arising from the decedent’s death often fall on the shoulders of close family members. They have to deal with the practical and necessary tasks created when a loved one dies.
Things to Be Done When Death Occurs
1. Notify funeral parlor, funeral society, or other institution responsible for removing the body from the hospital.
Note: Request at least 10 death certificates. The funeral directors will usually handle such requests as a part of their duties.
2. Obtain and begin to implement any instructions the decedent left regarding his or her dispo-sition, including anatomical gifts or special funeral instructions.
3. Contact appropriate religious officials and proceed with funeral services or other planned dis-position.
4. Locate the Will, if any, and notify the executor.
Note: This may require access to safe deposit boxes. In many states, the next of kin may legally enter each box in the presence of a bank officer to retrieve legal papers such as wills, trusts, deeds, and burial instructions.
5. The executor should select and/or contact the estate lawyer.
6. Notify the immediate family, close friends, employer, and business colleagues of the death.
Note: When contacting relatives and friends confirm their addresses and telephone numbers.
7. Decide on an appropriate memorial for the decedent and notify acquaintances if flowers are to be omitted.
8. Prepare and deliver obituary to local newspapers, giving time and place of services.
9. Notify concerned persons too far away to attend the funeral.
10. Arrange for care of members of the family.
1-10
Note: This is a particular concern where there are minor children, an elderly spouse, a disabled dependent, or animals.
11. Determine if the decedent’s credit cards should be canceled.
12. Check carefully all death benefits.
13. Promptly check all debts and installment payments.
14. Notify utilities and landlord, if any.
15. Tell the post office where to send mail.
16. Determine the location of decedent’s vehicles and who has access to them.
Note: No one should be permitted to use the decedent’s vehicles except his or her surviving spouse. As legal owner, the decedent’s estate may be held liable for any accidents.
Estate Planning Techniques & Devices
While it is difficult to list all estate planning techniques and devices, the most popular can be cate-gorized by common use and objective rather than by tax code section. In fact, first approaching es-tate planning in this way will actually help your later understanding of the related tax issues that gave birth to most of these devices.
Transfers within Probate
Probate is the process through which legal title to property contained in the probate estate is trans-ferred from the decedent to the decedent’s heirs and beneficiaries. When a person dies with a will (testate), the probate court determines if the will is valid, hears any objections to the will, provides for the payment of creditors, and supervises the distribution of property by the personal representa-tive or executor according to the terms of the will. When an individual dies without a will (intestate) the probate court appoints an administrator who receives all claims, pays creditors, and distributes any remaining property according to the laws of the state in which the decedent died.
The “probate estate” refers to any property subject to the authority of the probate court. This prop-erty includes all solely owned property plus any other property that does not pass to someone else by operation of law.
Disposition of Property without a Will
If there’s no will, property in the probate estate is distributed according to the state law of intes-tacy. When an individual dies intestate, the probate court chooses a person responsible for ad-ministering the estate and distributing the probate assets. This person, called the administrator, may or may not have been the person you would’ve chosen. If there’s family bickering regarding the appointment of the administrator, the court often appoints a neutral party whose services must be paid from estate funds.
In addition, the probate estate is distributed to heirs based upon a statutory distribution scheme. While state laws vary greatly, most provide an allowance to be set aside for the surviving spouse and/or children. After this spousal set aside or if there is no spouse, the remaining probate estate, after payments of claims against the estate or debts of the decedent, is distributed in a variety of ways depending upon marital status, surviving heirs, and nature of the property.
1-11
Note: When there is a will, many states give the surviving spouse the ability to renounce the will and elect to take her intestate share provided by state law. Usually, the surviving spouse can take about one-third to one-half of the probate estate. This election procedure is meant to protect the surviving spouse from being disinherited by the predeceasing spouse.
Disposition of Property with a Will
A will is typically a written document that provides instructions for disposing of a person’s prop-erty upon his or her death. Upon the decedent’s death, the will must go through the probate process in order to have the instructions carried out. There are many reasons for having a will, including:
(1) The ability to dispose of your property other than through intestate succession;
(2) Nomination of your personal representative;
(3) Making specific bequests to individuals and charities;
(4) Appointment of guardians for minor children; and
(5) Apportionment of death taxes among heirs.
1-12
Review Questions
1. When considering income, gift, and, ultimately, death taxes, taxpayers should attempt to re-duce the overall tax load for the whole family unit. What is this process called?
a. building the estate.
b. distribution of the estate.
c. estate planning.
d. preservation of the estate.
2. An accountant, an attorney, a financial planner, and an insurance agent are the professionals most often on an estate planning team. Of these professionals, whose responsibilities include being familiar with the client’s financial affairs and being well-informed on income and estate tax laws?
a. accountant.
b. attorney.
c. financial planner.
d. insurance agent.
3. What procedure must a will go through in order for an executor to carry out the terms set forth by the decedent?
a. probate avoidance.
b. the intestacy process.
c. the probate process.
d. the transfer process.
Transfers Outside Probate
There are many devices for the transfer of property or money outside of the probate system. Typi-cally, these arrangements produce no state or federal death tax savings. Their primary rationale is avoidance of probate and transfer convenience.
Note: The probate estate does not equate with the definition of “estate” for federal estate tax purposes. Avoiding probate is not the same as avoiding federal estate tax. In addition, avoiding probate does not necessarily avoid state inheritance tax.
These techniques are very popular. However, there can be traps for the unaware. Using probate avoidance techniques also avoids any disposition provisions given in the will. This is because a will has no control over any property outside of probate. Probate avoidance techniques operate independently of one’s will. These devices determine who gets property at the estate owner’s death regardless of the owner’s will or trust.
1-13
Note: A trust only disposes of property that has been transferred to it. If no assets have been trans-ferred to a trust either during life or at death by the decedent’s will, no property will be controlled by the terms of trust.
Joint Tenancy with Right of Survivorship
When an asset is held in joint tenancy with right of survivorship, each joint tenant has an equal, undivided interest in the whole asset. In addition, a decedent’s share automatically shifts to the surviving joint tenant(s) at the moment of death by operation of law. In most situations, no fed-eral estate tax is saved. Fifty percent of any property held in such a manner with a spouse is included in the decedent’s estate. If the surviving joint tenant(s) is not the decedent’s spouse, 100% of the jointly held property is included in the decedent’s taxable estate, unless the surviving joint tenant(s) can prove actual contribution to the property.
Tenancy in Common
Tenancy in common is an arrangement in which each tenant takes an interest in the property. The interests owned by each co-tenant do not have to be equal. Each tenant can sell or bequeath his or her portion of the asset independent of the other tenant(s). Tenancy in common is fre-quently used for joint ownership of property among family members who are not spouses.
Retirement Plan & Individual Retirement Accounts
Naming a beneficiary to your retirement plan or individual retirement account (IRA) permits the benefits to go directly to the named beneficiary, bypassing probate. While at one time these funds enjoyed a special exclusion from the decedent’s estate, they are now generally includible in the decedent’s estate for federal estate tax purposes.
Note: Income tax planning has generally favored naming a spouse as the beneficiary even if the individual has a living trust. The spouse can take advantage of a variety of tax provisions which essentially treat the funds as the spouse’s own retirement account.
Life Insurance
When there is a named beneficiary other than the decedent’s estate, life insurance proceeds “spring” outside of probate. Proceeds from an insurance policy owned by the decedent that go to a named person as beneficiary are excluded from income tax. However, if the decedent owned the policy (or had any incidents of ownership), the proceeds are includible in the decedent’s fed-eral taxable estate even though the proceeds were payable to someone else.
Note: Frequently, an irrevocable insurance trust is used to avoid inclusion of the insurance proceeds in the decedent’s estate.
Gifts
Completed gifts made during one’s life avoid probate and in most cases federal estate tax. Essen-tially what has been given away is gone and is not includible in either the probate or federal estate. If a gift is given to a minor child, the transfer is typically made under the Uniform Transfers to Minors Act (UTMA) or the Uniform Gifts to Minors Act (UGMA). In such a case, the donor placing the asset in the name of a person called the “custodian” makes a gift of property or
1-14
money. Legal title is actually held by the minor. However, the custodian manages the asset until the minor becomes an adult at which time the property is turned over to the minor.
Note: If funds in such an account can be used to pay parental obligations for support, this may be considered taxable income to the parents. In addition, if a parent serves as custodian, such funds may be included in the parent’s estate should he or she predecease the child.
Payable on Death Accounts (POD)
Payable on death bank accounts are often referred to as “Totten” trusts. In either event, the account owner names a beneficiary (or payee) who automatically receives the account balance on the death of the owner. Until the owner dies, the beneficiary has no right to the account. In addition, the owner of the account can change the beneficiary or close the account at anytime. While such an account may be convenient and avoids probate, it saves no federal estate tax.
Transfers Using a Trust
A trust is a legal contract in which one party, the trustor, transfers property to a trustee for the ben-efit of one or more beneficiaries. While there are numerous types of trusts with a variety of charac-teristics, for estate planning purposes the most popular is the living revocable trust.
While a simple living trust will avoid probate, it does not necessarily save any federal income or es-tate taxes. From an income tax standpoint, it is typically classified as a “grantor” trust and the person creating the trust is taxable on its income. In addition, since the trust is typically revocable by the trustor, on the trustor’s death all assets in the trust are included in the trustor’s federal taxable es-tate.
For married couples, a popular type of trust is the “A-B” marital deduction trust. These trusts not only can avoid probate but also can reduce or avoid federal income and estate tax. This is accom-plished through the effective use of the marital deduction and the applicable exclusion amount. For example, such a trust can transfer tax-free to the couples’ heirs up to twice the applicable exclusion amount ($11,700,000 in 2021) plus the growth in up to one-half of their estate.
Note: Testamentary trusts are created by will at the time of the decedent’s death. As a result, tes-tamentary trusts require probate. This is a severe drawback with few offsetting advantages.
Special Planning Tools
The motivation to pass more wealth to survivors and save death taxes while retaining maximum control where possible has generated a variety of specialized estate planning tools. While many of the techniques listed below are more appropriately used for larger estates (i.e., those well in excess of the applicable exclusion amount), given the proper circumstances, they should be considered re-gardless of the size of the estate.
Spending
You may wish to simply spend and use up your estate for your own benefit. You earned it; you spend it. You do not have to leave it to anyone. However, most people are not so aggressive in reducing their estates.
1-15
Annual Gift Tax Exclusion
Up to $15,000 (in 2021) per donee per year can be given without gift tax consequences to each of an unlimited number of recipients. This amount is adjusted for inflation. In addition, an unlim-ited amount may be transferred free of gift tax for qualified tuition and medical expenses. Such gifts do not reduce the donor’s gift tax applicable exclusion amount ($5,000,000 in 2011; $5,120,000 in 2012; $5,250,000 in 2013; $5,340,000 in 2014; $5,430,000 in 2015; $5,450,000 in 2016; $5,490,000 in 2017; $11,180,000 in 2018; $11,400,000 in 2019; $11,580,000 in 2020; and $11,700,000 in 2021) and do not result in income tax to the recipient.
1-16
Gifting Tips
• Avoid Gifts of Future Interests
• Use Gift Splitting
• Make Direct Tuition or Medical
Expense Payments
• Don’t Give Appreciated Property
Shortly Before Death
• Don’t Give Property That May Drop in
Value
• Beware of Kiddie Backfire Tax
• Careful of Gifts of Mortgaged
Property
• Don’t Delay Lifetime Gifts
• Consider Crummy Trusts
• Beware of Generation Skips
• Beware of Transfers With Retained
Interests
• Watch COD on Life Insurance
• Give Power to Make Gifts in POA
• Careful of Donor as Trustee
1-17
The estate planning benefit of such gifts is a reduction in the taxable federal estate by both the original gift and any subsequent appreciation. For large estates, a pattern of gifts should be initi-ated early in order to transfer any substantial funds.
Applicable Exclusion Amount
The applicable exclusion amount is the size of an estate that can pass estate tax-free to one’s heirs. As a result of recent tax law, this amount has gradually risen over several years. In 2009, individuals could transfer a total of $3,500,000 in assets either during their lives or at death with-out paying any federal estate or gift tax. After applying this applicable exclusion amount the es-tate tax rate began at 45%. In 2010, the estate and generation-skipping transfer taxes were re-pealed.
However, in December of 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRJCA”) reinstated (subject to a special election for 2010) the es-tate and generation-skipping transfer taxes effective for decedents dying and transfers made af-ter December 31, 2009.
Note: This reenactment of the estate tax is in a complicated section of TRUIRJCA that sunsets cer-tain provisions of EGTRRA as if they had never been enacted.
For 2010 and 2011, the estate tax applicable exclusion amount was $5 million: for 2012 the ex-clusion was inflation indexed to $5.12 million. Amounts exceeding this exclusion amount were taxed at 35%. ATRA kept the inflation-indexed exclusion ($11.7 million in 2021) but, permanently increased the top estate, gift, and GST rate from 35% to 40% for transfers over the exclusion.
Spousal Portability of Unused Exemption Amount
Under TRUIRJCA, any applicable exclusion amount that remains unused as of the death of a spouse who dies after December 31, 2010 (the "deceased spousal unused exclusion amount"), is available for use by the surviving spouse, as an addition to such surviving spouse's applicable exclusion amount.
Note: The Act does not allow a surviving spouse to use the unused generation-skipping transfer tax exemption of a predeceased spouse.
If a surviving spouse is predeceased by more than one spouse, the amount of unused exclu-sion that is available for use by such surviving spouse is limited to the lesser of $11.7 million (in 2021) or the unused exclusion of the last such deceased spouse. This last deceased spouse limitation applies whether or not the last deceased spouse has any unused exclusion or the last deceased spouse's estate makes a timely election. A surviving spouse may use the pre-deceased spousal carryover amount in addition to such surviving spouse's own $11.7 (in 2021) million exclusion for taxable transfers made during life or at death.
Note: A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return.
1-18
2010 Special Election
For a decedent who died during 2010, TRUIRJCA allowed the executor of such a decedent's estate to elect to apply the Code as if the TRUIRJCA estate tax and fair market value basis step-up rules had not been enacted. When such an election was made, the estate would not be subject to estate tax but, the basis of assets acquired from the decedent would be deter-mined under the modified carryover basis rules of §1022.
Comment: Estates not covered by the applicable exclusion amount should have made this election. However, the executor would have had to consider a variety of factors, particularly, the estate tax savings vs. the gain that would be subject to tax on a future sale of assets.
Unlimited Marital Deduction
Since 1981, transfers between spouses during lifetime or at death are not taxed. An individual’s total gross estate at death is reduced by the marital deduction for any property passing directly to, or in trust for, the individual’s surviving spouse. Thus, property transferred outright to the surviving spouse qualifies for the unlimited marital deduction.
In addition to outright transfers, property payable to a marital deduction trust for the sole benefit of the surviving spouse can also qualify for this unlimited estate tax deduction. In order to qualify, the marital deduction trust must pay all of the income it generates to the spouse and only the spouse is eligible for principal distributions during his or her lifetime. The surviving spouse must also be given the right to convert unproductive property to income-producing property.
Family Business Deduction - Expired
Prior to 2004, a Qualified Family-owned Business Interest (QFBI) could receive an estate tax value deduction of $1.3 million less the applicable exclusion amount. In order to receive the deduction, a variety of complex requirements had to be met, including the following:
(1) Decedent must have been a U.S. citizen or resident;
(2) The qualified business’s principal place of business must be in the U.S.;
(3) Ownership of the business must be held at least 50% by the decedent and the decedent’s family, or 70% by two families or 90% by three families;
Note: In the latter two cases, the decedent and the decedent’s family must own at least 30%.
(4) The value of the decedent’s interest passing to qualified heirs must exceed 50% of the decedent’s adjusted gross estate;
(5) In the year of the decedent’s death no more than 35% of the adjusted ordinary gross income of the business can be personal holding income;
(6) The decedent or a member of the decedent's family must have owned and materially participated in the business; and
(7) The business’s stock must not have been publicly traded within three years of the dece-dent's death.
Installment Payment of Estate Taxes - §6166
Federal estate taxes are normally payable in full within nine months of the decedent’s death. However, certain qualified business interests can qualify for the installment payment of federal
1-19
estate taxes over a period of up to 15 years. This deferral of federal estate taxes is available for the tax attributable to the first $1,590,000 (for 2021) in taxable value of the closely held business. The annual interest rate on such installments can be as low as 2%.
Private Annuities
A private annuity is where one person transfers property to another (who is not in the business of selling annuities) for that person’s unsecured promise to make fixed periodic payments to the other for life. The property must be transferred for full and adequate consideration. The results can be similar to a self-canceling installment note, however, under a private annuity, the pay-ments never stop so long as the annuitant is alive. An annuity can also reduce the transferor’s estate and spread out the gain on the transferred property over the annuitant’s life expectancy.
Regs Restrict Private Annuity Tax Benefits
The IRS has issued proposed regs that would eliminate the income tax advantages of selling appreciated property in exchange for a private annuity. Under the new rules, the property seller's gain would now be recognized in the year the transaction occurs rather than as pay-ments are received ((Prop. Reg. § 1.72-6, Prop Reg § 1.1001-1)).
The regs generally would apply for transactions entered into after Oct. 18, 2006. However, certain transactions effected before Apr. 19, 2007 would continue to be subject to the current rules.
Installment Sale to Family Member
While there are restrictions on the use of the installment sale method among family members and related entities, it can be used very effectively as an estate planning tool. When selling an asset to a family member on the installment method, the potential appreciation of the asset is shifted to the purchasing family member. The installment note can be secured by the property sold. In addition, any gain on the sale can be spread out over the term of the installment note or perhaps enjoy the §121 exclusion. However, the promissory note will be part of the seller’s estate and receives no step up in basis on death.
Self-Canceling Installment Notes
The self-canceling installment note is a device that arose to prevent the inclusion of the in-stallment note in the seller’s estate. This type of installment sale uses a promissory note that by its terms expires on the death of the payee. As a result, the unpaid balance of the note is reduced to zero at death and there is arguably nothing included in the payee’s estate at death. Since the note may expire before the payee receives all payments, an additional “premium” must be paid for the self-canceling provision. Determining the amount of the premium with any certainty is extremely difficult.
Note: Self-canceling installment notes are frequently referred to as death terminating notes.
Irrevocable Life Insurance Trust
While life insurance proceeds are generally not income taxable, they are included in the insured’s federal estate. To prevent this inclusion an irrevocable life insurance trust can be used. This is a
1-20
specific type of trust in which you give up all ownership rights. The trust is made the owner and beneficiary of the life insurance to remove the proceeds from the estate of the insured and the insured’s spouse. Strict formalities are required to set up such a trust.
To avoid estate taxation, the insured must avoid all incidents of ownership in the policy. Obvi-ously, the insured should not own the policy outright. Unfortunately, the concept of “incidents of ownership” is not clearly defined and courts have been inconsistent in applying the term. As a result, the IRS looks for any strings or links between the insured and the policy.
1-21
Estate Tax Reduction
• Spend & Use Up the Estate
• Make Effective Gifts
– Annual Exclusion
– Use of Appreciating Property
– Value-Discounted Interests
• Minority & Fractional Interests
– Gifts in Trust
• Irrevocable Life Insurance Trust
• Charitable Remainder Trusts
• GRIT, GRAT, GRUT & QPRT
• Buy-Sell Agreements
• Installment Sales
– Death Terminating Notes (SCINs)
• Private Annuities
1-22
Special Valuation of Farms and Businesses - §2032A
In general, the value of real estate must be determined based upon its highest and best use. However, an executor may, when certain requirements are met, elect to value, for estate tax purposes, real estate used as a farm or other closely held business based upon its actual use rather than its highest and best use (§2032A). Thus, farmland and real property used in a closely held business can be valued at less than fair market value.
The election cannot result in a reduction of more than $1,190,000 (in 2021) in fair market value. If the real property is later sold to non-qualified heirs or the qualified use of the property ceases, then the tax savings are recaptured and the amount of the additional tax which would have been payable if the election had not been made is then required to be paid.
Crummey Trusts
This concept takes its name from a court case lost by the IRS. In this case, the taxpayer wanted to set up a trust for several beneficiaries and take advantage of the $15,000 (in 2021) annual exclusion. While the taxpayer could have simply made outright gifts, he or she wished to do it through a trust that would discourage the beneficiaries from spending the gifts immediately.
However, making gifts to a trust presents problems when one also wants to take advantage of the annual exclusion. The annual exclusion requires that any excluded gifts must be present in-terests, not future - as in a trust. A Crummey trust is meant to overcome this problem.
Under this estate planning tool, gifts are made to an irrevocable trust. The beneficiaries are given only a short period of time each year to withdraw the gift from the trust. If they do not make such a withdrawal the funds remain in the trust and are administered pursuant to its terms. The result is hopefully the use of the annual exclusion with subsequent control of the funds by the trust.
Charitable Remainder Trusts
A charitable remainder trust can provide substantial annual payments to one’s heirs and a tax deduction to the grantor while at the same time benefiting a charity. The heirs can receive pay-ments during their lifetime or during a fixed term of up to 20 years. In general, the payments to the heirs must be at least 5% of the value of the trust’s assets. They cannot exceed 50%, and the present value of the amount going to the charity must be at least 10% of the amount contributed. On the death of the heirs, the remainder must pass to the charity.
Note: The grantors of the trust can also be life or term beneficiaries and receive payments.
Charitable remainder trusts are tax-exempt and do not pay any income taxes. However, the ben-eficiaries who receive payments are taxed on income that is distributed to them.
There are three basic types of charitable trusts:
(1) Charitable remainder annuity trusts,
(2) Charitable remainder unitrusts, and
(3) Charitable lead trusts.
1-23
Minor Trusts
Minor trusts under §2503 are similar in purpose to Crummey trusts. However, unlike Crummey trusts, minors' trusts are based on a federal statute, not written court opinion. If properly struc-tured these trusts qualify in whole or in part for the annual gift tax exclusion by law.
Minor trusts come in two variations. In the §2503(c) trust, the annual income may be accumu-lated, however, the trust must provide that both income and principal can be used for the minor’s benefit. Unfortunately, all trust assets must be distributed when the beneficiary turns age 21. In the §2503(b) trust, the annual income cannot be accumulated, however, the trust can continue past age 21. Trust principal is not required to be distributed to the income beneficiary and can actually go to someone else.
Family Limited Partnerships
A family limited partnership can be a great income, estate, and gift tax savings device. Senior family members can control property transferred to such a partnership while discounted gifts of limited partnership interests are made to the remaining family members. During its operation, partnership income can be split among family members through their ownership of interests in the partnership. In the meantime, senior family members can continue to exercise control of the partnership assets through their retention of general partnership interests. Finally, on the death of a senior family member, an estate tax discount may be in order because of the minority inter-est held at death.
Grantor Retained Income Trusts
A grantor retained income trust is an estate planning tool in which a grantor transfers certain property to an irrevocable trust for the benefit of his or her heirs while retaining an income or beneficial right in the property. In the estate and gift tax setting, the retention of an income or beneficial right in the property arguably reduces the value of the initial transfer to the trust. As a result, this discounted transfer would absorb less of the applicable exclusion amount. The longer the grantor has a right to the income generated by the trust property, the lower the value of the remainder interest.
If the grantor dies before his or her benefits are terminated under the terms of the trust, the trust assets are subject to estate taxes in the grantor’s estate. However, if the grantor outlives his or her right to receive benefits under the trust, the trust assets are excluded from his or her estate.
Over the years, Congress has limited the use of this tool to very specific types of trusts.
Qualified Personal Residence Trusts (QPRTs)
A qualified personal residence trust (QPRT) is a grantor retained income trust still permitted under federal law. In this variation of the tool, a grantor transfers his or her primary personal residence to a trust that allows the grantor to continue to reside in the home for a designated time. When the designated time expires, the property passes to the grantor’s heirs.
While the gift to the grantor’s heirs is subject to federal gift tax, the value of the present gift is determined under IRS tables after considering the term of the grantor’s retained interest,
1-24
the grantor’s age, and the applicable interest rate published by the IRS monthly. The reduc-tion in value can be substantial.
Grantor Retained Annuity Trusts (GRATs)
Grantor retained annuity trusts (GRATs) have similar rules to those of charitable remainder annuity trusts. The grantor transfers assets to a trust and retains a right to annuity payments. GRATs allow the gift of remainder interests that are discounted for gift-tax purposes under the IRS valuation tables. Longer terms produce lower remainder values.
Grantor Retained Unitrusts (GRUTs)
Grantor retained unitrusts (GRUTs) have similar rules to those of charitable remainder unitrusts. The grantor transfers assets to a trust and retains a right to unitrust payments. GRUTs are not considered as effective as GRATs where the trust’s assets are expected to ap-preciate.
Buy-Sell Agreements
Whenever two or more people are in business together it is an absolute necessity that they have a buy-sell agreement. Buy-sell agreements have a number of benefits, including:
(1) Liquidity for the deceased owner’s family,
(2) The ability to set the value of a business interest for estate tax purposes,
(3) Providing funds for retirement, and
(4) Lifetime transfer restrictions.
Estate Planning Facts
Garbage in - garbage out. Only accurate facts can serve as the basis for designing and implementing an estate plan. In many cases, this is the most challenging part of the estate planning process. The facts can be classified into three categories:
(i) Family
(ii) Property, and
(iii) Objectives.
Family
The estate planning team must gather family information. These facts should at the very least include the names, birth dates, and general health of all family members, prior marriages, and adoptions. The character of the spouse and other heirs and their business abilities must be considered. The financial needs of the family and the attitudes of individual heirs toward each other will also be im-portant.
1-25
Property
A property inventory must be gathered. The inventory should include stocks & bonds, insurance pol-icies, real property owned separately and jointly, business interests, and retirement and death ben-efits. Information about personal debts, business debts, installment contracts, and all other debts, including contingent liabilities should be obtained.
Note: Valuation problems are often caused by ownership of business interests. Generally, such in-terests must be valued under R.R. 59-60.
Domicile
Domicile determines many estate related factors, including:
(1) Title to property (e.g., community property versus separate property and joint tenancy versus a tenancy in common),
(2) The law that will govern the validity of the will and its provisions, and
(3) What state(s) will try to tax your assets.
Objectives
Estate goals must be formulated. Some people want their heirs to have unrestricted use of the assets they inherit. Others fear entrusting their heirs with substantial money, especially in one lump sum. In this environment, human considerations will supersede tax considerations. Basic estate planning objectives include:
(1) A valid will and trust that are periodically reviewed and revised when necessary,
(2) Flexibility to permit family members and heirs to meet changing needs and emergencies,
(3) Cash liquidity at death to cover final expenses and taxes,
(4) A business succession plan,
(5) The integration of insurance and retirement benefits with other estate assets,
(6) Maximization of income, gift, and estate tax savings devices,
(7) Providing for a comfortable retirement, and
(8) Financial independence.
Most estate planning is primarily for the benefit of the heir. In fact, as a result of the unlimited marital deduction, with minimal estate planning, all assets can pass to the surviving spouse without any fed-eral estate tax. Since there is no federal estate tax until the surviving spouse dies, only the benefi-ciaries save death taxes by detailed planning.
Existing Estate Plan
People have an estate plan that may have been developed consciously or accidentally. Intestate suc-cession will become their estate plan, even when they have signed no estate documents.
Information on this “plan” must be gathered and analyzed. If estate planning documents exist, they should be obtained and reviewed.
1-26
Date: ___________
Short Form Estate Planning Questionnaire
Please supply the following information so that we may prepare a proposal for your consideration. Be sure to print clearly! When completed, please return to our office for review.
Personal Information
1. a. Name: Date of Birth:
b. Spouse2 (if any): Date of Birth:
c. Date of Marriage: Place:
d. Date Came to California -Client: Spouse:
2. a. Residence Address:
Street City County Zip
b. Business Address:
Street City County Zip
c. Business Phone: ( ) ______________ Home Phone: ( )_____________
3. Prior Marriages (if any)3: Client:
Spouse:
4. Children4 (including deceased children):
Name Birth Date Name of Parents Name of Spouse
5. Grandchildren (including deceased grandchildren):
Name Birth Date Name of Parents Name of Spouse
Assets
6. If you are married:
a. Is all your property community property? yes no
2 If you are living with someone please indicate such and give date cohabitation began. 3 Indicate how marriage was terminated (e.g., death, divorce, etc.) and approximate date of termination. 4 Include adopted as well as natural.
1-27
b. Does the husband own separate property? yes no
c. Does the wife own any separate property? yes no
7. Do you (or your spouse) have a retirement plan? yes no
8. a. What is the total amount of insurance on your life? $
b. If married, what is the total amount of insurance
on your spouse’s life? $
9. a. Estimated net total of cash and notes: $
b. Estimated net value of real property: $
c. Estimated net value of stocks & bonds: $
d. Estimated net value of my business: $
e. Estimated net retirement plan benefits: $
f. Estimated net value of miscellaneous assets: $
Total estimated net worth: $
Estate Objectives
10. Who do you want to receive your personal effects?
Husband:
Wife:
11. Do you want to leave money or specific items to anyone or charity? If so, please specify what and to whom:
12. How do you wish the balance of your estate to be distributed?
13. Please list any further information or comments concerning the disposition of your estate:
1-28
Review Questions
4. Life insurance proceeds are included in a decedent’s estate where the decedent retained inci-dents of ownership over the policy. What planning device can taxpayers use to avoid this inclu-sion?
a. a payable on death account.
b. a private annuity.
c. a self-canceling installment note.
d. an irrevocable insurance trust.
5. Crummey trusts are based on a court case in which a taxpayer wanted to make present interest gifts through a trust. What is a characteristic of such a Crummey trust?
a. The taxpayer makes gifts to a revocable trust.
b. If funds are not withdrawn, they are administered according to the trust’s terms.
c. Making gifts to it presents problems when one wants to take advantage of the annual ex-clusion.
d. The beneficiaries may withdraw the gift from the trust at any time.
6. For their heirs, grantors may transfer some assets to an irrevocable trust and, for themselves, they may keep an income or beneficial right in the property. What is such an estate-planning device often called?
a. buy-sell agreement.
b. family limited partnership.
c. grantor retained income trust.
d. minor trust.
1-29
Learning Objectives
After reading Chapter 2, participants will be able to:
1. Identify potential death taxes including federal estate tax as it applies to various size estates, specify the principal taxes that impact death taxation, and determine the expira-tion of the death tax credit.
2. Determine what constitutes a taxable estate under §2501 specifying what assets are included in a gross estate using basic categories of property and transfers.
3. Specify estate deductions allowed under federal estate tax law stating their tax ad-vantages and disadvantages.
4. Determine the value of a decedent’s assets using permitted elections, recognize the use of Form 706 to pay any estate tax due, select the tax basis of estate assets stating how common transactions affect property basis under §1014.
5. Recall the advantages of gift planning including estate reduction recognizing the impact of the GST, specify the steps to compute gift tax identifying the gift tax exclusion amount, and determine the value of gifts including those that are split.
6. Identify the various gift tax exclusions, specify the tax treatment of below-market loans, recall the gift tax marital deduction requirements, determine the tax consequences of giv-ing various assets specifying factors to consider when gifting, and recognize the use of Form 709 to compute and pay federal gift tax.
2-1
CHAPTER 2
Estate & Gift Taxes
There are not one but eight potential death taxes that may apply at death:
• FEDERAL ESTATE TAXES: Taxes imposed by the Federal Government on the transfer of assets on death (Form 706).
• STATE INHERITANCE TAXES: Taxes imposed by many (but not all) states on the right of heirs to receive assets on death.
• FEDERAL INCOME TAXES: No one ever dies on December 31 while mailing his or her in-come tax return early, so a return is due for the period January 1 to date of death (Form 1040).
• STATE INCOME TAXES: Most states (e.g., California Form 540) have his or her own income tax and require a return for the decedent’s income to date of death.
• FEDERAL GIFT TAXES: If the decedent made taxable gifts during his or her lifetime but failed to pay gift taxes these taxes plus interest and penalty must be paid by the executor (Form 709).
• STATE GIFT TAXES: Some states duplicate the Federal Gift Tax structure and impose a gift tax of his or her own.
• FEDERAL FIDUCIARY INCOME TAXES: If your estate has any income after your death it must also pay taxes on any such funds (Form 1041).
• STATE FIDUCIARY INCOME TAXES: Most states (e.g. California Form 541) also tax income received by your estate after your death.
Federal Estate Tax
Federal estate tax is a death tax imposed on the fair market value of taxable assets, less liabilities, owned at death. Taxable assets include the home, all life insurance (even though paid to someone else), and property owned jointly with someone else. Gift tax is imposed on transfers by gift during life, and the estate tax is imposed on the taxable estate at death.
Federal estate tax is not a property tax. It is an excise or privilege tax - i.e., it is imposed upon property transfers, not on property itself. This difference has constitutional significance. Article 1, section 9, clause 4 of the Constitution requires direct (property) taxes to be apportioned among the states according to population.
2-2
Note: Despite popular belief, a person does not have a right to have his or her property transferred to others at death. This is a privilege granted by the state and not a right.
However, indirect (transfer) taxes need only be uniform (New York Trust Co. v. Eisner, 256 U.S. 345 (1921)).
Historical Note: The revenue needs of World War I generated the first federal estate tax under the Revenue Act of 1916. However, the end of the war did not end the tax. While refined over the years, the essential elements of that estate tax continue today in §2001 through §2209 of the Internal Revenue Code.
While substantial dollars are raised by the federal estate tax, the percentage of federal revenue it collects is small. Initial supporters of the tax saw the federal estate tax as a way to limit the accumu-lation of wealth rather than an income resource.
Changing Legislative Landscape
Changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 greatly affected estate planning repealing the 5% surtax (which phased out the benefit of graduated rates) and rates in excess of 50%. In addition, in 2002, the applicable exclusion amount (for both estate and gift tax purposes) was $1 million.
Note: The applicable exclusion amount is the size of an estate that can be passed free of federal estate tax. Everyone is entitled to the applicable exclusion amount.
In 2003, the estate and gift tax rates in excess of 49% were repealed. In 2004, the estate and gift tax rates in excess of 48% were repealed, and the applicable exclusion amount for estate tax purposes became $1.5 million.
Note: Until 2011, the applicable exclusion amount for gift tax purposes remained at $1 million as increased in 2002. However, for gifts after December 31, 2010, the exclusion amount was $5 million in 2011 and was $5.12 million in 2012.
In 2005, the estate and gift tax rates in excess of 47% were repealed. In 2006, the estate and gift tax rates in excess of 46% were repealed, and the applicable exclusion amount for estate tax purposes was increased to $2 million. In 2007, the estate and gift tax rates in excess of 45% were repealed. In 2009, the applicable exclusion amount was increased to $3.5 million. In 2010, the estate and gener-ation-skipping transfer taxes were repealed. However, in December of 2010, TRUIRJCA reinstated (subject to a special election for 2010) the estate and generation-skipping transfer taxes effective for decedents dying and transfers made after December 31, 2009. This reenactment of the estate tax was in a complicated section of TRUIRJCA that sunseted certain provisions of EGTRRA as if they had never been enacted.
Note: The Tax Relief Act of 2001 gradually phased out the state death tax credit between 2002 and 2004, with the credit repealed in 2005. Since 2005, the state death tax credit is replaced by a de-duction for state death taxes paid. TRUIRJCA continued this deduction through 2012 (§2058). ATRA made the state death tax deduction permanent for decedents dying after December 31, 2012.
For 2010 and 2011, the estate tax applicable exclusion amount was $5 million: for 2012 the exclusion was inflation indexed to $5.12 million. Amounts exceeding this exclusion amount were taxed at 35%. ATRA kept the inflation-indexed exclusion ($11.7 million in 2021) but, permanently increased the top
2-3
estate, gift, and GST rate from 35% to 40% for transfers over the exclusion. As a result, the applicable exclusion amounts and their credit equivalents are as follows:
Year of death Exclusion Amount Credit Equivalent
2012 5,120,000 1,772,800
2013 5,250,000 2,045,800
2014 5,340,000 2,081,800
2015 5,430,000 2,117,800
2016 5,450,000 2,125,800
2017 5,490,000 2,141,800
2018 11,180,000 4,360,200
2019 11,400,000 4,505,800
2020 11,580,000 4,577,800
2021 11,700,000 4,625,800
Note: The exclusion amounts apply to cumulative transfers. Thus, a taxpayer who made $1,000,000 of taxable gifts in 2021 could not then transfer $11,700,000 upon death in 2021 without paying wealth transfer tax. The taxpayer could transfer only $10,700,000 free of tax upon death ($11,700,000 estate tax exclusion amount minus $1,000,000 taxable lifetime gifts).
The generation-skipping transfer tax exemption for a given year is equal to the applicable exclusion amount for estate tax purposes. In addition, the generation-skipping transfer tax rate for a given year will be the highest estate and gift tax rate in effect for such year.
Spousal Portability of Unused Exemption Amount - §2010(c)(2)
Under TRUIRJCA, any applicable exclusion amount that remains unused as of the death of a spouse who dies after December 31, 2010 (the "deceased spousal unused exclusion amount"), is available for use by the surviving spouse, as an addition to such surviving spouse's applicable exclusion amount.
Note: The Act does not allow a surviving spouse to use the unused generation-skipping transfer tax exemption of a predeceased spouse.
If a surviving spouse is predeceased by more than one spouse, the amount of unused exclusion that is available for use by such surviving spouse is limited to the lesser of $11.7 million (in 2021) or the unused exclusion of the last such deceased spouse. This last deceased spouse limitation applies whether or not the last deceased spouse has any unused exclusion or the last deceased spouse's estate makes a timely election. A surviving spouse may use the predeceased spousal carryover amount in addition to such surviving spouse's own $11.7 million (in 2021) exclusion for taxable transfers made during life or at death.
Note: A deceased spousal unused exclusion amount is available to a surviving spouse only if an election is made on a timely filed estate tax return (including extensions) of the predeceased spouse on which such amount is computed, regardless of whether the estate of the predeceased spouse otherwise is required to file an estate tax return.
2-4
Persons Subject to Federal Estate Tax
The federal estate tax applies to all property owned by a citizen or resident of the United States without regard to its location (§2031). Likewise, gift tax applies to all property transferred by a citizen or resident (§2501). In the case of nonresident aliens, only property located in the United States is subject to the federal estate tax (§2103).
Applicable Exclusion Amount, Basic Computation & Rates
In 2021, the first $11,700,000 of a person’s estate who died is not taxable – this is called the applica-ble exclusion amount. The law is written so that the first $4,625,800 (in 2021) of estate taxes (i.e., the credit equivalent) is not paid, which translates into a taxable estate of about $11,700,000. There-after, the tax rate is a flat 40% for taxable estates over $11.7 million.
Note: A single set of deductions, exemptions, and graduated rates apply to a decedent’s estate. It makes little difference how many heirs share in the estate, or who they are.
Progressive or Flat Rate
Federal estate and gift taxes are technically progressive. However, as a result of increased appli-cable exclusion amounts, both impose a flat (or top) rate on all taxable amounts in excess of his or her applicable exclusion amounts. Below are the technically progressive and unified estate and gift tax rates after 2012.
“Technically Progressive” Estate & Gift Tax Rates – Years After 2012
If the amount is: Tax is: Over But not over Tax +% Excess Over 0 $10,000 0 18 $0 $10,000 $20,000 $1,800 20 $10,000 $20,000 $40,000 $3,800 22 $20,000 $40,000 $60,000 $8,200 24 $40,000 $60,000 $80,000 $13,000 26 $60,000 $80,000 $100,000 $18,200 28 $80,000 $100,000 $150,000 $23,800 30 $100,000 $150,000 $250,000 $38,800 32 $150,000 $250,000 $500,000 $70,800 34 $250,000 $500,000 $750,000 $155,800 37 $500,000 $750,000 $1,000,000 $248,300 39 $750,000 $1,000,000 ------------ $345,800 40 $1,000,000
However, even though above the table shows a progressive application of estate tax rates, the size of the applicable exclusion amount negates his or her effect and resulted in a 45% flat estate tax from 2007 to 2009, a 35% flat estate tax from 2010 through 2012, and a 40% flat estate tax for years after 2012.
Likewise, the maximum gift tax rate also fluctuated. In 2010, the maximum gift tax rate was scheduled to equal the highest marginal individual income tax rate then in effect (35%). However,
2-5
for gifts made after December 31, 2010, the gift tax was reunified with the estate tax, with the same applicable exclusion amount and the top estate and gift tax rate was 35%. In 2013, the American Tax Relief Act (“ATRA”) permanently increased the gift rate from 35% to 40% for trans-fers over the applicable exclusion amount.
2-6
Estate & GST Tax Chart
Year Rate RangeEstate & GST
Exclusion
2008 Flat 45% $2 million
2009 Flat 45% $3.5 million
2010 0% or Flat 35% $5 million
2011 Flat 35% $5 million
2012 Flat 35% $5.12 million
2013 Flat 40% $5.25 million
2014 Flat 40% $5.34 million
2015 Flat 40% $5.43 million
2016 Flat 40% $5.45 million
2017 Flat 40% $5.49 million
2018 Flat 40% $11.18 million
2019 Flat 40% $11.4 million
2020 Flat 40% $11.58 million
2021 Flat 40% $11.7 million
2-7
Note: The gift tax imposed for each calendar year is an amount equal to the excess of (1) a tentative tax, computed using the rate schedule above, on the aggregate sum of the taxable gifts for such calendar year and for each of the preceding calendar periods, over (2) a tentative tax, computed using the rate schedule above, on the aggregate sum of the taxable gifts for each of the preceding calendar periods.
2010 Special Election
For a decedent who died during 2010, TRUIRJCA allowed the executor of such a decedent's estate to elect to apply the Code as if the TRUIRJCA estate tax and fair market value basis step-up rules had not been enacted. When such an election was made, the estate would not be subject to estate tax but, the basis of assets acquired from the decedent would be determined under the modified carryover basis rules of §1022.
State Inheritance Tax
There are two fundamental types of death taxes:
(1) Estate taxes, and
(2) Inheritance taxes.
Estate tax is basically a tax upon the value of all property owned at death which is transferred to heirs. Inheritance tax is a tax upon property received by heirs.
Many states impose inheritance taxes on the amounts received by heirs. Most inheritance tax sys-tems apply separate exemptions and rates to the share received by each heir. Typically, the rates and exemptions vary depending upon the relationship of the heir.
State inheritance taxes are often tied to the federal estate tax. However, even where there is no direct tie, state inheritance taxes are often similar to federal estate tax concerning the property and transfers subject to tax. Thus, federal estate tax planning should achieve suitable state inheritance tax results as well.
State Death Tax Credit Turns into Deduction – §2011 & §2058
Prior to 2005, the maximum allowable state death tax credit was based on the size of the "ad-justed taxable estate," which, for purposes of the credit, was the taxable estate reduced by $60,000 (§2011). The chart below shows the maximum credit formerly available for state death taxes.
Death Tax Credit
Column #1 Column #2 Column #3 Column #4
Adjusted Taxable Es-tate* Equal to or
More Than:
Adjusted Taxable Estate* Less Than:
Credit on Amount in Column (1):
Rate of Credit on Ex-cess over Amount in
Column (1)
0 40,000 0 None
40,000 90,000 0 0.8
90,000 140,000 400 1.6
140,000 240,000 1,200 2.4
240,000 440,000 3,600 3.2
2-8
440,000 640,000 10,000 4.0
640,000 840,000 18,000 4.8
840,000 1,040,000 27,600 5.6
1,040,000 1,540,000 38,800 6.4
1,540,000 2,040,000 70,800 7.2
2,040,000 2,540,000 106,800 8.0
2,540,000 3,040,000 146,800 8.8
3,040,000 3,540,000 190,800 9.6
3,540,000 4,040,000 238,800 10.4
4,040,000 5,040,000 290,800 11.2
5,040,000 6.040,000 402,800 12.0
6,040,000 7,040,000 522,800 12.8
7,040,000 8,040,000 650,800 13.6
8,040,000 9,040,000 786,800 14.4
9,040,000 10,040,000 930,800 15.2
10,040,000 — 1,082,800 16.0
*"Adjusted taxable estates" equals taxable estate minus $60,000.
The Tax Relief Act of 2001 gradually phased out the state death tax credit between 2002 and 2004, with the credit being repealed in 2005. Since 2005, the state death tax credit has been replaced by a deduction for state death taxes paid (§2058). ATRA made this deduction permanent (§2058).
Prior to 2005, the state death tax credit was reduced as follows:
(1) 25% in 2002,
(2) 50% in 2003, and
(3) 75% in 2004.
Thus, the maximum state death tax credit allowable for:
(1) 2002 was $812,100 plus 12% of the excess of over $10,040,000,
(2) 2003 was $541,400 plus 8% of the excess of over $10,040,000, and
(3) 2004 was $270,700 plus 4% of the excess over $10,040,000.
Many states used a “credit estate tax” calculation, which meant that since the Federal govern-ment allowed a credit for presumed state death taxes, rather than permitting this credit to go unused, most states imposed a tax equal to the allowed credit as their state inheritance tax (e.g., California). With the expiration of the federal credit, many states have had to modify this calcu-lation.
2-9
Review Questions
7. Upon a decedent’s death, numerous tax forms must be filed. Which form is due for the period of January 1 to the date of the decedent’s death?
a. Form 706.
b. Form 709.
c. Form 1040.
d. Form 1041.
8. Federal estate tax is one of eight potential death taxes. What is a distinguishing characteristic of the federal estate tax?
a. It is not a privilege tax.
b. It is a tax on a property transfer.
c. It is not an excise tax.
d. It is a tax on property.
9. Estate and inheritance taxes are the two basic types of state death taxes. What is a character-istic of the estate tax used by many states?
a. Distinct exemptions and rates apply to amounts received by each heir.
b. It applies to the value of property that heirs receive.
c. It applies to the value of all assets that the decedent owned at death and is transferred to heirs.
d. It is similar to federal estate tax concerning the property and transfers subject to tax.
10. Section 2033 provides that when an interest terminates at death, said interest is excluded from taxation. Under R.R. 75-127, what has also been excluded from taxation?
a. any insurance proceeds remaining at death if the insured is dead when the policy owner dies.
b. income accruing from rental property after death.
c. income accruing from stocks or bonds after death.
d. the proceeds from wrongful death claims.
2-10
Taxable Estate - §2051
Federal estate tax is applied to the “taxable estate” (§2001). Under §2051, the “taxable estate” is defined as the “gross estate” less any allowable deductions. Thus, before estimating estate tax, one must know:
(1) What assets are included in the gross estate,
(2) The value of those assets, and
(3) Any and all allowable deductions.
The estate planner is helpless without knowledge of these three things.
Gross Estate - §2031
Under §2031, the gross estate includes the value of all real or personal, tangible or intangible property, owned by the decedent in whole or in part at the time of death, wherever situated.
Section 2033 further provides that: “The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his or her death.” This includes any real property located outside the United States.
Note: Because the gross estate includes the value of all property owned at death, ownership is important to determine the gross estate. Generally, state law will control the issue of ownership for tax purposes.
Section 2033 through §2046 list four basic categories of property and transfers included in the gross estate:
1. Owned Property - Under §2033 and §2034, all property owned at death is included in the gross estate.
2. Lifetime Transfers - Under §2035 through §2038, even lifetime transfers of property may be included in the gross estate under certain circumstances.
3. Interests, Rights & Powers - Some interests, rights, or powers while not technically “prop-erty” or “transfers” do transfer value upon death. Section 2039 through §2042 handle four such types of property:
(a) Annuities (§2039),
(b) Joint tenancies (§2040),
(c) Powers of appointment (§2041), and
(d) Life insurance (§2042).
4. Gratuitous Transfers - Under §2043 gratuitous transfers are subject to the estate tax. These are sales or exchanges not for full consideration.
2-11
Federal Gross Estate
Interests Owned At Death:
– §2033 - property owned outright
– §2034 - dower & curtsey
– §2039 - survivor annuities
– §2040 - joint interests
– §2041 - powers of appointment
– §2042 - life insurance
Transfers With Retained Interest:
– §2036 - retained life interests
– §2037 - reversionary interests
– §2038 - revocable transfers
Transfers within 3 years of death of
interests includable under §2036, 2037,
2038 & 2042 (§2035)
2-12
Owned Property - §2033
A decedent’s gross estate is composed of a wide variety of “owned” property. All types of property are subject to federal estate tax whether real or personal, tangible or intangible. This includes notes or other claims, contract rights, accrued salary, rent, interest, and divi-dends.
When a person has a note or claim against another, the amount thereof is taxable under §2033 even if the obligation is canceled in the will. The cancellation is treated as if the decedent had transferred the amount of the debt to the debtor (Reg. §20.2033-1(b)).
Note: The result is different for self-canceling installment notes. In Moss v. Commissioner, 74 T.C. 1239 (1980), the decedent sold stock taking back an installment note that canceled on his death. The Tax Court held that the obligation was extinguished by the decedent’s death and any unpaid balance was not includible in the decedent’s estate.
The “ownership” required by §2033 is beneficial ownership. Mere legal title is not included in an estate (Reg. §20.2033-1). Thus, if Dan holds title to property as trustee for Daphne but he has no beneficial interest, the property is not included in Dan’s estate.
Note: A transfer that is void under local law does not convey beneficial ownership and the property remains taxable in the transferor’s estate under §2033 (City National Bank v. United States, 383 F. 2d 341 (5th Cir. 1967)).
A mere expectancy is not an interest in property. The possibility that a decedent may receive property under a will or under the laws of intestate succession is not includible in his or her estate as property.
Interests Terminating At Death - Life Estates & Joint Tenancies
Interests that terminate upon death (e.g., a life estate) are not taxable under §2033 (Wil-liams v. United States, 41 F. 2d 895 (Ct. Cl. 1930) and Helvering v. Rhodes’ Estate, 117 F. 2d 509 (8th Cir. 1941))1. However, if a person’s life estate is measured by the life of another and he or she dies before the end of the measuring life, the remaining term of that life estate is includible in the decedent’s gross estate. A similar result applies to future inter-ests not contingent upon survival (R.R. 67-370) and the remaining portion of a term of years (Millard v. Malony, 121 F. 2d 257 (3d Cir. 1941)).
Note: While interests terminating on death are not taxable, this rule only applies to interests conveyed to the decedent by another. Transfers by the decedent with a retained life estate are taxable in the decedent’s estate under §2036.
Joint tenancies with right of survivorship are also interests that terminate at death. As a result, there is no “transfer” from a deceased joint tenant to the survivor and §2033 does not apply. However, §2040 does tax this form of ownership.
Note: Tenancies in common do not carry survivorship rights and are taxable under §2033 be-cause the interest of a deceased co-tenant is inheritable (Harvey v. United States, 185 F. 2d 463 (7th Cir. 1950)).
1 Similarly, a life interest under an annuity contract (purchased by the decedent or another) having no refund or survivor
feature is not included in the gross estate because all rights end on death.
2-13
Interests Created After Death
Lawsuits - For many years the Service insisted that wrongful death actions were taxable under §2033. However, in R.R. 75-127, the Service reversed itself and agreed that the value of wrongful death claims (or the proceeds) is not taxable.
Note: Any claims or causes of action owned by the decedent at the time of death and which survive death are includible in the gross estate under §2033 (Maxwell Trust v. Commissioner, 58 T.C. 444 (1972)).
Insurance Contracts - While insurance proceeds are subject to special rules under §2042, an insurance contract is brought into the policy owner’s gross estate under §2033 if the owner is not the insured. This can happen where one spouse owns an insurance contract on the other.
If the insured is alive when the policy owner dies, only the value of the policy (at replace-ment cost) is includible in the policy owner’s estate (DuPont’s Estate v. Commissioner, 233 F. 2d 210 (3d Cir. 1956)). However, if the insured is dead when the policy owner dies, then any proceeds remaining at death are taxable.
Income - If income property (e.g., rental property, stocks, or bonds) is owned at death, §2033 includes, in the estate, both the value of that property and the income therefrom which has accrued at the date of death (Reg. §20.2033-1(b)). However, income accruing after death is not included but is income taxable to the estate or heirs.
The present value of a right to receive income in the future owned at death is included in the gross estate. This value is determined by discounting the amount of the expected pay-ments using tables specified by Reg. §20.2031-7.
Note: Future interests that are contingent on survival are terminated at death and are not included in the estate under §2033.
Remainder Interests
Under §2033, a remainder interest or other future interest in property is included in the gross estate, unless the interest is a contingent remainder or terminates on the death of a decedent. Thus, if a decedent transfers property and retains an interest in the property, but that interest is contingent on the person remaining alive, §2033 does not apply.
A contingent remainder is an interest that:
(i) Does not come into enjoyment or possession unless a future condition occurs, or
(ii) Can end on the occurrence (or nonoccurrence) of a future event.
A vested remainder is included in the estate of a remainder person who dies before ob-taining such property interest. However, a remainder interest is limited to the remainder person’s life.
Example
Husband transfers assets to a trust with income to his wife, for life, with remainder to his son (if living), and any remainder to his nephew. If the son dies survived by wife, nothing is included in the son’s estate since the interest ended at his death. However,
2-14
the nephew’s interest vests on the son’s death. If the nephew now dies (i.e., after the son is dead), survived by the wife, his interest is included in his estate.
Dower & Curtsey - §2034
Dower and curtsey are not vested interests, but mere expectancies in the property. A dower (to the wife) or curtsey (to the husband) is a statutory provision in a common-law state that directs a certain portion of the estate to the surviving spouse. Section 2034 includes in the decedent’s gross estate “the value of all property to the extent of any interest therein of the surviving spouse, existing at the time of the decedent’s death as dower or curtsey, or by virtue of the statute creating an estate in lieu of dower or curtsey." Thus, property owned at death is included at its full value without reduction for the surviving spouse’s marital interests therein (Reg. §20.2034-1).
For example, a husband without a will dies, with an estate of $1,200,000. Under state law, the wife is entitled to one-third of the husband’s estate. As a result, the $400,000 that the wife receives is included in the husband’s estate under §2034.
Community Property Comparison
In community property states each spouse owns a present, undivided one-half interest in the community assets. On the death of either spouse, only his or her one-half is includible in his or her estate.
Gifts within Three Years of Death - §2035
Formerly, estate tax law automatically included in the donor’s estate any gifts made within three years of the donor’s death (§2035(a)). However, the Economic Recovery Tax Act of 1981 eliminated most outright gifts from inclusion in the donor’s gross estate under this rule. Nev-ertheless, §2035 was not repealed and continues to have two important effects:
(i) Any gift taxes paid or payable on such gifts are included in the donor’s estate, and
(ii) If the decedent holds an interest under §2036, §2037, §2038, or §2042 and attempts to transfer or release it within three years of death it will still be included in the decedent’s estate.
Transfers from Revocable Trusts
In the past, there was significant litigation as to whether these rules required that certain transfers made from a revocable trust within three years of death be includible in the gross estate. See, e.g., Jalkut Estate v. Commissioner, 96 T.C. 675 (1991) (transfers from revoca-ble trust includible in gross estate); McNeely v. Commissioner, 16 F. 3d 303 (8th Cir. 1994) (transfers from revocable trust not includible in gross estate); Kisling v. Commissioner, 32 F. 3d 1222 (8th Cir. 1994) (acq.) (transfers from revocable trust not includible in gross es-tate).
The TRA ‘97 codified the rule set forth in the McNeely and Kisling cases to provide that a transfer from a revocable trust (i.e., a trust described under §676) is treated as if made directly by the grantor. Thus, an annual exclusion gift from such a trust is not included in the gross estate.
2-15
Retained Life Interest - §2036
A transfer with a retained life interest is included in the gross estate. Section 2036 imposes a tax upon any lifetime transfer made by a decedent “under which he has retained for his life or any period not ascertainable without reference to his death or for any period which does not in fact end before his death - (1) the possession or enjoyment of, or the right to income from, the property, or (2) the right either alone or in conjunction with any person, to desig-nate the persons who shall possess or enjoy the property or the income therefrom.”
Section 2036(a) specifies four requirements for taxation:
(1) There must have been a lifetime transfer of property;
(2) Decedent retained interests in or powers over the property;
(3) The retained interests or powers must be either:
a. The possession, right to income, or other enjoyment of the property (§2036(a)(1)); or
b. The right to designate who shall possess or enjoy the property or its income (§2036(a)(2)); and
(4) The taxable interest or power is retained:
a. For life; or
b. For a period other than life if the period cannot be determined without reference to the transferor’s death; or
c. For a period of time other than life if in fact, the decedent dies before the end of that period.
The enjoyment of the property is considered as having been retained by the decedent if it is to be applied to discharge any legal obligations, including the support of a dependent.
Section 2036 does not apply to a power held solely by a person other than the decedent, such as an independent trustee. However, if the decedent reserved the power to remove a trustee and appoint himself or herself as trustee, the decedent is considered as having the powers of the trustee.
Example
Dan creates a trust naming an independent trustee. Trust income is used to support his three minor children. Dan dies while all his children are still minors. Because the trust income was being used to satisfy his legal obligation of support, the trust assets would be included in his estate under §2036.
The entire value of property subject to a retained interest or power is taxable under §2036. The tax is not limited to the value of the specific interest or power2.
2 However, where the retained right relates only to a portion of the property, only that portion is taxed.
2-16
Example
Dan transfers property in trust for Alice for life and remainder to Ralph, retaining the power to substitute other income beneficiaries. While Dan’s power affects only the income interest, (not the remainder), the full value of the property is taxable in Dan’s estate.
Retained Voting Rights
Directly or indirectly retained voting rights in stock of a controlled corporation is the re-tention of the enjoyment of the stock under §2036(a). Control is ownership of, or the right to vote, stock possessing at least 20% of the total voting power of all classes of stock.
Lifetime Transfers With Reversionary Interests - §2037
The estate includes the value of any property transferred by the decedent in any way, except for full consideration, when two (perhaps three?) requirements are met:
(1) Possession or enjoyment of the property could only have been obtained by surviving the decedent (§2037(a)(1)); and
Note: However, for estate tax to apply the property must be “owned” by the decedent at death and it must be “transferred” from the decedent to another. If a decedent’s death is merely instrumental in someone acquiring an interest in property that is not enough to sup-port imposition of the estate tax - e.g., a discretionary bonus granted to an employee after his or her death and paid to his or her executor is not taxable in the employee’s gross estate (R.R. 65-217).
(2) The decedent retained a reversionary interest in the transferred property valued at more than 5% of the value of the transferred property (§2037(a)(2)).
Note: A reversionary interest is a possibility that property transferred by the decedent may return to the decedent or his or her estate or be subject to a power of disposition by the decedent (§2037(b)). The value of a reversionary interest is determined using mortality tables and actuarial principles.
The last sentence of §2037(b) imposes a final “negative requirement”:
“Notwithstanding the foregoing, an interest so transferred shall not be included in the decedent’s gross estate under this section if possession or enjoyment of the property could have been obtained by any beneficiary during the decedent’s life through the exercise of a general power of appoint-ment (as defined in §2041) which in fact was exercisable immediately before the decedent’s death.”
Example
Dan (decedent) transfers property to a trust. The income is payable to his wife for life and with the remainder payable to Dan or, if he is not living at his wife’s death, to his brother or his estate. The brother cannot obtain possession or enjoyment of the prop-erty without surviving Dan. If Dan’s reversionary interest immediately before his death exceeded 5% of the value of the property, the value of the property, less the value of the wife’s outstanding life estate, is includable in the decedent’s gross estate under §2037.
2-17
Thus, under §2037, the property must have been transferred by the decedent during life. Sec-tion 2037 does not apply to property transferred by another. In addition, a reversionary in-terest must be “retained” by the decedent.
Revocable Transfers - §2038
Under §2038, the gross estate includes the value of any property that decedent transferred during lifetime, in trust or otherwise, where at the date of death the transfer was subject to a power to alter, amend, revoke or terminate, exercisable by the decedent alone or in con-junction with any other person.
The tax is imposed upon transfers where enjoyment of the transferred property is subject, at the date of the transferor’s death, to any change through the exercise of a power by the decedent (§2038(a)). The power must either be possessed or exercisable by the decedent at the time of death.
However, a contingent power is not a taxable power if:
(i) The contingency is not within the control of the decedent, and
(ii) The contingency has not occurred at the time of the decedent’s death (Reg. §20.2038-1(b)).
Example
Dan put property into a trust directing that income be paid to Ralph for life, remainder to Mary. Dan can name additional income beneficiaries or remaindermen if he survives Ralph. If Dan dies before Ralph, the trust property is not taxable under §2038 since Ralph’s death is not within Dan’s control and the condition did not occur by the time of Dan’s death. However, such a contingent power will be estate taxable under §2036(a)(2).
Annuities - §2039
There is included in the estate of the decedent the value of amounts receivable by a benefi-ciary under a contract or agreement where the decedent, during life, was receiving or had a right to receive payments under the contract or agreement (§2039).
Section 2039(a) taxes the value of an annuity or other payment receivable by any beneficiary by reason of surviving the decedent under any form of contract or agreement entered into after March 3, 1931, other than as insurance under policies on the life of the decedent.
Payments to the survivor that are in the nature of life insurance proceeds are not taxable under §2039. However, if the decedent retained “incidents of ownership” in the policy, life insurance payable under an annuity may be taxed in the decedent’s estate under §2042.
Section 2039 applies if the decedent was actually receiving payments or had a right to receive payments in the future. For example, if the decedent could receive a pension upon retire-ment, with a death benefit payable to a designated survivor, and he or she died before re-tirement, the survivor’s benefit is includible in decedent’s estate under §2039.
Note: The payments to the beneficiary after the decedent’s death must be “by reason of sur-viving the decedent.” If payments are made at a scheduled time or upon the happening of an
2-18
event, whether the decedent is alive or dead, they are not taxable under §2039 (Reg. §20.2039-1(b)).
The estate tax is on the value of the survivor’s benefit that is proportionate to contributions made by the decedent (§2039(b)). It is not always the entire value of the survivor’s benefit that is includible. Only the amount proportionate to decedent’s contributions is taxed.
Valuation is made as of the date of the decedent’s death. When a lump-sum payment, the value is the amount of the survivor’s benefit. If an annuity or other deferred payments, the benefit is the present value of the right to receive these payments, determined actuarially.
Joint Interests - §2040
Under §2040, co-tenancies with a “right of survivorship” (e.g., joint tenancies, tenancies by the entirety, joint bank accounts, etc.) are included in the gross estate of the first joint tenant to die. Co-ownership without survivorship rights (e.g., tenancies in common, community property, etc.) are not taxable under §2040. However, the interest of the decedent in such property is taxable under §2033.
The inclusion is not limited to the value of the decedent’s undivided interest. It applies to the full value of the joint tenancy property except any part shown to have originally belonged to the survivor and never to have been received or acquired by the survivor from the decedent for less than full consideration (§2040(a)). Thus, to the extent the property originally be-longed to the survivor, or the survivor furnished consideration for its acquisition, the property is not includible in the decedent’s estate.
Note: The amount excluded from the decedent’s estate is not the amount that the survivor contributed. It is an amount proportionate to the survivor’s contribution.
A gift made to a noncitizen spouse before July 14, 1988, toward the creation of a joint tenancy is the surviving noncitizen spouse’s consideration in determining the value of the tenancy includible in the gross estate of the first spouse to die. The RRA ‘90 retroactively provided that the transfer creating a joint tenancy is consideration belonging to the surviving spouse. This rule, however, only applies if the transfer would have constituted a gift had the donor been a U.S. citizen. The transfer, therefore, proportionately reduces the amount of the joint tenancy property includible in the gross estate of the first spouse to die.
Qualified Joint Interests Between Spouses - §2040(b)
Section 2040(b) provides a special rule for husband-and-wife joint tenancies. In the case of such “qualified joint interests,” only one-half of the value of the property will be in-cluded in the estate of the first to die, without regard to which co-tenant furnished the consideration at the time of the joint tenancy’s creation.
Note: The qualified joint interest rule does not apply where the surviving spouse is not a U.S. citizen, unless (1) the surviving spouse becomes a U.S. citizen before the estate tax return is filed, and (2) the spouse was a U.S. resident at all times after the decedent’s death and before becoming a U.S. citizen (§2056(d)).
A “qualified joint interest” is any interest held by a decedent and the decedent’s spouse that is either:
(i) A tenancy by the entirety, or
2-19
(ii) A joint tenancy with right of survivorship, but only if the decedent and his or her spouse are the only joint tenants.
Note: In community property states, each spouse has a present, vested one-half interest in all community assets. Thus, on the death of either spouse, only the deceased spouse’s one-half of the community property is taxable under §2033.
Powers of Appointment - §2041
A “power of appointment” is a power granted by one person to another to dispose of prop-erty even though it is “owned” by another. Section 2041 includes in the gross estate of the holder of such a power the value of the property subject to a general power of appointment.
Note: Under §2041(a), a general power of appointment is “a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate . . .” (§2041(b)(1)).
Ascertainable Standard - The Safe Harbor Limitation
Section 2041 provides an exception for a power to consume, invade, or appropriate prop-erty for the benefit of the decedent which is limited by an ascertainable standard relating to health, education, support, or maintenance of the decedent (§2041(b)(1)(A)). Even though such a limited power enables the decedent to appoint the property to himself or herself or his or her creditors, it is not a general power. Where an ascertainable standard is used, anyone, including the trust beneficiary, may be the trustee.
Example
Dan dies having set up a trust for his wife, Daphne, in which she is the sole trustee, receives all income, and can use trust principal for her “health, support, maintenance, and education.” On Daphne’s death, she is not considered the owner of the trust as-sets, and they are not taxed in her estate.
The terms “health, support, maintenance, and education” are important:
1. “Health” would include medical treatment such as hospital, doctor, convalescent hos-pital, prescription drugs, nursing care, etc.
2. “Education” refers to payments to an educational institution such as a private sec-ondary school, college or university, graduate school, and even trade school, together with related expenses such as room and board, transportation, books, etc.
3. “Support” and “maintenance” mean the normal standard of living that the individual enjoys at the time the trust is created or the trustor dies. It includes the cost of housing, utilities, transportation, clothing, and other reasonable, related expenses.
If a “nonascertainable standard,” such as “joy or comfort” is used, there may be problems. If the surviving spouse is the beneficiary and trustee and can take out the principal of the trust for his or her “joy,” then the entire trust could be revoked. Under §2041, this would be a general power. However, it is possible to use a broad, nonascertainable standard when there is an independent trustee.
2-20
5/5 Power
An individual can also be given the right to withdraw a portion of the trust each year. Un-der §2041(b)(2), one can withdraw up to 5% of the value of the trust or $5,000, whichever is greater, each calendar year. This right cannot be accumulated and must be used each year or lost.
Example
Dan creates a trust for his wife, Daphne, and gives her the right to withdraw the greater of 5% of the value of the trust or $5,000. If the trust has a $600,000 value, she can withdraw up to $30,000 (5% of $600,000, which is greater than $5,000).
There is a disadvantage to this right. In the year the beneficiary dies, the beneficiary’s estate will be taxed on this right if it is not used. If no withdrawal in the year of death occurred, then 5% of the value of the trust will be added to the beneficiary’s estate (R.R. 79-373).
Example
For example, assume that A transferred $200,000 worth of securities in trust providing for payment of income to B for life with the remainder to B’s issue. Assume further that B was given a noncumulative right to withdraw $10,000 a year from the principal of the trust fund (which neither increased nor decreased in value prior to B’s death). In such case, the failure of B to exercise his right of withdrawal will not result in estate tax with respect to the power to withdraw $10,000 which lapses each year before the year of B’s death. At B’s death, there will be included in his gross estate the $10,000 which he was entitled to withdraw for the year in which his death occurs less any amount which he may have taken during that year (Reg. §20.2041-3(d)(3)).
Life Insurance - §2042
Under §2042, the proceeds from life insurance on the decedent’s life are includible in the gross estate if the proceeds are:
(i) Payable to (or for the benefit of) decedent’s estate; or
(ii) Payable to any other beneficiary, but only if the decedent possessed “incidents of own-ership” in the policy at the time of death.
2-21
Incidents of OwnershipIncidents of Ownership
The Code does not define “incidents
of ownership.” However, regulations
(e.g., Reg. §20.2042-1(c)(2)) apply
the phrase to any right or interest in
the policy where the insured has the
power, directly or indirectly, to:
(a) control the existence of the
policy,
(b) rearrange the economic
interests therein, or
(c) affect the benefits payable
thereunder.
2-22
Incidents of Ownership
The Code does not define “incidents of ownership.” However, regulations (e.g., Reg. §20.2042-1(c)(2)) apply the phrase to any right or interest in the policy where the insured has the power, directly or indirectly, to:
(a) Control the existence of the policy,
(b) Rearrange the economic interests therein, or
(c) Affect the benefits payable thereunder.
If the insured makes a complete and effective gift of all ownership and beneficial interests in the policy, the proceeds are normally not taxable in the estate. However, if the insured transfers incidents of ownership within three years of death, the proceeds will be taxed in his or her estate by reason of the interaction between §2035 and §2042.
Community Property Issue
Where insurance is purchased with community property funds, it is treated as a commu-nity asset. Each spouse is deemed to have an existing, one-half interest in the policy. Thus, if the insured spouse dies first one-half of the proceeds are taxable in the insured’s estate under §2042. If the uninsured spouse dies first, the deceased spouse’s one-half interest in insurance on the other spouse’s life is “property owned by the decedent” and taxable un-der §2033.
The value of this property would be one-half of the present value of the insurance (meas-ured by its replacement cost). When the insured subsequently dies, all of the proceeds attributable to premiums paid by the insured are taxable.
Example
If 60% of premiums are paid with community funds while husband and wife are alive (30% attributable to each spouse), and 40% of the premiums are paid by the insured husband after the uninsured wife’s death, then 70% of the proceeds are taxed in the insured’s estate when he later dies (Scott v. Commissioner, 374 F. 2d 154 (9th Cir. 1967)).
Deductions from Gross Estate
Four basic deductions from the gross estate are allowed under federal estate tax law:
(1) Expenses of and claims against the estate (§2053);
(2) Casualty & theft losses during estate administration (§2054);
2-23
Deductions From GrossDeductions From Gross
EstateEstate
The following deductions are allowed
from the gross estate:
(1) expenses of and claims against
the estate (§2053),
(2) casualty & theft losses during
estate administration (§2054),
(3) charitable transfers (§2055),
and
(4) the marital deduction (§2056).
2-24
(3) Charitable transfers (§2055); and
(4) The marital deduction (§2056).
Estate Expenses & Claims - §2053
Certain expenses incurred by the estate and various types of claims against the estate, includ-ing debts and taxes owed by the decedent, are deductible. Section 2053(a) lists four catego-ries of deductible items:
(i) Funeral expenses;
(ii) Administration expenses;
(iii) Claims against the estate; and
(iv) “Unpaid mortgages on, or any indebtedness in respect of, property where the value of the deceased’s interest therein, undiminished by such mortgage or indebtedness, is in-cluded in the value of the gross estate . . .”
Note: Expenses are only deductible when paid before expiration of the statute of limitations relating to the estate tax return.
Inclusion of Administrative Expenses on Non-Probate Assets
Section 2053(b) also provides a deduction for administration expenses on property that is not part of the decedent’s probate estate but is part of the federal gross estate, i.e., prop-erty includable under §2035 through §2042.
Casualty & Theft Losses during Administration - §2054
Section 2054 provides a deduction for casualty or theft losses that are not compensated for by insurance or otherwise. While such losses are deductible against the estate’s income tax return (§165) or the gross estate (§2054), no double deductions are allowed and the executor must elect the treatment (§642(g)).
Note: Losses on the sale of property during administration may be deducted for income tax purposes, but are not deductible for estate tax purposes.
Charitable Transfers - §2055 (§170 & §2522)
Taxpayers can have numerous reasons for making charitable contributions, including reli-gious, educational, psychological, and social agendas. In addition, there are substantial tax reasons to make a charitable contribution.
There are three basic formats for charitable contributions in the federal tax system:
(1) An income tax deduction under §170,
Note: Depending on the type of charity receiving the contribution, the available income tax deduction is limited to 20%, 30%, or 50% of the taxpayer’s AGI.
(2) A gift tax deduction under §2522, and
(3) An estate tax deduction under §2055.
Section 2055 provides for an estate tax deduction for a charitable contribution made by an individual’s estate. While income tax provisions place percentage AGI limitations on
2-25
contributions, the estate regulations permit an unlimited charitable deduction if the property is passed by will or other testamentary means.
Under §2055, a deduction is allowed for property transferred by a decedent for charitable purposes. The contribution must be to an organization operated exclusively for a recognized religious, scientific, literary, educational, or other charitable purpose (Reg. §20.2055-1(a)). Sections 501 and 170 define, in detail, the qualifications organizations must meet to be con-sidered charitable. In addition to the definitions found in the Code, the IRS publishes an an-nual report, Publication 78, listing organizations that qualify for federal tax-deductible contri-butions.
There are three primary ways to make a charitable contribution:
(1) Immediate,
(2) Split-interest, or
(3) Insurance-related.
Immediate Contributions
If a taxpayer wishes to make a charitable contribution, he or she can give cash, write a check, or transfer property to a charitable organization. The organization receives the cash or prop-erty and the transaction is complete.
Note: When property is transferred or willed directly to a charity (and not by trust), deductions are easier to determine since the property value is the current fair market value.
Split-Interest Contributions
In a split-interest contribution, interests in the same property are given to both charitable and noncharitable beneficiaries. Examples would be an income interest to an individual for life with the remainder to a charity (“charitable remainder gift”) or income to a charity for a term of years with the remainder to an individual (“charitable lead gifts”).
Note: The charitable deduction is only the value of the interest transferred to the charity (§2055(a)). Special IRS tables, used together with published monthly rates, are used to deter-mine the specific value of the charitable deduction.
2-26
2-27
Sections 170 and 2055(e) require a split gift be in the form of:
(1) Annuity trust,
(2) Unitrust, or
(3) Pooled income fund.
Charitable Remainder Trusts
A deductible contribution can be made by a taxpayer in trust to a charity and that tax-payer can keep (or give to another person or persons) the right to receive regular pay-ments from the trust, for life or a period of years, before the charity receives any amount (§170(f)(A)).
Under a charitable remainder trust, the taxpayer contributes property to a trust for the “split” benefit of the taxpayer and a charity. The charity does not receive the full benefit of the contributed property until some future time.
However, the taxpayer receives a current income tax deduction in the year of the con-tribution for the value of the future interest passing to the charity. The amount of the charitable deduction is the present value of the contributed property less the income interest retained by the taxpayer.
The contributed property is, then, typically sold and the proceeds invested to pay an annual income to the taxpayer.
Note: If the taxpayer is one of the income beneficiaries, the value of the charitable trust assets will be included in his or her gross estate. However, since the interest passes to a charity on death, there should be an offsetting estate tax deduction.
Example
Years ago Danny purchased some land for $10,000, which is now worth $100,000. Danny, now age 70, establishes a 7% charitable remainder trust and transfers the land into the trust. The trustee sells the land and invests the entire $100,000. Since the trust is a tax-exempt entity, it pays no tax on the sale of the land. Danny will now receive $7,000 per year for the remainder of his life. Without the charitable trust, the $90,000 would have been taxed at 28% and Danny would only have $74,800 after tax. Danny would have had to invest this $74,800 at an annual rate of approx-imately 9% to receive the comparable $7,000 annually.
Danny is entitled to an income tax deduction for the actuarial present value of the charitable remainder interest on the $100,000. The tables in IRS Publication 1457 are used to determine the amount of the deduction. In addition, the land has been re-moved from Danny’s estate. If he wishes to replace the value of the land for the benefit of his heirs, Danny could purchase life insurance with the cash savings generated.
The Code narrowly defines these trusts and several points should be observed:
(a) Any individual beneficiaries must be alive when the trust is created;
(b) The contribution must be of real property or intangibles; and
2-28
(c) A contribution of a remainder interest in tangible personal property is deductible only when all intervening interests have expired or are held by parties unrelated to the donor (§170(a)(3); Reg. §1.170A-5(a)(1)).
Charitable Remainder Unitrust
This is a trust where the trustee must distribute annually the lesser of:
(i) A fixed percentage (at least 5%) of the trust estate (determined annually), or
Note: The payout must be a fixed percentage of not less than 5% of the net fair market value of the trust assets.
(ii) All trust income (§664(d)).
Note: The trust instrument may limit the payout to the net income of the trust, with any deficiency to be made up in later years. This is commonly referred to as a net income unitrust.
Thus, a charitable remainder unitrust provides the noncharitable beneficiary a varia-ble payout based on the annual valuation of the trust assets. Because the trust is val-ued annually, the donor may make additional contributions to the trust. In addition, the trust must be irrevocable.
The payout term may extend for a period of up to a maximum of 20 years, or if the beneficiary is an individual, for life (or the lives of more than one beneficiary), after which time the remainder assets pass to the charity. However, no payments other than those described may be made to anyone other than a qualified charity. Upon the termination of all payments, the remainder interest is passed to the charity or is re-tained by the trust for the benefit of the charity (§664(d)(2) and (3)).
2-29
2-30
Life Insurance Funding
Since a unitrust is permitted to receive additional contributions, it is an excellent device to be funded with life insurance. The life insurance can be transferred to the trust and the trust named as beneficiary of the policy. The trust beneficiaries will be the charity and the heirs. The cash value of the policy can be used as a source of income payments to the heirs. The benefit amount that passes to the charity will generate a charitable deduction.
Note: The benefit amount that passes to the charity will depend on actuarial calculations based on the life expectancies of the heirs.
Charitable Remainder Annuity Trust
This is a trust where the trustee must annually distribute to the noncharitable benefi-ciary at least five percent of the original value of the trust assets (§664(d); Reg. §1.664-1(a)(1)). Because the payout amount is fixed at the inception of the trust, valuation occurs only once and the payout cannot be limited to the net income of the trust. The donor cannot make additional payments to the trust and it must be irrevocable. Again, the payout term may extend for up to 20 years or, if the beneficiary is an individual, for life (or the lives of more than one beneficiary). On termination of the payments, the remainder interest is transferred to the charity or retained by the trust for the benefit of the charity (§664(d)(1)).
Note: In both the annuity and unitrust formats the annuity can be cumulative. Thus, if the investment return is insufficient to pay the full annuity, the trust can make up the deficiency in subsequent years.
50% & 10% Annuity Restrictions - §664(d)
Since 1997, a trust cannot be a charitable remainder annuity trust if the annuity for any year is greater than 50% of the initial fair market value of the trust’s assets or be a charitable remainder unitrust if the percentage of assets that are required to be distributed at least annually is greater than 50%. In addition, tax law requires that the value of the charitable remainder with respect to any transfer to a qualified charitable remainder annuity trust or charitable remainder unitrust be at least 10% of the net fair market value of such property transferred in trust on the date of the contribution to the trust. There are special rules that deal with revocations and reformations of trusts created after that date that do not meet the 10% require-ment.
2-31
2-32
Note: The 10% requirement does not apply to trusts created by will or other testamentary instrument if the settlor dies before January 1, 1999, and the will or other testamentary instrument is not changed after June 28, 1997, or the settlor is under a mental disability on that date.
Finally, tax law provides that additional contributions made after July 28, 1997, to a charitable remainder unitrust created before July 29, 1997, that does not meet the 10% requirement with respect to the additional contribution, is treated, under the regulations as if those contributions were made to a new trust that does not affect the status of the original unitrust as a charitable remainder trust.
Pooled Income Fund
A pooled income fund is a trust maintained by the charity into which each donor trans-fers property and from which each named beneficiary receives an income interest. Donors contribute property to the trust reserving a life estate in a share of the total property. The public charity must be the irrevocable remainder (§642(c)). The remain-der interest ultimately passes to the charity that maintains the fund.
All contributions to a pooled income fund are commingled, and all transfers to it must meet the requirements for an irrevocable remainder interest. The pooled income fund cannot accept or invest in tax-exempt securities, and no donor or beneficiary of an income interest can be a trustee of the fund. The income to the beneficiaries is determined by the rate of return earned by the trust each year (§642(c)(5); Reg. §1.642(c)-5).
A pooled default income fund is similar to a mutual fund since it maintains a portfolio of investments and provides the taxpayer with a rate of return comparative to stock market funds. By pooling assets into a common fund, taxpayers have less risk of loss and greater diversity.
Taxation of Charitable Trust Beneficiaries - §664
Amounts paid to a beneficiary of a charitable remainder trust retain his or her char-acter when received. While a regular trust characterizes its payments according to the trust’s annual income, a charitable remainder trust characterizes payments based on the entire history of the trust.
Multi-Tiered Structure
Section 664(b) sets forth a multi-tiered structure for taxing distributions to in-come beneficiaries of a charitable remainder trust. Distributions paid to a chari-table remainder trust beneficiary are first taxed as ordinary income to the extent of the trust’s current and prior undistributed income.
Once all the ordinary income is exhausted, remaining distributions are character-ized as follows:
(1) Short-term capital gain to the extent of current and past undistributed short-term capital gains;
(2) Long-term capital gain to the extent of current and past undistributed long-term capital gains;
2-33
(3) Other income, such as tax-exempt income, to the extent of the trust’s cur-rent and past undistributed income of such character; and
(4) Tax-free distributions of principal (§664(b)(1) through (4)).
Generation-Skipping Transfer Tax
Even though the generation-skipping transfer (GST) tax does not apply to charitable gifts, the impact on the GST tax should be considered if the donor’s grandchild (or another skip person) is an income beneficiary of the charitable remainder trust. In such a situation, the donor must plan the allocation to the trust so that it (together with other assets transferred) does not exceed the GST exemption. The generation-skipping transfer tax exemption for a given year is equal to the applicable exclusion amount for estate tax purposes. In addition, the generation-skipping transfer tax rate for a given year will be the highest estate and gift tax rate in effect for such year.
Example
Danny transfers $600,000 to a charitable remainder unitrust. The value of the remain-der interest is $375,000. Danny has $450,000 of his GST tax exemption still available. He could allocate $225,000 [$600,000 total value - $375,000 charitable remainder value] of the remaining GST tax exemption to the trust. The trust would have an inclu-sion ratio of zero, and no GST tax.
2-34
HEIRS
CHARITY
CHARITABLE LEAD TRUST
FOR TERM OF YEARS
TAXPAYER'S ASSETS
END OF TRUST
GIFT TAX ON
REMAINDERGIFT
Charitable Lead Trust
INCOME
REMAINDER
2-35
Charitable Lead Trusts
A deduction is also permitted for a gift of an income interest, generally referred to as a charitable lead trust (§170(f)(2)(B)). A charitable lead trust is where the donor gives an income interest to the charity, with the remainder reverting to the donor (or named beneficiaries). It is essentially the reverse of a charitable remainder trust.
The gift of the income interest will be deductible if the interest is in the form of:
(a) A “guaranteed annuity interest,” or
Note: A guaranteed annuity interest is an irrevocable right to receive at least an annual payment of a determinable amount. A guaranteed annuity may be made to continue for the shorter of a term of years or lives in being plus a term of years (R.R. 85-49).
(b) A “unitrust interest” (§170(f)(2)(B)).
Note: A unitrust interest is an irrevocable right to receive payment at least annually of a fixed percentage of the fair market value of the trust assets, determined annually.
In either case, payments may be made to the charity for a term of years or over the life or lives of an individual (who is living at the date of the transfer to the trust). After ter-mination of the income interest, the remainder interest in the property goes to children or other designated remainder beneficiaries.
Insurance Related Contributions
Life insurance can be used to fund charitable contributions by:
(1) Assigning ownership of an existing policy to a charity,
(2) Making a charity beneficiary of an existing policy,
(3) Assigning a split-interest in a policy to a charity, and
(4) Making a charity an irrevocable beneficiary of a new policy.
Unlimited Marital Deduction - §2056
A deduction is allowed for property passing unconditionally to the surviving spouse of the decedent’s death. Section 2056(a) provides that this deduction shall be an “amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse . . .”
Requirements
The marital deduction has six basic requirements:
(1) The decedent must have been a citizen or resident of the United States (§2056(a));
(2) Property passing to the surviving spouse must have been included in the decedent’s estate (§2056(a));
(3) The decedent must have been married at the time of death;
Note: State law determines marital status (R.R. 67-442).
(4) The spouse survived the decedent;
Note: Survival is determined using the presumptions under the Uniform Simultaneous Death Act (Reg. §20.2056(e)-2(e)).
2-36
(5) Property must have “passed” from the decedent to the surviving spouse - by will, by operation of law, or otherwise; and
(6) The property must be a “deductible interest.” Nondeductible interests include inter-ests:
(a) Not included in the gross estate,
(b) Deductible under §2053 or §2054, and
(c) Some (but not all) “terminable interests.”
Note: Section 2056(b)(1) defines a terminable interest as one where “on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the surviving spouse will terminate or fail . . .”
Net Value Rule
The marital deduction is restricted to the net value of property passing to the surviving spouse. When property going to the surviving spouse is subject to a mortgage (which has not been paid off by the estate), the value of the property under the marital deduction is reduced by that debt (§2056(b)(4)(B)).
The value of the property must also be reduced by any death taxes payable by the spouse or payable out of property passing to the spouse (§2056(b)(4)(A)).
Non-Citizen Spouse
When a foreign-born spouse is a United States resident but not a citizen, he or she is still taxed in the same manner as a United States citizen for federal income tax purposes. Like-wise, if such a spouse makes a gift of property abroad (outside the United States), he or she would be subject to gift tax like any United States citizen. Should the foreign-born spouse be the first to die, his or her estate would be entitled to the marital deduction for bequests and transfers to the surviving citizen spouse. However, if the foreign-born spouse is the survivor, there are important estate tax implications.
2-37
Marital Deduction ElementsMarital Deduction Elements
1. Decedent was a US citizen or resident;
2. Property was included in the decedent’s
estate;
3. Decedent was married at death;
4. Spouse survived the decedent;
5. Property “passed” from decedent to
surviving spouse by will, operation of law,
or otherwise; and
6. Property was a “deductible interest.”
Nondeductible interests include interests:
(a) not included in gross estate,
(b) deductible under §2053 or §2054, and
(c) some (but not all) “terminable interests.”
Note: A terminable interest is where on the lapse of
time, on the occurrence of an event or contingency,
an interest passing to the surviving spouse will
terminate or fail
2-38
Example
Dan’s spouse was born in France, and even though she has established permanent residence in California, she has never given up her French citizenship to become a United States citizen. She is considered a non-citizen or alien.
Under §2056(d)(1), no marital deduction is allowed if the surviving spouse is not a citizen of the United States, even though the decedent is a citizen. Thus, if a citizen spouse dies, assets passing to a surviving non-citizen spouse will not qualify for the unlimited estate tax marital deduction that is available to United States citizens.
Note: The marital deduction is allowed if the surviving spouse becomes a citizen before the estate tax return is filed, and was a resident of the U.S. at all times after the decedent’s death and before becoming a citizen.
This denial of the marital deduction for non-citizen spouses has an important exception. If assets, otherwise qualifying for the marital deduction, are transferred into a qualified do-mestic trust (QDT), the marital deduction will be available without limit (§2056(d)(2)).
Qualified Domestic Trust
Under §2056A(a), a QDT means a trust:
(a) That requires that at least one trustee be an individual U.S. citizen or a domestic corporation,
Note: Under Prop. Reg. §20.2056A-2(c), a domestic corporation would be defined as a cor-poration that is created or organized under the laws of the U.S. or under the laws of any state or the District of Columbia.
(b) That provides that no distribution (other than a distribution of income) may be made from the trust unless a trustee who is an individual U.S. citizen or domestic cor-poration has the right to withhold the tax imposed by §2056A,
Note: The tax imposed by §2056A is the amount by which the citizen-decedent’s estate tax would have been increased if the amount taxable (the amount of the distribution or amount remaining in trust at the survivor's death) had been included in the citizen-decedent’s tax-able estate. For this purpose, any previous taxable distribution must be taken into account. All distributions from a qualified domestic trust except distributions of income or distribu-tions to the surviving spouse on account of hardship are subject to the tax imposed by §2056A. The tax imposed because of a distribution during the surviving spouse’s life is due on the 15th day of the fourth month following the calendar year in which the distribution occurs.
The tax is also imposed on the value of any property remaining in the trust on the date of the surviving spouse’s death (§2056A(b)(1)(B)).
The trustee is personally liable for the amount of tax imposed. In addition, there is a lien against the property giving rise to the tax for 10 years after the taxable event.
Some relief for this tax cost is also offered through a credit provision. If property is be-queathed to a non-citizen spouse and that property transfer is subjected to estate tax but would not have been taxed if the surviving spouse had been a citizen, a credit will be avail-able to the surviving spouse’s estate on his or her death. This percentage credit will be for
2-39
the tax paid by the first spouse’s estate on the earlier transfer to the non-citizen spouse that did not qualify for the marital deduction.
(c) Which meets such requirements as the Treasury Secretary may by regulations pre-scribe to ensure the collection of the tax, and
Note: The IRS has exercised the authority given by this section to issue proposed regula-tions. A sample of these regulations follows.
Under Prop Reg. §20.2056A-2(d)(1), if the fair market value of the assets passing to the QDT, determined as of the date of the decedent’s death, exceeds $2,000,000, the trust in-strument would have to require that either:
(1) At least one U.S. trustee be a bank, as defined in §581, or
(2) The U.S. trustee furnish a bond or security in an amount equal to 65% of the fair market value of the trust corpus determined as of the date of the decedent’s death.
If the fair market value of the assets passing to the QDT is $2,000,000 or less, the trust instrument would either have to meet requirement (1) or (2), above or require that no more than 35% of the fair market value of the trust assets, determined annually on the last day of the tax year of the trust, may consist of real property located outside of the U.S. that is owned by the trust.
When the U.S. trustee of a QDT is an individual U.S. citizen, the individual would have to have a tax home in the U.S. (Prop. Reg. §20.2056A-2(d)(2)).
A QDT would have to provide that all trust assets must be physically located in the U.S. (Prop. Reg. §20.2056A-2(d)(3)). However, this rule would not apply when the requirements for QDTs with assets in excess of $2,000,000 apply.
The U.S. trustee of a QDT would have to file a statement annually with IRS. The statement would have to be attached to the fiduciary income tax return (Form 1041) filed by the QDT (Prop Reg. §20.2056A-2(d)(4)(i)).
(d) With respect to which the citizen-decedent’s executor elects to have the trust qualified as a qualified domestic trust.
Note: The executor must make an irrevocable election on the estate tax return with respect to the trust. However, the executor is not required to make such an election. The executor’s right to make this election should appear in the will or the QDT trust.
An executor may make a protective election if there is a bona fide legal controversy that would render the making of the election at the time of the estate tax return not feasible (Prop. Reg. §20.2056A-3(c))). Partial QDT elections are not permitted.
If property passes to a trust that otherwise would qualify for the marital deduction ex-cept that the surviving spouse is not a U.S. citizen, the property can be treated as passing to a qualified domestic trust if the trust is reformed to meet the QDT requirements. The revision may occur pursuant to the decedent’s will, trust, or a judicial proceeding (Prop. Reg. §20.2056A-4(a)).
Gifts to Non-Citizen Spouses
The gift tax provisions specify that the unlimited marital deduction is not available for gifts to non-citizen spouses. However, since July 14, 1988, a gift of up to $100,000 (in-dexed for inflation) per year can be made to a non-citizen spouse without incurring a
2-40
gift tax (§2523(i)). To qualify, the gift must be one of a present interest. Under this pro-vision, substantial assets can be transferred to a non-citizen spouse during lifetime to effect estate planning objectives.
Example
Dan, a U.S. citizen, is married to Maria, a resident alien. Dan transfers to Maria 100 shares of X Corporation stock valued for federal gift tax purposes at $130,000. The transfer is a gift of a present interest and is a deductible interest for gift tax purposes. Accordingly, $100,000 of the $130,000 gift is not included in the total amount of gifts made by Dan during the calendar year for federal gift tax purposes. Dan must include $30,000 on his annual gift tax return, Form 709, as a taxable gift.
Valuation
Determination of the estate tax begins with the value of the decedent’s assets at death (or the alter-nate valuation date). The estate tax is measured by the fair market value of the property transferred. Since estate tax attaches at the instant of death, the value of estate assets is his or her value imme-diately after death, not the instant before death.
Note: Sections 2031 (gross estate) and 2512(a) (valuation of gifts) use “value” without elaboration. Reg. §20.2031-l(b) defines FMV as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” Reg. §25.2512-1 provides a similar definition for gift tax purposes.
The estate and its representatives have the burden of proof as to the fair market value of the estate assets.
IRS Valuation Explanation - §7517
Under §7517, the estate can request that the IRS furnish a written statement explaining its pro-posed or actual valuation. This statement must:
(i) Describe the basis of the valuation,
(ii) Show any computation, and
(iii) Enclose a copy of any appraisal.
Alternate Valuation - §2032
Under §2032, the executor is given an election to value the estate assets either at:
(i) The date of the decedent’s death, or
(ii) At the “alternate valuation date.”
When the alternate date is elected3, all assets in the estate are valued as of six months after the decedent’s death. However, any assets sold, exchanged, or otherwise disposed of during the six months after death are valued as of his or her disposition.
3 The election must be made on the estate tax return - Form 706.
2-41
Assets included in the estate because of §2035 through §2038 are valued as of decedent’s death (or alternate date) not as of the transfer date. This is true even if the donee has sold or exchanged the property.
Special Valuation - §2032A
Farmland and real property used in a closely held business can be valued at less than fair market value (§2032A). Farmland can be valued by dividing the net average annual gross cash rental for comparable land (gross cash rental less real estate taxes) by the average annual effective interest rate for all new federal land bank loans (§2032A(e)(7)). Business real property can be valued by several methods that primarily rely upon a capitalization of earnings (§2032A(e)(8)). In any event, the decrease in value for estate tax purposes cannot exceed $1,190,000 in 2021.
Estate Tax Return & Payment - §6018
Under §6018(a), the executor is responsible for filing the federal estate tax return, Form 706. A return is required only if the amount of the gross estate exceeds the applicable exclusion amount (e.g., $11,700,000 in 2021)4 (§6018(a)(1)). The return must be filed within nine months of the decedent’s death (§6075(a)). However, a filing extension of up to six months can be granted (§6018(a)).
The executor is also personally responsible for the payment of the estate tax (§6151(a)). This liability continues until he or she has been discharged upon application to the IRS (§2204). If the tax is not paid, the persons who received the property that was in the estate are liable for the tax to the extent of the value of the property received (§6324).
Payment of the estate tax is due at the same time as the estate tax return itself - i.e., within nine months of death. Extensions for payment of the tax5 can be granted (after showing reasonable cause) for up to ten years (§6161).
Installment Payment of Federal Estate Taxes - §6166
Estates of individuals whose major assets are interests in a closely held business may elect to pay the estate tax in installments if the value of the closely held business interest relative to the gross estate or taxable estate is large enough.
Where the estate is substantially (35% of the adjusted gross estate) made up of an interest in a closely held business, §6166 permits installment payment of the tax associated with the business. Under §6166, the tax is deferred for five years (interest only is due) and then paid in ten annual installments. For years 6 through 15 after the decedent’s death, the tax is payable in equal in-stallments.
Computation
For estate taxes that are deferred under §6166, the tax attributable to the first $1,000,000 (indexed for inflation) in taxable value of the closely held business (i.e., the first $1,000,000 in value in excess of the effective exemption provided by the applicable exclusion amount
4 A return is required for estates of nonresident aliens if that part of the gross estate that is situated in the United States
exceeds $60,000. 5 Interest still accrues.
2-42
and any other exclusions) is subject to interest at a rate of 2%. The remainder of such taxes is subject to interest at a rate equal to 45% of the rate applicable to underpayments of tax, and all taxes paid under §6166 are made nondeductible.
Note: Interest paid on estate taxes deferred under this provision is not deductible for estate or income tax purposes.
Example
Dan died in 2011 when the applicable exclusion amount was $5,000,000. He owned a business that qualified for the $1 million deferral of tax payments for qualified family-owned business interests. If his executor so elected, the amount of estate tax attribut-able to the value of the closely held business between $6,000,000 and $5,000,000 was eligible for the 2% interest rate.
Eligibility & Court Supervision
If an estate never qualified or ceases to qualify for the installment payment of estate taxes, the total amount of deferred estate tax is immediately due. However, taxpayers are given access to the courts to resolve disputes over an estate’s eligibility for the §6166 election. The U.S. Tax Court is authorized to provide declaratory judgments regarding initial or con-tinuing eligibility for deferral under §6166.
Closely Held Business
A closely held business is:
(a) A sole proprietorship,
(b) An interest as a partner in a partnership where 20% or more of the total capital interest in such partnership is included in determining the gross estate of the decedent or the part-nership has 45 or fewer partners, or
(c) Stock in a corporation where 20% or more is included in the gross estate or the corpo-ration has 45 or fewer shareholders (§6166(b)(1)).
An estate with an interest in a qualifying lending and financing business is eligible for install-ment payment of the estate tax. However, an estate with an interest in a qualifying lending and financing business must make installment payments of estate tax (including both princi-pal and interest) over five years.
Only the stock of holding companies, not that of operating subsidiaries, must be nonreadily tradable to qualify for installment payment of the estate tax. However, an estate with a qual-ifying property interest held through holding companies must also make all installment pay-ments over five years.
Acceleration of Payment
Section 6166(g) provides for acceleration of installments upon default or the disposition or with-drawal of more than fifty percent in value of the business interest.
2-43
Deferred Payment of Federal Estate Tax
Section 6161 Section 6166
Maximum Period of Tax Payment
10 Years 15 Years
(Interest only for first 5 years)
Amount of Tax Af-fected
Total Federal Estate Tax Tax Allocable to Qualifying Business
Interest Rate Same as for Deficiencies 2% on the portion of tax allocable to the first $1 million (indexed for inflation) of
the business, remaining tax is 45% of defi-ciency rate
Requirements Show Reasonable Cause 1. Business value is greater than 35% of Adjusted Gross Estate
2. Businesses can be combined if decedent owned 20% or more of each
3. Business has 45 or fewer shareholders or partners or 20% or more ownership in-terest
Flower Bonds
Formerly, certain Treasury bonds owned by a decedent at death could be redeemed at par value (plus accrued interest) to pay federal estate taxes. These bonds could be turned into the Treasury as payment and represented an excellent method of paying some or all or the estate tax liability at a substantial discount. However, these “flower” bonds can no longer be purchased directly from the government, but might still be obtained through stockbrokers for a limited time. The government accepts them at par to pay death taxes. The author is not aware of any such bonds still being available. The last of such bonds matured in 1998.
2-44
Review Questions
11. If a remainder person dies prior to obtaining a decedent’s property interest, it can be included in the remainder person’s estate. In such a case, what is this interest called?
a. a contingent remainder.
b. a curtsey.
c. a dower.
d. a vested remainder.
12. Section 2036(a) imposes four requirements for taxation of transfers with a retained life inter-est. What is one of those requirements?
a. An independent trustee solely holds a power over the property.
b. Interests in the property are retained by the decedent.
c. The tax is limited to the value of the specific interest or power.
d. The decedent did not make a lifetime transfer of property.
13. According to the author, taxpayers may make charitable contributions in three basic ways. In which method are property interests received by both charitable and noncharitable beneficiar-ies?
a. immediate.
b. insurance-related.
c. pledge.
d. split-interest.
14. A taxpayer can make a deductible contribution in trust to a charity. What is a planning con-sideration in establishing a charitable remainder trust?
a. The taxpayer may deduct a contribution of a remainder interest in tangible personal prop-erty only when related parties hold all intervening interests.
b. The taxpayer may deduct a contribution of a remainder interest in intangible real property only upon the expiration of all intervening interests.
c. When the taxpayer establishes the trust, all individual beneficiaries must be over 18 years of age.
d. The taxpayer must contribute real property or intangibles.
15. Under §§170 and 2055(e), split gifts can be in three formats. In which format does the charity maintain the trust?
a. a charitable lead trust.
b. a charitable remainder annuity trust.
c. a charitable remainder trust.
d. a pooled income fund.
2-45
16. In a charitable remainder trust, a taxpayer makes a contribution of property to a trust for the immediate benefit of the taxpayer and the future benefit of a charity. What is fundamentally the opposite of a charitable remainder trust?
a. a charitable lead trust.
b. a charitable remainder annuity trust.
c. a charitable remainder unitrust.
d. a pooled income fund.
17. Upon the decedent’s death, a marital deduction is allowed for assets that pass completely to the surviving spouse. When is said deduction denied for assets?
a. when they pass to a marital deduction trust for the survivor’s benefit.
b. when they pass to a qualified domestic trust of which a noncitizen surviving spouse is a beneficiary.
c. when they pass to a surviving spouse as an outright transfer.
d. when they pass to a surviving spouse who is a non-U.S. citizen.
Tax Basis for Estate Assets - §1014
Under §1014, heirs receive a stepped-up basis in estate assets and take as his or her income tax basis the fair market value of the property included in the estate.
Property Basis
Property Basis in Common Transactions
Type of Transaction Basis Holding Period Starts
Purchase Cost of property plus improve-
ments Date of purchase
Gift Later Sold At Gain Donor’s basis Date donor’s holding period
started
Gift Later Sold At Loss
Lesser of:
Donor’s basis, or FMV on date of gift
Date donor’s holding period started on date of gift
Seller Repossession
Adjusted basis of the debt due, plus gain from the reposses-
sion, plus any repossession ex-penses
The holding period includes the period before and after the
seller repossession
Tax-deferred Exchange Original basis of property given up, plus “boot” given, plus any
net increase in debt
The holding period includes the period before and after the ex-
change
Inheritance FMV on date of death or 6
months thereafter
Generally, date of decedent’s death but, automatically
deemed more than one year for C/G
2-46
Community Property Cost Basis
Holding title as community property can have significant cost basis advantages. When property is held as “community property,” the decedent’s and the surviving spouse’s respective commu-nity shares of an asset receive a complete “stepped-up” basis at the decedent’s death. This is true even though only the decedent’s share is included in the estate (R.R. 87-98).
This could result in a substantial income tax advantage over couples holding property in other forms of joint ownership. Here only the portion of an asset included in the decedent’s estate will be eligible for a “step-up” in basis.
Basis of Property Under the 2010 Special Election
For a decedent who died in 2010, TRUIRJCA allowed the executor of such a decedent's estate to elect to apply the Code as if the TRUIRJCA had not been enacted. Without the enactment of TRUIRJCA, the 2010 repeal of the estate, gift, and generation-skipping transfer taxes would have eliminated the step-up basis rules and imposed a modified carryover basis regime. Thus, when such an election was made, the estate was not subject to estate tax but, the basis of assets ac-quired from the decedent was determined under the modified carryover basis rules of §1022.
Under this modified carryover basis regime, recipients of property transferred at the decedent’s death received a basis equal to the lesser of:
(1) The adjusted basis of the decedent, or
(2) The fair market value of the property on the date of the decedent’s death.
The modified carryover basis rules applied to property acquired by bequest, devise, or inher-itance, or by the decedent’s estate from the decedent, and property passing from the decedent to the extent such property passed without consideration.
Property acquired from a decedent was treated as if the property had been acquired by gift. Thus, the character of gain on the sale of property received from a decedent’s estate was carried over to the heir. For example, real estate that had been depreciated and would be subject to recapture if sold by the decedent would be subject to recapture if sold by the heir.
Property to Which the Modified Carryover Basis Rules Apply
The modified carryover basis rules applied to property acquired from the decedent. Property acquired from the decedent was:
(1) Property acquired by bequest, devise, or inheritance,
(2) Property acquired by the decedent’s estate from the decedent,
(3) Property transferred by the decedent during his or her lifetime in trust to pay the in-come for life to or on the order or direction of the decedent, with the right reserved to the decedent at all times before his or her death to revoke the trust,
(4) Property transferred by the decedent during his or her lifetime in trust to pay the in-come for life to or on the order or direction of the decedent with the right reserved to the decedent at all times before his or her death to make any change to the enjoyment thereof through the exercise of a power to alter, amend, or terminate the trust,
2-47
(5) Property passing from the decedent by reason of the decedent’s death to the extent such property passed without consideration (e.g., property held as joint tenants with right of survivorship or as tenants by the entireties), and
(6) The surviving spouse’s one-half share of certain community property held by the dece-dent and the surviving spouse as community property.
Limited Basis Increase for Certain Property
The modified carryover basis rules allowed an executor to increase the basis of assets owned by the decedent and acquired by the beneficiaries at death. Under this rule, each decedent’s estate generally was permitted to increase (i.e., step up) the basis of assets transferred by up to a total of $1.3 million.
The $1.3 million was increased by the amount of unused capital losses, net operating losses, and certain “built-in” losses of the decedent. In addition, the basis of property transferred to a surviving spouse could be increased by an additional $3 million.
Thus, the basis of property transferred to surviving spouses could have been increased by a total of $4.3 million. Nonresidents who were not U.S. citizens were allowed to increase the basis of property by up to $60,000. The $60,000, $1.3 million, and $3 million amounts were to be adjusted annually for inflation occurring after 2010.
Example
Danny died in 2010 leaving an estate consisting of stock worth $6,000,000 with a basis of $1,000,000 and his executor made the special election. If Danny left his estate to his surviving spouse, the executor could increase the total basis in the stock to $5,300,000 ($1,000,000 carryover basis + $1,300,000 million general basis and $3,000,000 spousal basis.) If Danny left his estate to a beneficiary other than his spouse, the executor could increase the total basis in the stock to $2,300,000.
In general, the basis of property could be increased above the decedent’s adjusted basis in that property only if the property was owned, or was treated as owned, by the decedent at the time of the decedent’s death. In the case of property held as joint tenants or tenants by the entireties with the surviving spouse, one-half of the property was treated having been owned by the decedent and was thus eligible for the basis increase.
In the case of property held jointly with a person other than the surviving spouse, the portion of the property attributable to the decedent’s consideration furnished was treated as having been owned by the decedent and was eligible for a basis increase. The decedent also was treated as the owner of property (which was eligible for a basis increase) if the property was transferred by the decedent during his or her lifetime to a revocable trust that pays all of its income during the decedent’s life to the decedent or at the direction of the decedent. The decedent also was treated as having owned the surviving spouse’s one-half share of commu-nity property (which will be eligible for a basis increase) if at least one-half of the property was owned by, and acquired from, the decedent.
2-48
The decedent was not, however, treated as owning any property solely by reason of holding a power of appointment with respect to such property.
Property not eligible for a basis increase included:
(1) Property that was acquired by the decedent by gift (other than from his or her spouse) during the three-year period ending on the date of the decedent’s death;
(2) Property that constitutes a right to receive income in respect of a decedent;
(3) Stock or securities of a foreign personal holding company;
(4) Stock of a domestic international sales corporation (or former domestic international sales corporation);
(5) Stock of a foreign investment company; and
(6) Stock of a passive foreign investment company (except for which a decedent share-holder had made a qualified electing fund election).
Basis increase was allocable on an asset-by-asset basis (e.g., basis increase could be allocated to a share of stock or a block of stock). However, in no case could the basis of an asset be adjusted above its fair market value. If the amount of basis increase was less than the fair market value of assets whose bases were eligible to be increased under these rules, the ex-ecutor determined which assets and to what extent each asset received a basis increase.
GST Tax - §2601
The 1976 Tax Reform Act introduced a completely new and entirely separate6 transfer tax - the “Gen-eration-Skipping Transfer Tax.” It is a tax on the value of property at the time an interest shifts from one generation to a succeeding generation (§2601). The generation-skipping transfer tax was a flat rate of 45% (in 2009) on cumulative generation-skipping transfers in excess of $3.5 million (in 2009). While this tax was repealed in 2010, it was reinstated by TRUIRJCA for 2010 through 2012 at a flat (or top) rate of 35% for amounts exceeding its exemption. In 2013, ATRA permanently increased the top GST rate from 35% to 40% for transfers over the exemption
Note: The generation-skipping transfer tax exemption for a given year is equal to the applicable exclusion amount for estate tax purposes.
The generation-skipping transfer tax is imposed on transfers, either directly or through a trust or similar arrangement, to a “skip person” (i.e., a beneficiary in a generation more than one generation below that of the transferor). Under §2611, the tax applies to the following types of transfers:
1. Taxable Terminations - This is defined as any termination (by death, lapse of time, release of a power, or otherwise) of an interest in property held in trust, unless:
(a) Immediately after such termination, a non-skip person has an interest in such property, or
(b) At no time after such termination may a distribution be made from such trust to a skip person (§2612(a)).
6 Nonetheless, the generation-skipping transfer tax is related to the estate tax. It is designed to produce a tax result for
generation-skipping transfers as would have occurred had the property passed through successive generations.
2-49
Note: A skip person may be a natural person or certain trusts. All persons assigned to the second or more remote generation below the transferor are skip persons (e.g., grandchildren and great-grandchildren). Trusts are skip persons if (1) all interests in the trust are held by skip persons, or (2) no person holds an interest in the trust and at no time after the transfer may a distribution (includ-ing distributions and terminations) be made to a non-skip person (§2613(a)(1)).
2. Taxable Distributions - This means any distribution from a trust to a skip person (§2612(b)).
3. Direct Skips - This is a transfer subject to gift or estate tax but which is made to a skip person (§2612(c)).
Note: A transfer to a grandchild is exempt if the parent of the grandchild is dead (§2612(c)(2)).
The tax is computed by multiplying the “taxable amount” by the “applicable rate” (§2602). The tax-able amount differs with the type of transfer. For taxable terminations, it is the value of all property that was the subject of the taxable termination reduced by expenses under §2053(b) (§2622). In the case of taxable distributions, it is the value of the property received by the transferee reduced by expense related to the determination of the tax (§2621(a)). For direct skips, it is the value of the property received (§2623).
The applicable rate is the maximum federal estate tax rate in effect on the date of the transfer mul-tiplied by the “inclusion ratio.” This ratio is the reciprocal of a fraction that has, as its numerator, the amount of the exclusion allocated to the subject property and, as its denominator, the value of all property transferred less any federal estate taxes (§2642).
In short, the GST is imposed at a flat rate of 40% (i.e., the top rate of estate and gift taxation in 2021) on cumulative generation-skipping transfers in excess of an exemption amount ($11,700,000 in 2021).
Predeceased Parent Exception
Under the “predeceased parent exception”, a direct skip transfer to a transferor’s grandchild is not subject to the generation-skipping transfer (“GST”) tax if the child of the transferor who was the grandchild’s parent is deceased at the time of the transfer (§2612(c)(2)). This “predeceased parent exception” to the GST tax is not applicable to:
(1) Transfers to collateral heirs (e.g., grandnieces or grandnephews), or
(2) Taxable terminations or taxable distributions.
The predeceased parent exception applies to transfers to collateral heirs, provided that the de-cedent has no living lineal descendants at the time of the transfer. For example, the exception applies to a transfer made by an individual (with no living lineal heirs) to a grandniece where the transferor’s nephew or niece who is the parent of the grandniece is deceased at the time of the transfer.
Example
Dan is a granduncle with no children. Rocko, his sister’s son (his nephew) is deceased. A transfer from Dan to his grandniece (nephew’s daughter) is excluded from the GSTT because of the predeceased parent exception. However, the transfer is subject to gift and estate taxes.
2-50
In addition, the predeceased parent exception (as modified by the change in the preceding par-agraph) also applies to taxable terminations and taxable distributions, provided that the parent of the relevant beneficiary was dead at the earliest time that the transfer (from which the bene-ficiary’s interest in the property was established) was subject to estate or gift tax. For example, where a trust was established to pay an annuity to a charity for a term of years with a remainder interest granted to a grandson, the termination of the term for years is not a taxable termination subject to the GST tax if the grandson’s parent (who is the son or daughter of the transferor) is deceased at the time the trust was created and the transfer creating the trust was subject to estate or gift tax.
Exemption
The generation-skipping transfer tax exemption for a given year is equal to the applicable exclu-sion amount for estate tax purposes. In addition, the generation-skipping transfer tax rate for a given year will be the highest estate and gift tax rate in effect for such year. The exemption can be allocated by a transferor (or his or her executor) to transferred property.
Allocation
If an individual makes a skip during his or her lifetime, any unused generation-skipping trans-fer tax exemption is automatically allocated to a skip to the extent necessary to make the inclusion ratio for such property equal to zero. Lifetime direct skips (gifts) use up the GST exemption first. Since 2001, allocation of the exemption is also made for transfers to a GST trust. A GST trust is a trust that could have a GST.
2-51
2-52
An individual can elect out of the automatic allocation for lifetime skips. The election out of the automatic allocation for lifetime direct skips must be made on a timely filed gift tax return Form 709. The automatic allocation of the exemption is irrevocable after the due date for Form 709.
Retroactive Allocation
The GST exemption can be allocated retroactively when there is an unnatural order of death. If a lineal descendant of the transferor predeceases the transferor, then the trans-feror can allocate any unused generation-skipping transfer exemption to any previous transfer or transfers to the trust on a chronological basis. A transferor may retroactively allocate a generation-skipping transfer exemption to a trust when a beneficiary:
(a) Is a nonskip person,
(b) Is a lineal descendant of the transferor's grandparent or a grandparent of the trans-feror's spouse,
(c) Is a generation younger than the generation of the transferor, and
(d) Dies before the transferor.
An exemption is allocated under this rule retroactively, and the applicable fraction and inclusion ratio is determined based on the value of the property on the date that the prop-erty was transferred to a trust.
2-53
Review Questions
18. The property basis for an asset can vary based on how it was acquired. In what type of trans-action is the basis the lesser of the original owner's basis or the fair market value on the transac-tion date?
a. a gift later sold at a gain.
b. a gift later sold at a loss.
c. a purchase.
d. a tax-deferred exchange.
19. The start of a holding period for an asset can depend on how it was acquired. In which of the events below does the holding period for an asset commence on the date of someone's death?
a. a reversion.
b. a gift.
c. an inheritance.
d. a repossession.
20. Under the 2010 special estate election, property received from a decedent was subject to the modified carryover basis rules. According to this legislation, what qualified as an asset that was obtained from the decedent?
a. property obtained by gift.
b. property obtained by the decedent’s estate from the surviving spouse.
c. property passed from the decedent to joint tenants of said property as a right of survivor-ship.
d. the entire community property that passes to a surviving spouse.
21. Six types of property were ineligible for a modified basis increase under the 2010 special election. However, what property qualified for a basis increase?
a. property that establishes an entitlement to receive income in respect of a decedent.
b. property transferred during the decedent’s lifetime to a revocable trust that pays all of its income to the decedent during the decedent’s life.
c. stock shares of a foreign investment company.
d. stock or securities of a foreign personal holding company.
22. The generation-skipping transfer tax (§2601) applies to three basic types of transfers. Which of these transfer types is considered an outright transfer to a second generation family member?
a. a nontaxable distribution.
b. a direct skip.
c. a taxable distribution.
d. a taxable termination.
2-54
Gift Taxes - §2501 to §2524
The gift tax applies to any transfer of property by gift whether made directly or indirectly and whether made in trust or otherwise. A transfer is a transaction where property is passed to or con-ferred upon another regardless of the means or device employed. Gift taxes were not repealed in 2010.
Gifting is a method of reducing or eliminating growth in estate value and consequent future potential estate tax liability. Each completed gift made over a donor’s lifetime removes not only the current value of the property gifted from the estate but any appreciation in the property as well.
However, there is a price to pay for making gifts. This price is the federal gift tax. This tax has two purposes:
(1) To discourage the avoidance of federal income taxes by giving away income-producing assets to those in lower income tax brackets, and
(2) To limit avoidance of federal estate taxes by lifetime gifts that remove property from the donor’s estate.
The present gift tax had its roots in the Revenue Act of 1932 and persists today in §2501 through §2524.
Gift Tax Computation
Lifetime gifts and transfers at death are taxed on a tax schedule that has cumulatively progressive rates. Each taxable transfer, including the final transfer at death, begins in the tax bracket attained by the prior gift.
For gifts made in 2010, the applicable exclusion amount for gift tax purposes was $1 million, and the gift tax rate was 35%. However, for gifts made after December 31, 2010, the gift tax was reunified with the estate tax, with the same applicable exclusion amount of $11.70 million (in 2021) and a top gift tax rate that has risen from 35% to 40% for transfers that exceed this exclusion.
Note: The applicable exclusion amount can be used during lifetime or at death, not both.
Calculation Steps
The following schedule is an outline of the basic gift tax calculation steps:
2-55
Federal Gift Tax
1. Gross value of current gift $___________ 2. Less: 50% of line 1 if spouse splits gift $___________ 3. Less: Annual exclusion ($15,000/per donee in 2021) $___________ 4. Less: Marital deduction if gift is to spouse $___________ 5. Less: Charitable deduction if gift is to charity $___________ 6. Equals: Current taxable gift (line 1 less lines 2-5) $___________ 7. Sum of all prior taxable gifts $___________ 8. Add lines 6 and 7 $___________ 9. Tax on line 8 $___________ 10. Less: Tax on line 7 $___________ 11. Equals: Tentative tax on current taxable gift $___________ 12. Less: Exclusion credit equivalent for year of gift $___________ 13. Plus: Any exclusion credit equivalent previously used $___________ 14. Gift tax due and payable $
Applicable Exclusion
Under the Tax Reform Act of 1976, a single or unified set of graduated gift and estate tax rates applied to both lifetime and death transfers. However, the Tax Relief Act of 2001 changed this unified struc-ture. Under the 2001 Act, the applicable exclusion amounts differed for estate and gift taxes. The estate tax exclusion rose to $3.5 million but, the gift tax exclusion amount stayed at $1,000,000.
However, for gifts made after December 31, 2010, the gift tax is again reunified with the estate tax, using an applicable exclusion amount and a top tax rate.
Application
Under §2501, the gift tax is imposed on the transfer of property by gift by any individual7. The tax applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible (§2511(a)).
Note: Nonresident aliens pay gift tax on transfers of property located in the United States (§2511(a)). However, gifts of intangible property by nonresident aliens are exempt from gift tax (§2501(a)(2)).
Entity Rule
When a gift is made to an entity, the gift is deemed made to the individuals who own beneficial interests in the entity. Thus, a gift to a trust is not treated as a single gift to the trustee, but a gift to each of the trust beneficiaries. The same rule applies to corporations and partnerships.
Valuation
The value of a gift is the fair market value of the property on the date the gift is made. There is no alternate valuation date for the federal gift tax as there is for the federal estate tax.
7 This language implies that gift tax cannot apply to entities. However, the regulations state that a gift by an entity is
taxable to the persons owning a beneficial interest in the entity (Reg. §25.2511-1(h)).
2-56
The fair market value is the price at which the property would change hands between a willing buyer and a willing seller when neither one is under any compulsion to buy or to sell, and both have reasonable knowledge of all relevant facts.
Note: Fair market value is not determined by a forced sale price, or by the sale price of the item in a market other than that in which that item is most commonly sold to the public.
A valuation understatement occurs if the value of any property claimed on the gift tax return is 66 2/3% or less of the amount determined to be the correct valuation. If there is an underpayment of the gift tax because of this understatement, an addition to tax of up to 30% of the underpayment may be assessed. The addition to tax will not apply if the underpayment is less than $1,000. The IRS may waive all or part of this addition to tax if it can be shown that there was a reasonable basis for the valuation claimed and that it was made in good faith.
Real Property
Generally, the best indication of the value of real property is the price paid for the property in an arms-length transaction on or before the valuation date.
Note: Unimproved real property is defined as land without significant buildings, structures, or any other improvements that contribute to its value.
If the property has not recently been the subject of an arms-length transaction, the best method of estimating value is by using the market data or comparable sales approach. This approach uses arms-length sales of properties that are as similar as possible to the property being valued.
Stocks & Bonds
The value of stocks and bonds is his or her fair market value per unit (share or bond) on the date of the gift. If there is a market for stocks and bonds on a stock exchange, in an over-the-counter market, or otherwise, the fair market value per unit is the mean (midpoint) between the highest and lowest quoted selling prices on the date of the gift.
Annuities, Life Estates, Terms for Years, Remainders, & Reversions
The value of all annuities, life estates, terms for years, remainders, or reversions is generally the present value on the date of the gift determined by IRS tables. The tables and factors used depend on the date of the transfer.
However, the value of an annuity, or of a life insurance policy issued by a company regularly engaged in the selling of such contracts, is the amount that the issuing company would charge for a comparable contract on the date of the decedent’s death.
Split Gifts - §2513
If a married individual makes a gift of his or her own separate property to someone other than the spouse, and the donor’s spouse consents8 to “split-gift,” it may be regarded as made one-half by each spouse (§2513). The net effect of this gift-splitting provision is to make the gift tax exclusions
8 The consent is made on the gift tax return.
2-57
and credit of the spouse available to the donor. Thus, the first $30,000 ($15,000 X 2 in 2021) of gifts of present interests is excluded when the non-donor spouse consents to split the gift.
This privilege of “splitting” gifts is extended only to separate property given away by a husband or wife.
Note: The spouses must be married when the gift is made and the consent must be applied to all gifts made by each spouse during the year (Reg. §25.2513-1).
Community Property States
For gifts of community property, there is no need to “split” the gift since each spouse actually owns his or her one-half interest in the property. Thus, persons with community property have the ad-vantage of not having to file a gift tax return on a gift of $30,000 ($15,000 X 2 in 2021) worth of community property to a given donee.
Annual Exclusion
Section 2503 provides an annual exclusion of $15,0009 for gifts (other than” future interests”) made to any donee. Tax law provides for annual indexing for inflation of the $15,000 (in 2021) annual ex-clusion for gifts.
Indexing the annual exclusion permits donors to give more property without transfer tax costs and without using part of his or her applicable exclusion amount. Lifetime transfers deliver deeper tax savings because the post-transfer appreciation in the value of the gifts shifts to the recipient of the gift, instead of the donor’s estate.
The annual gift tax exclusion applies only to “present interests.” No exclusion is allowed for a “future interest in property” (§2503(b)).
Note: Under Reg. §25.2503-3, a future interest is any interest or estate, whether vested or contin-gent that is:
(1) Limited to commence in use, possession, or enjoyment at a future date, or
(2) Subject to the will of some other person.
Future interests include reversions, remainders, and other interests or estates that are to commence in use, possession, or enjoyment at some future date. On the other hand, an unrestricted right to the immediate use, possession, or enjoyment of property or the income from the property is a present interest in property.
Example
Dan created a trust under the terms of which his son was to receive for life the entire income from the property, with the remainder going to Dan’s grandson at the death of his son. There is a gift of a present interest to the son and of a future interest to the grandson. However, if Dan directed the trustees to pursue an investment policy that results in future increases in the value of the trust, rather than current income, his son
9 Annual exclusion was $13,000 but in 2021 is $15,000.
2-58
would not have a present interest, and the annual exclusion would not be allowed for Dan’s gift to his son.
Although treated as a gift to its shareholders, a gift to a corporation generally is a gift of a future interest, not qualifying for the annual exclusion.
Per Donee/Per Year
The annual exclusion is available with respect to gifts made to each donee, irrespective of the number of donees. For instance, if $15,000 (in 2021) is given to each of 10 individuals (a total of $150,000), the annual exclusion applies to each, and there is no gift tax liability. Moreover, the annual exclusion is available year after year, and gifts made within three years of the donor’s death are not brought back into the donor’s estate, as are pre-1982 gifts in excess of the annual exclusion.
Note: For a gift in trust, each beneficiary of the trust is treated as a separate person for purposes of the annual exclusion.
A gift to a corporation is a gift of a future interest to its stockholders and does not qualify for the annual exclusion. If the donor’s spouse is a shareholder, such a gift qualifies for the marital de-duction in proportion to the interest of the donor’s spouse in the corporation.
Gifts in Excess of the Annual Exclusion
Gifts in excess of the annual exclusion can be made without having to pay gift taxes, provided the remaining applicable exclusion amount is sufficient to offset the “tentative gift tax.” The applica-ble exclusion amount offsets the gift tax liability otherwise due with respect to the gift. The max-imum gift applicable exclusion amount may be used to offset gift taxes on lifetime transfers and, to the extent not so used, to offset estate taxes upon death.
Despite this reduction of the applicable exclusion amount available for estate tax purposes, it may still be advantageous to make certain gifts during one’s lifetime. For instance, if a gift of appreciating property is made prior to death, neither the donor nor the estate incurs any transfer tax liability on the appreciation amount (i.e., the appreciation is removed from the donor’s estate without tax liability to the donor).
No Gift Tax
If gifts are made within the annual exclusion amount, assets can be transferred to one’s eventual heirs without any gift tax liability. Thus, if a gift does not exceed $15,000 (in 2021), no gift tax return must be filed. However, if the gift to any donee is less than $15,000, the balance of the annual exclusion is lost. There is no carry over to other donees. If the gift to any donee is over $15,000, only the excess is taxed.
Gifts within 3 Years of Death
Since 1982 the old rule that gifts made within three years of death were included in the dece-dent’s estate no longer applies. However, a special provision applies to life insurance.
If the insured transferor dies within three years of the transfer of a policy, the entire policy pro-ceeds will be included in the insured’s gross estate even though the value of the policy on the
2-59
date of the gift was less than $15,000 (in 2021). But if any premiums paid after the transfer are paid by the donee rather than by the insured, only proceeds in the ratio of premiums-paid-by-donor to total-premiums-paid should be includable in the donor’s estate.
Uniform Gifts to Minors Act
Most states have adopted the Uniform Gifts to Minors Act to provide a simple and inexpensive method of making gifts to minors, which will qualify as a “present interest” for the annual gift tax exclusion. The asset is placed in the name of an adult as “Custodian under the Uniform Gifts to Minors Act.” Legal title, however, vests in the minor. The custodian is to use the assets during the child’s minority for support, education, and maintenance of the minor.
The custodianship terminates when the child reaches his or her majority, which is 18 in most states. Assets that can be conveyed under the Uniform Gifts to Minors Act are (i) money, (ii) securities, (iii) life insurance, and (iv) annuity contracts. Income on the assets is taxable to the minor, whether distributed or accumulated. If the donor is the custodian, the assets will be part of his or her estate should he or she die before distribution to the minor. To remove the asset from the gross taxable estate a third party should be named as custodian.
Note: Many states have adopted the Uniform Transfer to Minors Act. This Act permits a wider va-riety of assets to be transferred.
Exception for Minor’s Trusts - §2503(b) & (c)
Making an outright gift of a present interest to a minor is dangerous, even though state law may require the appointment of a guardian. It would be safer to make gifts to a trust with discretion-ary distributions of income and transfer of the trust principal to the child when he or she is more mature. However, such a transfer into trust is a future interest and no annual exclusion would be allowed.
2-60
2-61
2-62
Fortunately, §2503(b) and §2503(c) provide an exception to this rule and permit certain transfers into trust to qualify under the annual exclusion as a present interest.
Medical & Tuition Exclusion - §2503(e)
In addition to the annual exclusion of $15,000 (in 2021), the law provides unlimited gift tax exclusion for amounts paid for a donee’s medical expenses or school tuition (§2503(e)). Technically, these transfers are not treated as a transfer of property by gift.
Qualifying Transfers
Qualifying transfers are amounts paid on behalf of any individual to:
(1) A qualified educational institution (defined in §170(b)(A)(ii)) as tuition for such individual, or
(2) Any person providing medical care (defined in §213) with respect to such individual.
The statutory language refers to “tuition” without further definition. The Committee report indi-cates that the exclusion applies to tuition for both full and part-time students. However, it is limited to “direct tuition costs (i.e., no exclusion is provided for books, supplies, dormitory fees, etc.).”
Interest-Free or Below-Market Loans
In Dickman 465 U.S. 330 (1984), the Supreme Court held that an interest-free or below-market in-terest-rate demand loan was a gift. The Court held that the right to use money is a valuable right, and the failure to demand repayment over time passes wealth.
After Dickman, §7872 was passed providing that certain loans bearing a below-market rate of inter-est result in:
(1) The borrower being treated as if he or she paid interest to the lender, and
(2) The lender being treated as if he or she made an annual gift of the foregone interest to the borrower.
Gift Tax Marital Deduction
The value of gifts made to a spouse may be deducted from the total amount of gifts made during the calendar year. The amount of this marital deduction is unlimited. However, to qualify for the marital deduction, the following conditions must be met at the time the gift is made:
(1) The spouses must be married; and
Note: A gift to a person who becomes the donor’s spouse after the gift has been made does not qualify for the marital deduction.
(2) The spouse receiving the gift must be a U.S. citizen.
Note: The spouse making the gift does not have to be a U.S. citizen or resident.
Nondeductible Terminable Interests
Not all interests qualify for the gift tax marital deduction. Nondeductible interests include prop-erty interests transferred to a spouse that are terminable interests. A terminable interest in
2-63
property is an interest that will end or fail after a period of time or when some contingency occurs or fails to occur. Examples of terminable interests are life estates, annuities, estates for a term of years, and patents.
For purposes of the marital deduction, there is a distinction between “property” and an “interest in property.” “Property” refers to the underlying property in which various interests exist. How-ever, interests in property are not considered “property.”
For purposes of the marital deduction, terminable interests fall into three categories:
(a) Terminable interests that qualify for the marital deduction without the need for an elec-tion;
Note: If the donor transfers a property interest to his or her U.S. citizen spouse and the two spouses are the only joint tenants, the donor is not considered to have retained an interest in the property and the marital deduction is allowed even if the donor may receive the property because his or her spouse dies or the tenancy is severed. Likewise, if the donor makes a transfer of a life estate with power of appointment that meets certain conditions, the donor is considered to have made a trans-fer to his or her spouse that qualifies for the marital deduction.
(b) Terminable interests that do not qualify for the marital deduction unless the donor makes an election to treat the interest as qualified terminable interest property; or
Note: If the donor gives his or her spouse a life interest in property, the gift generally is a terminable interest and does not qualify for the marital deduction. However, the donor may elect to treat the life interest as a qualified terminable interest for which the marital deduction is allowed. The elec-tion is made on the gift tax return for the calendar year in which the interest was transferred. You must make the election on or before the due date, including extensions, for filing the return (§2523(f)(4)(A)). This election is irrevocable and may be made for any property in which the spouse has a qualifying income interest for life.
(c) Terminable interests that cannot qualify for the marital deduction.
Gift Tax Charitable Deduction
A donor may deduct from the total amount of gifts made during the calendar year all gifts (included in that total) that were made to or for the use of:
(1) The United States, a state, a political subdivision of a state, or the District of Columbia, exclu-sively for public purposes,
(2) Any corporation, trust, community chest, fund, or foundation organized and operated exclu-sively for religious, charitable, scientific, literary, or educational purposes, including the encour-agement of art,
Note: Organizations that foster national or international amateur sports competitions also qualify, but only if none of his or her activities involve providing athletic facilities or equipment, unless they are qualified amateur sports organizations, and organizations for the prevention of cruelty to chil-dren or animals are included. These organizations qualify as long as no part of his or her net earnings benefits any private individual and no substantial activity is undertaken to carry on propaganda, or otherwise attempt to influence legislation or participate in any political campaign on behalf of any candidate for public office.
(3) A fraternal society, order, or association operating under the lodge system, if the transferred property is to be used exclusively for religious, charitable, scientific, literary, or educational
2-64
purposes including the encouragement of art, and the prevention of cruelty to children or ani-mals, or
(4) Any war veterans’ organization organized in the United States or any of its auxiliary depart-ments or local chapter or posts, as long as no part of the net earnings benefits any private indi-vidual.
Partial Interests
When an interest in property is transferred for both charitable and noncharitable purposes, a charitable deduction is allowed for the interest passing to the charity only if the transfer is:
(a) An undivided portion of the donor’s entire interest;
Note: An undivided portion of the donor’s entire interest in property must consist of a fraction or a percentage of each interest or right the donor owns in the property, and it must extend over the entire term of his or her interest in that property or in other property into which the donated prop-erty is converted.
(b) A remainder interest in a personal residence;
Note: If the donor transfers for a charitable purpose the remainder interest, not in trust, in his or her personal residence, the value of the interest is a deductible charitable contribution.
(c) A remainder interest in a farm;
Note: If the donor transfers the remainder interest, not in trust, in a farm to a qualified charity, the value of that interest is deductible.
(d) A qualified conservation contribution;
Note: If the donor transfers a qualified real property interest to a qualified organization exclusively for conservation purposes, the value of that interest is deductible.
(e) A remainder interest, charitable remainder trust, or pooled income fund; or
Note: A charitable remainder annuity trust is a trust from which a specified amount is paid at least annually to one or more persons who were living at the time the trust was created. The amount must be at least 5% of the initial fair market value of the property placed in trust. At the death of the last noncharitable beneficiary, or at the end of a term of up to 20 years, the remainder interest must be paid to or held for the benefit of a qualified charitable organization.
A charitable remainder unitrust is a trust from which a fixed percentage of the net fair market value of its assets, valued annually, is paid at least annually to one or more persons who are living at the time of the creation of the trust. The percentage must be at least 5%. At the death of the benefi-ciaries or at the end of a term of up to 20 years, the remainder interest is paid to or held for the benefit of a qualified charitable organization.
A pooled income fund is a trust maintained by a charity to which donors transfer property and contribute the remainder interest in the property to charity. You either keep an income interest for life for your part of the trust property or create an income interest in that property for the life of one or more beneficiaries who are living at the time of the transfer.
(f) A guaranteed annuity interest or unitrust interest (i.e., a lead interest).
Note: A guaranteed annuity interest is the right to receive a determinable amount for a specified term or for the life of an individual living at the date of the gift. The annuity may also qualify if the instrument of transfer provides for a term of years or a period of lives plus a term of years. The amount must be paid at least annually.
2-65
A unitrust interest is the right to receive payment at least annually of a fixed percentage of the net fair market value, determined annually, of the property that funds the unitrust.
Selecting Gift Property
The following factors should be considered when selecting gift property:
1. If property in excess of the annual exclusion is transferred and the primary reason for the transfer is to reduce estate taxes, the donor should transfer property with a low gift value relative to estate value (i.e., property with a high appreciation potential).
2. When the property will be sold by the donee, highly appreciated property may not be a good selection, since large capital gains may be incurred by the donee. In addition, if retained by the owner, the property should obtain a full step-up in basis at death.
3. If one of the objectives of the gift is to transfer income to a lower income tax bracket, high-yielding income property would be appropriate.
4. Property that may present problems of valuation, division, or sale for the personal representa-tive of the estate should be considered. For instance, art objects, antiques, and jewelry are apt to be good for lifetime giving, since they often present valuation problems. In addition, there are sometimes questions as to whether they are to be sold or retained, and if retained, to whom they should be given if not the subject of a specific legacy.
5. Assets that shrink in value with age such as copyrights, patents, leaseholds, mineral rights, and the like are not usually good for gifts. These are known as shrinking or wasting assets.
Gift Advantages
1. $15,000 (in 2021) may be transferred free of any transfer tax to any donee, each and every year; the amount may be $30,000 if spouses join in the gifts.
2. The future growth in the value of property given away can be removed from the donor’s estate and be transferred to the donee. Better to pay transfer taxes at the lower current value, rather than at the higher value that will exist at the time of death.
3. Giving income-producing property shifts the income tax consequences from the donor to the donee, who may be in a substantially lower income tax bracket. The income tax savings occur each year, and so the beneficial effect will be cumulative over the donor’s lifetime.
4. Gifts from one spouse to the other are completely free of gift tax (§1041).
5. Giving low basis property to a spouse or other person who may die before the donor, and who wills the property back to the donor can sometimes qualify that property for basis advantages.
6. In a community property state, a gift of low basis separate property to the community (a gift of one-half to the non-owning spouse) may ensure that upon the death of either spouse, the entire property will qualify for basis advantages.
7. Gifts may adjust the ownership percentages among the component parts of an owner’s estate, perhaps making it possible to qualify for long-term installment payments of estate taxes, or for §303 redemptions to pay death taxes and expenses.
8. Gift payments of medical and tuition expenses for a donee are gift tax-free.
2-66
Gift Disadvantages
1. Donor loses control over, and income from, the property given away. It is therefore not avail-able for his or her future security, or to meet unexpected emergencies. In an uncertain world, this could be disastrous.
2. Gifts can make the donee wealthier than the donor, thus making the ultimate tax burdens even higher, and shifting the obligation to pay those taxes from the donor to the donee.
3. Gifts can have an adverse effect on the donee’s personality, his or her family relationships, and his or her attitudes toward life. They could conceivably turn the donee into a sloth. They might cause a rift in his or her marriage or other personal relationships.
4. Gifts to a minor child, where the minor gets his or her hands on the property before he or she has reached financial maturity, are potentially the most dangerous of all. In the hands of a nor-mally rebellious teenager, they could break his or her relationship with his or her own parents.
5. Even though the list of disadvantages is not as long as that of advantages that does not mean that the disadvantages might not be the most important, and might not tip the scales in favor of not making a contemplated gift.
6. Weigh the disadvantages very carefully before making any gift that is motivated solely by po-tential tax savings.
Gift Tax Returns
Any individual who makes gifts to any one donee during a calendar year that are not fully excluded under the $15,000 (in 2021) annual exclusion must file a gift tax return, i.e., Form 709 (the Short Form 709-A is now obsolete and should not be filed). However, no return is required to report a qualified transfer for educational or medical costs (§6019(a)).
The return is due on April 15 of the year following the year the gifts were made (§6075).
Includibility of Gifts in the Estate
Since 1982, gifts made within three years of death are no longer considered in the computation of the taxable estate. If they exceed the annual exclusion, however, they may be added to the taxable estate as “adjusted taxable gifts.” However, the appreciation on the asset from the date of gift until the date of death is not brought into the computation.
Gifts of life insurance policies, however, are still included if made within three years of death. Certain incomplete transfers (e.g., retained life estates, revocable transfers, etc.) will also be included in the gross estate without regard to when they were made.
2-67
2-68
All transfers made within three years (except those qualifying for the annual gift tax exclusion) will be included for purposes of determining whether an estate qualified for §303 redemption, §2032A valuation, or §6166 deferral of tax payment.
Shifting Income & Gain
One of the valuable benefits of making lifetime gifts is that the donor can shift tax on the income to a donee who is in a lower income tax bracket. The gift tax exclusion of $15,000 (in 2021) a year per donee provides a substantial opportunity for a high-earning taxpayer to reduce his or her income tax burden without using up any part of his or her unified gift and estate tax credit. Not only can he or she make outright gifts of up to $15,000 a year which, if the property earns 10%, would shift $1,500 a year from the donor’s income tax bracket to that of each donee.
Gifts before Sale
When a high bracket family member holds substantially appreciated property, a gift of all or a portion of that property to low bracket family members should be considered prior to any taxable sale (See R.R. 78-197). Upon completion of the gift, the low bracket family member would then make the actual sale.
Note: A transfer to a child under age 18 will not accomplish the desired result since the child will be taxed at the parents’ top rate.
Transfers into Trust Prior to Sale
Transfers into a trust in advance of a sale can be extremely dangerous. Section 644 provides that when appreciated property is transferred to a trust and then sold within 2 years, the trust will be taxed as if the transferor had made the sale.
Note: Even when the sale is not treated as made by the transferor, recent changes in income tax rates for trusts make this format costly.
Installment Obligations
The use of installment sales can have interesting and controversial gift and estate planning as-pects. For purposes of gift tax, senior family members may wish to installment sell property to younger generation family members. While such a sale can result in gain to the seller, the gain can be reported under the installment method pursuant to §453. In addition, loan principal can be forgiven using the gift tax annual exclusion.
In this context, the installment sale has several advantages:
(1) The property sold should only need to be valued at the time of the original sale;
Note: A pattern of gifts involving annual percentages of a substantial property (i.e., valuable real property) would require annual appraisal of the property in order to ensure that each gift was within the annual exclusion amount.
(2) The buyers of the property should have a tax basis equal to the sales price;
Note: Buyer can use this new basis for purposes of depreciation and calculating gain or loss on sale.
(3) The buyers should not have cancellation of indebtedness income since this is a gift made out of detached generosity; and
2-69
(4) The buyers should have immediate possession and enjoyment of the entire property.
However, there are also several disadvantages:
(1) The amount forgiven is treated as a payment received by the seller for income tax pur-poses;
(2) The note may still be in the seller’s estate at his or her death and would get no step-up in basis;
(3) Such an installment obligation must bear at least the applicable federal interest rate or it will be imputed; and
(4) If the buyers resell the property within 2 years of the original installment sale, it can ac-celerate the original installment note and cause all gain to be recognized on that original note.
In making the sale to a younger family member, the seller might elect out of the installment method. While this would result in the immediate recognition of gain, the seller could argue a substantial discount on the current value of the installment obligation. Such a discount would reduce the immediate gain. In addition, when the seller dies, the estate may also argue a discount on the note if it is still part of the decedent’s estate.
Note: If the seller receives payments equal to the discounted fair market value of the note, any additional payments would constitute ordinary income. Likewise, if the estate or beneficiary re-ceived payments in excess of the discounted value of the note at death, such payments would be income.
When an installment obligation passes from the decedent to his or her estate and then from the estate to the beneficiary, there is no disposition of the installment obligation requiring all gain to be immediately recognized (§453B(c)). However, if the executor sells property during administra-tion using the installment method, distribution of the installment obligation is a disposition of the note and the entire amount of gain is recognized to the estate at the time of distribution (Shannon, 29 T.C. 702 (1958))).
Note: If an executor intends to sell property using the installment method, he or she should first consider a preliminary distribution of the property to a beneficiary. The beneficiary using the in-stallment method could then make the installment sale without risk of acceleration.
Transfer to Obligor at Death
When a seller sells property using the installment method and the installment obligation is later transferred at death to the obligor (buyer or person legally obligated to pay the install-ments), a taxable transfer occurs (§691(a)(5)(A)). The amount included in the income of the transferor (the estate or beneficiary) is the greater of the amount received or the fair market value of the installment obligation at the time of transfer, reduced by the basis of the obliga-tion. The basis of the obligation is the decedent’s basis, adjusted for all installment payments received after the decedent’s death and before the transfer.
Note: If the decedent and obligor were related persons, the fair market value of the obligation cannot be less than its face value.
Income in Respect of a Decedent
Uncollected installment obligations held by the decedent and disposed of on the decedent’s death result in income in respect of a decedent to the estate or beneficiary (§691). When an
2-70
installment note is transferred from the decedent to any other person at death, an amount equal to the excess of the face amount of the note over its basis to the decedent is considered income in respect of a decedent (Reg. §1.691(a)-5(a)). The installment obligation receives no step-up in basis.
Note: All gross income that the decedent had a right to receive and that is not properly includible on the decedent’s final return is called income in respect of a decedent.
Thus, if a decedent had sold property using the installment method and an heir receives the right to collect the payments after the date of death, the payments the heir collects are in-come in respect of the decedent. The heir will use the same gross profit percentage that the decedent used to figure the part of each payment that represents profit. The heir includes in income the same profit the decedent would have included had death not occurred.
Note: The character of the income received in respect of a decedent is the same as it would have been to the decedent if he or she were alive. Thus, if the income would have been a capital gain to the decedent, it will be a capital gain to the estate or beneficiary.
Income that a decedent had a right to receive is included in the decedent’s gross estate and is subject to estate tax. This income in respect of a decedent is also taxed when received by the estate or beneficiary. However, an income tax deduction is allowed to the person (or estate) receiving the income.
Reporting of Foreign Gifts - §6039(f)
Section 6039(f) generally requires any U.S. person (other than certain tax-exempt organizations) who receives gifts or bequests from foreign sources totaling more than $16,815 (in 2021) during the taxable year to report them to the Treasury Department. The threshold for this reporting requirement is indexed for inflation.
The definition of a gift to a U.S. person for this purpose excludes amounts that are qualified tui-tion or medical payments made on behalf of the U.S. person, as defined for gift tax purposes (§2503(e)(2)), and amounts that are distributions to a U.S. beneficiary of a foreign trust if such amounts are properly disclosed under the reporting requirements.
If the U.S. person fails, without reasonable cause, to report foreign gifts as required, the Secretary of the Treasury is authorized to determine the tax treatment of the unreported gifts. In addition, the U.S. person is subject to a penalty equal to 5% of the amount of the gift for each month that the failure continues, with the total penalty not to exceed 25% of such amount.
2-71
Review Questions
23. Most gifts are subject to gift tax. However, under §2501, what type of transfer is not subject to gift tax?
a. a gift by any entity.
b. a gift if the transfer is in trust.
c. an indirect gift.
d. an intangible gift.
24. A gift’s value must be determined for federal gift tax purposes. For which of the following items are IRS tables used to determine present value on the date that the gift is completed?
a. life insurance.
b. real property.
c. remainders and reversions.
d. stocks and bonds.
25. The portion of a property interest that is transferred to a charity, when the transfer is for combined charitable and noncharitable purposes, may qualify for a charitable deduction. Under what circumstance is this deduction allowed for said portion of the interest?
a. if the transfer is a qualified conservation contribution.
b. if the transfer is a divided portion of the donor’s partial interest.
c. if the transfer is a farm in trust.
d. if the transfer is a personal residence in trust.
26. Six disadvantages of giving gifts are provided in the course material. What is one of these disadvantages?
a. Spousal gifts are excessively taxed.
b. A donor may transfer only $5,000 tax-free to any donee.
c. The result could mean even higher tax burdens to the recipient.
d. Upon the death of either spouse, none of the property qualifies for basis advantages.
2-72
Learning Objectives
After reading Chapter 3, participants will be able to:
1. Specify types of wills citing the functions a will can perform, identify types of bequests, determine the duties of executors and guardians, and recall ways to hold title and their tax ramifications.
2. Identify advantages of a properly drafted will, determine the distribution flow of simple wills, and specify the pros and cons of probate proceedings.
3-1
CHAPTER 3
Wills & Probate
What Is A Will?
A will is a legal document executed by any competent person according to the prescribed statutes of his or her state and contains instructions to be followed at death. It is an important vehicle for the transfer of property and is often the first step taken in estate planning. Everybody needs a properly executed will.
If one does not have a will, the state will draft one for them under the laws of intestacy. Each state has enacted such laws that divide the decedent’s assets on death if there is no will.
A will can perform many functions. For example, it can:
(1) Dispose of decedent’s assets to any individual, association, corporation, group, or government entity,
(2) Name an executor to handle estate assets on death,
(3) Provide for the disposition of the decedent’s body or leave funeral instructions,
(4) Disinherit a spouse, child, or anyone else, or
(5) Designate a guardian for minor children.
Provisions & Requirements
Before a will is accepted for probate, the probate court determines whether the will is legal in sub-stance and form. The testator must be at least 18 years old, competent, and not under the undue influence of another.
Most wills have certain fundamental provisions. First, there is a statement identifying the individual and stating that the document is the person’s will. Normally, the county of residence is also stated.
All prior wills and codicils should be revoked. In some states, unless a will specifically revokes a prior will or codicil, the prior document is not canceled.
The will should identify all family members, even if the intent is to disinherit them. Many states re-quire that the testator name his or her:
(1) Spouse,
(2) All living children, and
(3) Any children of a deceased child.
3-2
Failure to mention or provide for them is presumed to be a mistake and they are entitled to a share they would have received if the testator had died without a will.
Example
Dan puts in his will that his entire estate goes to his son, Ralph, and his daughter, Daphne. No mention is made of his third child, Rocko. In many states, Rocko automat-ically receives one-third of Dan’s estate. Dan should have mentioned Rocko in his will and provided that he did not wish to leave him anything.
The will should effectively distribute your assets. This can be done with style and very simply, for example, “I leave my entire estate to my worthless son, Rocko, if he is lucky enough to survive me.” A number of specific or general bequests can also be made.
Specific & General Bequests
A specific bequest (called a specific devise when real property) is the distribution of a specific asset, for example, “my apartment house located at 2222 Marina Drive, Newporche Beach, Cali-fornia, to my good and faithful son, Ralph.” However, if the apartment house is not owned, the recipient gets nothing in its place.
A general bequest is actually a cash bequest, for example, “I leave $50,000 to the local chapter of the Small Animal League for research.” If there is not $50,000 cash in the estate on death, the executor must sell assets to raise the funds.
Residual Bequests
Even if the testator believes he or she has distributed everything, there still should be a clause that covers the “residue” of the estate. For example, after several small bequests, put at the end of your will “I leave the residue of my estate to Dan Santucci.” This means that everything that is not specifically itemized will go to someone who really deserves it.
Conditional Bequests
Some people add specific conditions to their will. This frequently cannot be done. For example, one may want to leave money to his or her daughter, but not want any of it to later go to her derelict spouse. Unfortunately, once you will something outright, you cannot add conditions to it. Unless the assets are put into a trust, you must leave it outright and hope the recipient will later carry out your wishes.
Executor
The will should name an executor (executrix if female) to handle the estate at death. In general, the executor’s job is to take possession of the assets subject to the will, pay all of the debts and any taxes, and distribute assets in accordance with the will. Some states place restrictions on the appointment of an executor. Generally, the executor must be at least 18 years of age, not con-victed of certain crimes, and agree to serve. Several people can serve together, or several people can serve in order so that if one cannot serve, the next named takes over.
3-3
Normally, the will “waives bond” for the executor. As a result, the executor does not have to obtain a bond to protect the estate if the executor were to steal assets. Most people trust their executor enough to waive this requirement. The executor is often given the “power to sell estate assets.” This gives the executor flexibility if estate assets, particularly real property, need to be sold during probate.
Guardian
When there are minor children, the will should name a guardian. There are two types of guardian:
(1) A guardian of a minor’s estate is the person who handles the minor’s assets until the child attains 18, and
(2) A guardian of the person raises the child until he or she turns 18.
In general, anyone can be named as guardian of the estate even if the other parent is living. Many people name close friends as guardians. If all children are over age 18, no guardians are needed.
Example
Dan is divorced and wants to leave his assets to his six-year-old son, Ralph. He can name his biker brother, Ron, guardian of Ralph’s estate. However, parents have the first right to custody. When Dan dies, his attractive but vicious ex-wife (Ralph’s mother) has the right to raise Ralph.
Types of Wills
Most states recognize several types of wills. First is the handwritten or holographic will. The majority of states allow a handwritten will if entirely in the decedent’s handwriting, dated and signed by the decedent. Normally, witnesses are not required.
Note: There is frequent litigation over interpreting handwritten wills.
The second type of will is a regular witnessed will. Two or three people must witness the will1. The witnesses have to see the will signed by the testator. The testator then declares the document to be his or her will and asks the witnesses to attest to it by also signing the will. The witnesses should not receive any assets under the will.
Note: A copy of the will should be kept outside the safe deposit box. If the only copy is inside, it may be impossible for the heirs or executor to get at it without a lot of time-consuming legal pro-cedures.
A joint will is when two people (usually husband and wife) sign one will disposing of both of their assets. This can be dangerous since there is some question whether such a will can be changed after the death of one of the parties.
Some states (e.g., California) have introduced a type of will called a statutory will. A statutory will is exactly that - a simple preprinted form established by statute. Normally, you cannot change any pro-vision.
1 California requires two witnesses to a will.
3-4
Title Implications
One of the most important aspects of estate planning is determining how title is held on assets. When stock is bought, a bank account opened, a car or home purchased, title is recorded on the asset. This title will determine what happens to the asset at death.
Title can be taken in a number of different ways. Four fundamental ways to hold title are:
(1) Individual
(2) Joint tenancy
(3) Tenancy in common, and
(4) Marital - i.e., tenancy by the entirety or community.
Each of these forms of title has different ramifications that are important to know before taking title.
To find out how title is held, obtain the transfer or purchase documents and see how title is recorded. Here are some guidelines:
1. For real estate, look at the original deed. When real estate is purchased, the buyer receives a deed called a “grant deed” or a “quitclaim deed,” or in some states a “warranty deed.” If the original deed can’t be found, a copy can normally be obtained from the County Recorder’s office for a small fee. Sometimes a copy can be obtained from a title company if it handled the purchase.
2. For bank accounts look on the saving passbook, certificate of deposit, or other document evi-dencing the account.
Note: If the bank doesn’t type how title is held on these documents, check the signature card for the account.
3. For securities look at the stock or bond certificate.
4. For automobiles, check the “pink slip” or certificate of ownership2.
5. Federal law governs U.S. saving bonds or government securities. If registered with an “or,” it is referred to as “co-ownership” which is equivalent to joint tenancy. At death, the asset will go to the surviving party.
Individual
Assets in decedent’s individual name are controlled by the decedent’s will. If the decedent is single, the will controls everything in the decedent’s individual name. However, if the decedent is married, the will may not control all property in the individual’s name since it could be com-munity property. In such a case, the will can only control the decedent’s one-half interest in the community asset.
Example
Dan has a brokerage account and accumulates $500,000 in bonds. The account is in his name alone but is community property. Since the property is community property,
2 In California, the Department of Motor Vehicles does not use the words “joint tenants” or “tenants in common.” Instead
they use “or” to mean joint tenancy and “and” or a slash “/” to mean tenants in common.
3-5
at his death only one-half of the account will be subject to his will, the other one-half belongs to his surviving spouse.
Even in a community property state, if the asset is a separate property asset (i.e., acquired either before marriage or during marriage by gift, inheritance, or earnings from a separate property), then the will can control all of it.
Joint Tenancy
Joint tenancy is when two or more people take title to an asset and at death, the asset automat-ically goes to the survivor or survivors. It is a simple and inexpensive way to pass property. There is no probate or other legal proceeding involved. A will does not affect joint tenancy property because the joint tenancy title supersedes the will. However, where there is no intent to transfer the property to the survivor, complications can arise.
Example
Dan has set up a will and a testamentary trust for the benefit of his son, Ralph. Using his will, Dan intends to put his property into trust at death. However, Dan has taken title to all his property as joint tenants with his girlfriend Suzy. On Dan’s death, his property automatically passes to Suzy as the surviving joint tenant. Nothing passes by his will, and nothing goes into his trust.
Example
Dan has $300,000 he wants to pass to his three nephews at death. He puts $120,000 in joint tenancy bank account with one nephew. This will permit that nephew to handle Dan’s financial affairs before death. Dan’s will leaves everything equally to the three nephews. On Dan’s death, the $120,000 passes to the one nephew as the surviving joint tenant, the remaining $180,000 is divided up three ways. Although Dan could have put a provision in his will to take joint tenancy or other assets into account in dividing up an estate, this is rarely done. Unless the nephew quickly disclaims the joint tenancy, he could be estate or inheritance taxed on it. If the nephew equalizes his share with the other two nephews, it could also then be a taxable gift.
Most people use joint tenancy to avoid probate. However, probate avoidance does not neces-sarily eliminate or reduce federal estate taxes. In short, joint tenancy avoids probate, but not federal death taxes. Section 2040(a) presumes that joint tenancy property belonged entirely to the decedent unless the survivor can prove his or her contribution3.
3 This presumption does not apply to husband and wife.
3-6
Example
Dan puts $800,000 into a joint tenancy bank account with his girlfriend, Suzy, to “prove his love” and then dies. The Service will presume it was all Dan’s unless Suzy can prove that part of the cash belonged to her.
Often the creation of a joint tenancy can itself be a gift (Reg. §25.2511-1). For example, it is a gift to put real estate or any form of securities into joint tenancy.
Example
Dan puts one of his children on title to his home as a joint tenant. Each joint tenant now has an equal interest in the property. Dan has made a gift of 50% of his home by putting it into joint tenancy. Even if Dan files a gift tax return, it will not reduce his taxable estate at death.
While establishing a U.S. savings bond or bank account in joint tenancy is not a gift, it becomes a gift when the other joint tenant withdraws funds. Thus, if Dan puts $100,000 in a joint tenancy bank account with his ex-wife, Jane, and she runs off with the money, he has made a gift to her of $100,000 at the time of withdrawal.
If the transfer of an asset into joint tenancy is a gift, then the other joint tenant(s) own a propor-tionate share of the assets and will be taxed on its income. The following list shows those assets that become gifts when put into joint tenancy.
Asset Gift?
Real Property Yes
Bank Account No
Credit Union Account No
Stocks & Bonds Yes
Mutual Funds Yes
Brokerage Account No
Money Market Funds Yes
U.S. Savings Bonds No
U.S. Treasury Bills Yes
U.S. Treasury Notes Yes
Vehicles No
Joint tenancy can be severed without the knowledge of the other joint tenant. For example, if Dan and his son, Ralph own a house in joint tenancy, either can deed the property to a third party who then deeds it back. Dan and Ralph would no longer be joint tenants but would become ten-ants in common. Their wills now pick up their one-half of the property.
Note: A surviving spouse is often shocked to discover that his or her spouse severed the joint ten-ancy and left his or her half to someone else.
3-7
Tenants in Common
Tenancy in common is frequently used when several people go together to buy real property. When two or more people hold title as “tenants in common,” they own an undivided interest in the property. A person’s will controls only his or her share of assets held as tenants in common. Unlike joint tenancy, their interests do not have to be equal4.
Example
Dan and his brother, Ron purchase a house. Dan puts up 60% of the money and Ron puts up 40%, taking title as tenants in common to reflect their unequal interests. Ten-ants in common title will also allow their wills to transfer their respective shares.
Tenants in common can partition property so that if one tenant wants it sold, they can require the other co-owners to either divide it (if possible) or sell it.
Tenants by the Entirety
Some states5 use a form of title called “tenants by the entireties.” This is basically a joint tenancy registration between husband and wife. However, it differs from a true joint tenancy in several ways. Its survivorship feature can only be broken with the consent of both spouses, while in a joint tenancy any co-owner can cause a severance and undo survivorship. Originally, only the husband had control of property held as tenants by the entirety, and he was entitled to all income from the property. While some states have modified this, in those that have not, it also differs from joint tenancy where each co-owner is entitled to an equal share of the income.
Community Property
Community property has a dual meaning:
(1) It refers to assets that have been acquired in a community property state during marriage; and
(2) It is a manner of holding title for a married couple.
In either event, each spouse has the right to convey one-half of the total community property at death. Thus, when the home is in the husband and wife’s names as community property and the wife dies, her will picks up one-half of the home.
Tax Basis Advantage
Community property title has a tax basis advantage. Under §1014(b)(9), when assets are in the husband and wife’s names as joint tenants and one dies, only half the assets get a new basis. However, §1014(b)(6) provides that when community property title is used all assets get a full stepped-up basis on the first spouse’s death.
4 However, if no percentage difference is stated, the presumption is equal shares. 5 California does not recognize such registration.
3-8
Example
Dan and Daphne buy a house for $50,000 and it increases in value to $200,000. If the house is held as joint tenancy and Dan dies, Dan’s one-half gets a stepped-up basis of $100,000 (half of the $200,000). However, Daphne keeps her original basis of $25,000 (half of the original $50,000). As a result, Daphne’s new basis in the house is $125,000 ($100,000 for Dan’s half and $25,000 for her half). If Daphne sells the house for $200,000, the gain will be $75,000. On the other hand, if the house were held as com-munity property, Daphne would step up her basis to $200,000 ($100,000 for Dan’s half and $100,000 for her half). Now, if Daphne sells the house for $200,000, there is no gain and no tax.
To gain this basis advantage, a community property agreement is often signed. This is a doc-ument stating that regardless of how a husband and wife have taken title to property, some or all of their assets are to be treated as community property (R.R. 87-98). Normally, the agreement6 lists each spouse’s separate property and provides that everything else the cou-ple owns shall be community property. Any separate property not listed will become com-munity property.
Untitled Assets
Furniture, jewelry, art objects, coin and stamp collections, etc. often have no recorded title. Such untitled assets are subject to the will of the decedent owner.
Changes to a Will
People often wish to change their will. When the change is simple, such as adding a cash bequest, it is usually done with a codicil. A codicil is a document that changes a will. It is the same as if the will had been retyped with the changes.
Note: In fact, with the rise of word processors, many attorneys prefer retyping the entire will with the changes in lieu of a codicil.
In any event, the original will should not be written on after it is signed. Going through the will cross-ing out language or making other changes is dangerous. This is referred to as “obliteration” and can completely cancel the will. The will should not be marked in any way after it is signed.
Note: Handwritten changes can be made on the will before it is signed. However, even here the testator and all the witnesses should initial the change to show that it was made before the will was signed.
Advantages of a Will
1. Intestacy is avoided.
2. Guardians can be appointed for the minor children.
6 In California, such an agreement has the same effect as if the couple had recorded the property as community property.
3-9
3. Bequests to relatives, individuals, and charities can be made.
4. Selection of executor.
5. Executor can be authorized to continue a business and make tax decisions.
6. Death taxes can be allocated and apportioned.
7. Probate bond may be waived.
8. Tax savings through trusts and the marital deduction.
9. Delayed distributions to minors and other heirs.
10. Sale of assets during estate administration.
11. Funeral instructions.
12. Protecting children by a previous marriage.
13. Disinheritance of potential heirs.
14. Grant life estates.
15. Avoid estate litigation.
Intestate Succession
When one dies without a will, the state laws direct how the assets will be distributed, i.e., a will by default. If there is no will, in effect the state drafts a will for the decedent. The county or state pro-bate court will appoint an administrator7.
The intestate succession is time-consuming and costly8. It is better to make a will and determine who will receive the assets.
Intestate Succession - Typical Community Property State
PERSONS LEFT SURVIVING:
DECEDENT’S SHARE OF COMMUNITY PROPERTY
DECEDENT’S SEPARATE PROPERTY
SPOUSE & ONE CHILD
All to surviving spouse One-half to spouse & one-half to child
SPOUSE & CHILDREN
All to surviving spouse One-third to spouse & two-thirds to children
ONLY CHILDREN No community property All to children
ONLY SPOUSE All to surviving spouse One-half to spouse, one-half to decedent’s parent’s if living,
otherwise to brothers & sisters
ONLY PARENTS No community property All to parents equally
7 Good luck! This person will have little or no knowledge of your family or assets. 8 Lawyers often get the bulk of the assets.
3-10
NO SPOUSE NOR CHILDREN NOR PARENTS
No community property All to brothers & sisters equally
Most state laws favor the surviving spouse, child, or grandchildren. As a result, assets could go to children of a previous marriage, or even distant nephews and nieces! In addition, state laws assume that family members (and not friends) are the natural objects of one’s bounty. Furthermore, most states do not recognize a “living together” relationship. Thus, for unmarried couples living together, dying without a will can have catastrophic consequences.
Periodic Review
A will is only as good as it is up to date. Wills and estate plans are not once-in-a-lifetime documents. Yet, once a will is signed, it is often put in a safe deposit box and forgotten for 10-20 years. People outgrow their estate plan, and new laws make revision essential. Estate planning is a lifelong process. Thus, it is important that the will be periodically reviewed at least every 3-5 years.
This does not necessarily mean meeting with an attorney. Frequently, just carefully reading over the will to review the disposition of assets and the people named as guardian, executor, or trustee can be satisfactory.
Changes Requiring Estate Planning Review
Change Married Person Single or Divorced Person
Family Relation Divorce or Separation
Death of Spouse or Child
Birth, Adoption, Illness, Marriage or Divorce of a Child
Marriage or Living Together
Death of Child or Heir
Birth, Adoption, Illness, Marriage or Divorce of a Child
Economic & Per-sonal Conditions
Asset Values: Increase or Decrease
Change in Insurability
Change in Employment
Change in Business Interests:
New Partnership, Corporation or
Co-Venture
Death of a Business Associate
Property Acquired Out of State
Retirement, Illness or Disability
Inheritance or Gift
Asset Values: Increase or Decrease
Change in Insurability
Change in Employment
Change in Business Interests: New Partnership, Corporation or Co-Ven-ture
Death of a Business Associate
Property Acquired Out of State
Retirement, Illness or Disability
Inheritance or Gift
External Change in Law
Change in Residence
Death of an Heir
Change in Law
Change in Residence
Death of an Heir
3-11
Death or Relocation of Executor, Trustee, Guardian, or Advisor
Death or Relocation of Executor, Trustee, Guardian, or Advisor
Continuing Business Operations
If a person runs a business, mention should be made in the will about the operation of the business after death. In some states, an executor cannot lawfully continue a business without specific author-ization. The business operation may come to halt, the building may deteriorate, or the business may have to be liquidated if proper authority is not given. Thus, key issues in the will should cover valuation of the business, succession, or disposal.
3-12
Simple Will
Married couples with small estates may wish to have a simple “I love you will.” Here each spouse leaves all of his or her assets to the surviving spouse. Even in such cases, however, it is necessary that a legal arrangement is made for the assets to be left in a trust for any minor children in case both parties die simultaneously (such as in a plane accident). In legal terms, a holographic will is in one’s own handwriting, and a nuncupative will is oral. An oral will is seldom valid.
Simple Will
On Husband’s Death Wife Owns 100% of Estate
Unlimited Marital Deduction Protects Wife
From Federal Death Taxes
On Husband’s Death Wife Owns 100% of Estate
Unlimited Marital Deduction Protects Wife
From Federal Death Taxes
Property Owned
by Husband
Property Owned
by HusbandProperty Owned
by Wife
Property Owned
by Wife
R.I.P.
Death
of
Wife
R.I.P.
Death
of
Wife
R.I.P.
Normally
Husband
Dies First
R.I.P.
Normally
Husband
Dies First
Federal Estate Taxes
If Wife’s Estate
Exceeds AEA
Remainder to
Children or Other
Heirs
3-13
Probate
Probate is a method of transferring assets as provided in a will, or, if a person dies without a will, of transferring assets to his or her heirs in accordance with state law. Assets in the decedent’s name alone must be probated to transfer title. Community property must be probated if it is left by will to someone other than the surviving spouse. Assets that cannot be controlled by a person’s will are not subject to probate.
Normally, a probate is handled by the superior court in the county where the individual lived at the time of death. Real property must be probated in the state where it is located. Thus, if real property is owned in another state, there may be an ancillary or secondary probate in that state. The probate will occur in the county where the real property is located.
If the decedent left a valid will, the will is offered on his or her death for probate and the court appoints an executor; if the decedent left no will, the court appoints an administrator to serve. The executor or administrator must collect assets subject to probate, pay debts and death taxes, and request court approval to transfer assets to the decedent’s heirs or to the persons named in the will. State law determines the fees charged by executors or administrators and their attorneys.
The estate pays tax due on the income of probate assets until the assets are distributed or the estate is closed. The usual duration of probate is from nine months to several years. The size and complexity of the probate estate determine the duration of probate.
The court grants the executor or administrator approval for transfer of probate assets to the heirs or to persons named in the will. On final distribution and transfer of all probate assets, the court dis-charges the executor or administrator.
Outline of an Average Probate
Action Usual Time Period
File Petition for Probate of will 0-30 Days After Death
Notice to Creditors Upon Granting Probate Petition
Family or Widow’s Allowance, or Probate Homestead
Upon Granting Probate Petition
Marshall Assets & Prepare Inventory; Present to Appraiser if Required
Soon After Executor Assumes Office
Creditor Period Elapses Varies Widely; Normally From 2 to 6 Months After First Publication or Posting
Liquidate Property to Raise Cash for Taxes & Distributions
Promptly After Executor is Appointed
Preliminary Distributions Normally After Creditor Period Elapses
File State Inheritance Papers Normally from 6 to 9 Months After Appoint-ment of Executor
Alternate Valuation Date for Federal Estate Tax Purposes
6 Months After Date of Death Unless Property Has Been Sold Earlier
When No Federal Estate Tax Return is Required - Make Final Accounting & Distribution, and
Close Estate
Roughly One Month After Creditor Period Elapses and State Taxes Paid
3-14
File Federal Estate Tax Return and Pay Tax 9 Months After Date of Death, Unless Exten-sion is Granted
If No Wish to Wait for Audit of Federal Estate Tax Return - Make Final Accounting & Distribu-
tion and Close Estate
Approximately One to Two Months After Es-tate Tax Paid
Keep Estate Open Until Federal Estate Tax Re-turn is Audited or Audit Period Elapses
3 Years After Form 706 is Filed
When Audit Period Elapses - Make Final Ac-counting & Distribution and Close Estate
One to Three Months After Audit Period Elapses
Large or Extraordinarily Complex Estates May Stay Open for Many Years
Advantages
The advantages claimed for probate proceedings are:
(a) The court protects the heirs and beneficiaries;
(b) Probate cuts off the claims of creditors after a period, determined by state law (e.g., 4 months in California), following the first date of publication of notice to creditors of the decedent’s death;
(c) The transfer of title is a public record that prevents problems with title companies;
(d) Questions and disputes are settled under the protection of the court;
(e) The estate is a separate taxpayer and some tax planning may result; and
(f) The costs are deductible for income tax purposes if properly planned and for death tax pur-poses if properly planned.
Disadvantages
The disadvantages asserted against probate proceedings are:
(a) They are expensive;
(b) They are time-consuming; the delays are excessive; and
(c) Court proceedings are inherently inflexible.
Sample California Statutory (Probate Code §901 & §910) Probate Fees
Probate Estate Executor’s Commission (Same as Attorney Fees)
% On Next Dollar
15,000 600 3%
50,000 1,650
100,000 3,150
2%
150,000 4,150
200,000 5,150
300,000 7,150
400,000 9,150
500,000 11,150
600,000 13,150
700,000 15,150
3-15
800,000 17,150
900,000 19,150
1,000,000 21,150
1,250,000 23,650
1%
1,500,000 26,150
2,000,000 31,150
3,000,000 41,150
4,000,000 51,150
Additional amounts are subject to the 1% rate.
Probate Avoidance
Most people want to avoid probate. Probate is complex, time-consuming, and costly. If you can rea-sonably avoid it, do so. Assets can be passed in several different ways to avoid probate.
Joint Tenancy
Joint tenancy assets avoid probate and pass at death to the surviving joint tenant. No legal pro-ceedings are necessary.
Community Property
In some community states, it is necessary to probate the decedent’s portion of community assets when one spouse dies. In California, for example, in lieu of probate, a simplified proceeding called a “Community Property Set Aside Proceeding” is available. This proceeding can transfer commu-nity property outright to the surviving spouse. While there is no statutory fee involved, legal costs are greater than a simple termination of joint tenancy.
If a spouse dies without leaving his or her community property to the surviving spouse, then his or her half of the assets will be subject to probate.
3-16
3-17
Totten Trust Accounts
In most states, it is possible to open an account in an individual’s name as trustee for someone else - called a “Totten Trust.” This is not a formal trust, but a bank account. When an account is opened in the name of “Dan, trustee for Ralph,” the account is Dan’s sole account during his lifetime. Only Dan can withdraw funds, deposit funds, or change the account around at his op-tion. On Dan’s death, the funds in the account automatically go to Ralph, without probate. Gen-erally, only a death certificate is needed to obtain the funds.
An account opened in the name of “Dan and Daphne, Trustees for Ralph” is a joint tenancy ac-count. If Dan or Daphne dies, the account passes to the survivor, not to Ralph. Only when both Dan and Daphne are dead does the account pass to Ralph.
A POD account is payable on death to a named beneficiary and is treated like a “Totten trust.” This type of account can be used for bank accounts and federal obligations, such as U.S. Treasury notes, U.S. Treasury bonds, and U.S. savings bonds.
Life Insurance & Employee Benefits
Policies and benefit programs that permit the decedent to name a beneficiary such as life insur-ance, retirement plans, and employee benefits bypass probate and go directly at death to the beneficiary.
Living Trusts
A funded (i.e., have been placed in the trustee’s name during lifetime) living trust can avoid pro-bate. If assets are not placed in the trust during the decedent’s lifetime, they will be probated at death.
3-18
Review Questions
27. A bequest can be used to dispose of assets at death. What type of bequest is actually a dis-position of cash?
a. a conditional bequest.
b. a general bequest.
c. a residual bequest.
d. a specific bequest.
28. Two individuals, typically spouses, may sign one will in which they dispose of both of their assets. What is such a will called?
a. a living will.
b. a joint will.
c. a statutory will.
d. a witnessed will.
29. When certain assets are put into a joint tenancy, the transaction can be treated as a gift. Which of the following assets become gifts when put into joint tenancy?
a. bank accounts.
b. credit union accounts.
c. money market funds.
d. vehicles.
30. Rather than making changes directly on an original will, a separate document can be created. What is the name of such a document?
a. a codicil.
b. a community property agreement.
c. a will.
d. an obliteration.
31. Individuals can choose from a variety of types of wills. For example, what is a holographic will?
a. a handwritten will.
b. an oral will.
c. a will that leaves all assets to a surviving spouse.
d. a will that is executed when a testator faces imminent death.
32. According to the author, there are at least three disadvantages in having an estate go through probate. What is one of these disadvantages?
a. Probate costs are nondeductible for income tax or death tax purposes.
b. The proceedings are intrinsically rigid.
c. The court does not look after heirs or beneficiaries.
d. Title transfers are not publicly recorded.
3-19
Learning Objectives
After reading Chapter 4, participants will be able to:
1. Identify the relationship of parties in a trust, reasons to establish a trust, and types of trusts specifying their estate planning function.
2. Specify recommended living trust provisions, identify the application of gift and income tax including the use of a grantor trust and an unlimited marital deduction, and determine what constitutes an “A-B” and “A-B-C” trust format.
4-1
CHAPTER 4
Trusts
One of the most valuable and flexible estate planning tools is a trust. Trusts evolved and became popular during the thirteenth century in England. In the wars of that period, wealthy people often wound up on the wrong side and lost all of their property. To avoid this result, assets were trans-ferred to a neutral person for the “use” of one’s family. These “uses” became the predecessor of modern trusts.
What is a Trust?
A trust is a legal relationship in which one person transfers property to a “trustee” for the benefit of a third person. The creator of the trust is the “grantor.” The person having legal title to the trust property is the “trustee” and has the responsibility of carrying out the terms of the trust. The person for whose benefit the trust is created is the “beneficiary.”
Note: One person can be a grantor, trustee, and beneficiary all at the same time.
Why a Trust?
Individuals establish trusts for a variety of reasons. Here are some of those reasons:
1. Management - Assets can be transferred to a trustee (corporation, individual, or both) who is skilled in managing and investing the trust property.
2. Protection - Certain trusts help insulate one’s assets from the claims of creditors. Others are established to protect against the grantor’s (or a beneficiary’s) incapacity, improvidence, or in-competence.
3. Tax Savings - Trusts are frequently created to afford the grantor and his or her family the opportunity to save current income taxes or future transfer taxes.
Example
When Dan dies, he can shelter up to $11.7 million (in 2021) in a trust. At the death of his surviving spouse, the assets in the trust are not taxed for federal estate tax pur-poses. If the surviving spouse also has an estate of $11.7 million, the use of a trust can
4-2
shelter up to $23.4 million from federal estate tax. While there is no limit on the assets which Dan can pass to his spouse on death, without a trust only $11.7 million (in 2021) might be passed tax-free on the surviving spouse’s death assuming no portability. Thus, $11.7 million more could be transferred estate tax-free using a trust.
4. Timed Disposition - People often want to put restrictions on the disposition of their assets. The primary way to do this is by use of a trust. If children are to receive assets at age 30, instead of age 18, a trust is an alternative to an outright transfer of the property.
Example
If Dan and Daphne die without an estate plan when their children are young, their assets will go to a court appointed guardian to hold for the children. When each child attains age 18, they receive their share of the assets outright. If Dan and Daphne set up a trust, the assets can be retained and used for the children’s benefit until each child reaches a more mature age.
5. Flexibility - Trust provisions can be established to complement almost any situation. Twenty-twenty foresight via the trustee can be invaluable, especially in today’s complex society. For ex-ample, two beneficiaries may be equal in every way today; but ten years from today one benefi-ciary may have a greater need for trust income than does the other beneficiary.
6. Privacy - Unlike a will, which becomes part of the public record after the probate process, the details of an inter vivos (“living”) trust can be kept confidential. In some cases, this confidentiality factor can be very important.
7. Probate Avoidance - Most people want to avoid probate because of the delays, the hassles, and the costs. Trusts, particularly living trusts, avoid probate. While there are some costs at death with a living trust, it can avoid 90-95% of probate costs.
8. Long-Term Care & Conservatorship Avoidance - Trusts can be used for long-term care. Physi-cally or mentally handicapped relatives need to be cared for financially. Assets left outright to these people will often require a conservatorship to manage the assets. However, a trust can leave assets with a trustee to be used for such a person.
Example
Dan dies and leaves his assets in trust for his son, Ralph. The trustee must pay the income to Ralph for life and in an emergency invade the trust principal for Ralph’s benefit. If Ralph marries and divorces, his ex-wife does not get the assets. If he goes bankrupt, his creditors cannot get the trust assets. Ralph can’t give the trust assets away during his lifetime.
4-3
Types of Trusts
The basic types of trusts break down into “living” trusts (trusts created during the lifetime of the grantor), and “testamentary” trusts (trusts created under the terms of one’s will). Living trusts can be either revocable (i.e., the grantor can amend or destroy the trust at any time), or irrevocable (unamendable or fixed). During one’s lifetime, a testamentary trust is also “revocable” in the sense that one can always change its terms through the formal procedure of changing the will of which it is a part. Living and testamentary trusts become irrevocable at the death of the grantor.
Common Elements
Every trust has four common elements:
(1) A grantor or donor (creator of the trust),
(2) A trustee (manager of the trust assets),
(3) A beneficiary or beneficiaries (person or persons receiving the trust income and/or principal), and
(4) The property or funds (corpus) that go into the trust.
Revocable Trust
While the trustor is alive, most trusts are revocable - i.e., it can be changed or terminated. Normally, when a person sets up a living trust, he or she wants the power to change the trust during his or her lifetime. Testamentary trusts are also revocable since one can always change his or her will before death. After death, the trust is irrevocable and cannot be changed.
When one has the right to revoke a trust, that person is its owner for estate (§2038) and income (§671 through §679) tax purposes.
Example
Dan sets up a revocable living trust for his son, Ralph. Since Dan can revoke the trust, he will be taxed on all the trust income and capital gains during his lifetime, and the trust assets will be included in Dan’s estate on death.
Irrevocable Trusts
An irrevocable trust cannot be changed or canceled. The term applies to living trusts, for with a tes-tamentary trust the trustor is dead and by definition cannot change the trust. Thus, most trusts be-come irrevocable at death.
Example
Dan sets up a trust for his wife, Daphne. If Dan does not wish the assets in the trust taxed on Daphne’s death, the trust must become irrevocable after Dan’s death. If Daphne can revoke the trust, she will be taxed on the trust assets at her death.
4-4
A living trust is made either revocable or irrevocable by the terms of the trust agreement. Some states provide that a trust is revocable unless it is expressly stated to be irrevocable. This seems wise since it prevents one from unintentionally creating an irrevocable trust. However, many states say that to be revocable the trust agreement must expressly state that it is revocable. Because of these differences, one should clearly declare the revocable or irrevocable nature of the trust in the trust agreement.
Sometimes, an irrevocable trust is set up during lifetime. For example, an irrevocable trust could be established for children or others. However, to avoid estate and income tax, the grantor cannot:
(1) Act as trustee,
(2) Receive income or other benefit from the trust, or
(3) Receive the assets from the trust (§2036 & §2043).
There are forms of irrevocable trusts, such as charitable trusts, §2503(b) & (c) trusts, insurance trusts, and trusts with “Crummey” provisions.
Testamentary Trust
Trust provisions can be contained in the will. In this event, the trust is referred to as a testamentary or court trust. However, since the trust does not come into existence until the time of death, property cannot be put into such a trust while the testator is alive. Property must go through probate to fund this type of trust. After death, there is no difference between a living trust and a testamentary trust.
Foreign Trusts - §679
Formerly, it was popular (among the “rich and famous”) and profitable to establish a trust in a foreign “tax haven” country. This loophole was closed with the passage of §679. A foreign trust can still be set up, but little if any taxes will be saved.
Under §679, a U.S. citizen or permanent resident, who sets up a foreign trust which can make any payments to a beneficiary in the United States, is the owner for income and estate tax purposes and is taxed on all of the income and capital gains.
Family Trusts
This is a popular term with no particular meaning. In recent years, unscrupulous individuals have promoted the idea that it is possible to set up a “family trust” that has the ability to avoid all federal taxes. This arrangement has been called “The American Birthright Trust,” “The Family Estate Trust,” “The Constitutional Trust” and other titles. Using such a device an individual sets up an irrevocable trust and appoints a committee to run it. The individual then assigns all his or her income (including future income) to the trust. The trust income is then either accumulated or distributed among spouses, children, or other relatives. The trust also pays for and deducts any expenses of the grantor. Supposedly, the grantor is taxed on only what he or she is paid by the trust.
There is no merit to such a trust.
4-5
Medicaid Trust
A Medicaid trust is a planning tool to help older people protect their assets from nursing homes. When done correctly, money and property put into such trusts will not be depleted by long-term health care costs.
Transfers to Medicaid trusts must generally be made at least 60 (formerly 36) months before a per-son enters a nursing home. In addition, the transferor must give up control of the transferred assets.
OBRA ‘93 changed this area dramatically and should be consulted before adopting any such trust.
Living Trust
If a trust is created during the trustor’s lifetime, rather than in his or her will, it is an inter vivos or living trust. When the trustor retains the right to dissolve the trust arrangement it is a revocable living trust.
A living trust is established by a written trust agreement, sometimes called a trust declaration. A living trust can be set up by a husband and wife, or by a single person. In addition to signing the trust agreement, it is necessary to transfer assets into the trust1. Transferring title to the trustee of the trust does this2.
Example
Dan set up a living trust and signs the trust agreement. Dan wants his home in the trust. The deed would transfer title from Dan to “Dan Santucci, Trustee of the Santucci Living Trust, under Trust Agreement dated October 7, 2009.”
Reversion
A living trust may be designed to benefit a person or persons other than the grantor for a limited period of time, thereafter the trust assets are returned to the grantor. Such a return of trust assets is a “reversion.” A reversion may be certain to occur or it may be contingent on a future event.
Advantages of a Living Trust
1. Assets in the trust are not subject to probate administration.
2. Professional Management is available if the trustor becomes incompetent, disabled, or wants to be free of the worries of management.
3. Should the trustor die, the successor trustee can step in and manage the estate without delay or “red tape.”
4. Annual Court accountings, with accompanying legal fees, are not required.
5. The trustee can collect life insurance proceeds immediately after the trustor.
6. A successor trustee can be in another state without complications.
1 Assets transferred into a living trust avoid probate at death, but must be transferred before death. 2 Recording may or may not be required to legally transfer title to the trustee.
4-6
7. Avoiding ancillary (secondary) administration.
8. Avoiding statutory restrictions on bequests of property.
9. Avoiding inheritance taxes.
10. Avoiding will contests.
10. Management uninterrupted by the incapacity of the grantor.
11. Uninterrupted income and access to principal for family beneficiaries.
Disadvantages
1. Creditors may not be cut off as quickly as they are in probated estates (i.e., four to six months).
2. A separate tax return is necessary if and when the living trust becomes irrevocable.
3. Assets must be transferred into the trust.
4. An attorney charges more for a living trust compared to a testamentary trust.
Priority
A living trust has priority over a will. If there is a will leaving specific property to an heir and later a living trust is created and the trustor transfers the same property into it, the trust takes prece-dence and the property will go to the trust beneficiary. However, this is the result most people want. In fact, people use a “pour-over” will together with their living trust to ensure that all assets are controlled by the trust.
Pour-Over Will
Many people who have a living trust also have a will to pick up any assets that are not in the trust at death. This will takes assets left out of the pre-existing living trust and “pours” them into the living trust at death. Such “poured-over” assets would be subject to probate.
Trust Taxation
As a legal entity, a trust can be subject to both income and estate tax. When taxed, trusts are required to file their own returns apart from the tax returns of their beneficiaries.
Income Tax
A trust may be treated as a separate taxpayer for federal income tax purposes, thus requiring the trustee to file a federal income tax return (i.e., Form 1041) for the trust. Whether a trust is treated as a separate taxpayer depends on the nature of the trust. A trust is not treated as a separate tax-payer for income tax purposes when the grantor is considered the substantial owner of the trust under the grantor trust rules contained in §671 through §678.
Grantor Trusts - §671 to §678
A grantor trust is a trust that a grantor can revoke or terminate. Trusts that fall into this category are not required to pay income tax or file an income tax return (§671 through §678). The reason-ing of the grantor trust rule is that if one can revoke a trust, he or she is the owner of the trust
4-7
assets for income tax purposes. Since the grantor has retained the power to revoke, he or she is treated as the beneficial owner of the trust, and therefore the trust income is taxable to him or her whether or not it is payable to him or her under the trust terms.
Under the grantor trust rules, the grantor will be treated as the owner of the trust and be taxed on the trust income if:
(1) The grantor, his or her spouse, or a nonadverse party has powers of disposition over the corpus or income (§674(a));
Note: Powers of disposition mean control over who gets the corpus or income or when he or she gets it (§674). Nevertheless, the following powers are deemed reasonable controls and will not cause the trust income to be taxed to the grantor, even if retained by the grantor:
(a) The power to invade corpus for the benefit of a designated beneficiary, if limited by a rea-sonably definite standard (§674(b)(5));
(b) The power to postpone payments of income to a beneficiary who is under age 21 or a legal disability (§674(b)(7));
(c) The power to change the distribution of income by will (§674(b)(3));
(d) The power to either distribute or accumulate income provided the accumulated income is certain to be paid to the person who would have received it (§674(b)(6)).
(2) The corpus will revert to the grantor or to the grantor’s spouse at any time and the rever-sionary interest is worth at least 5% of the value of the corpus as of the inception of the trust (§673, §672(e));
(3) The grantor, his or her spouse, or a nonadverse party has the power to revoke the trust and revest all or a portion of the corpus in the grantor (§676);
(4) The administrative control of the trust is, or may be, exercisable primarily for the benefit of the grantor or his or her spouse (§675);
(5) In the discretion of the grantor or any nonadverse party, trust income is, or may be:
(a) Distributed to the grantor or his or her spouse,
(b) Accumulated for future distribution to the grantor or his or her spouse,
(c) Used to buy insurance on the life of the grantor or his or her spouse, or
(d) Used to support other dependents, but only to the extent the income is actually so used (§677).
Generally, every fiduciary (e.g., a trustee of a trust) must make a return of income on Form 1041. This return lists the trustor’s name and address, the social security number, and the trust’s in-come or deductions. The trust must obtain a separate tax identification number. In addition, if any portion of trust income, loss, deduction, or credit is treated as owned by the grantor or an-other person, the trustee must show such items on a separate statement attached to Form 1041. However, there are two exceptions to the above rule and no Form 1041 need be filed where:
(1) The same individual is both grantor and trustee (or co-trustee) and that individual is treated as the owner of the entire trust under the grantor trust rules (Reg. §1.671-4(b)(1)); or
(2) Husband and wife are the sole grantors, one or both of the spouses are treated as owners of the trust under the grantor trust rules and the spouses file a joint income tax return (Reg. §1.671-4(b)(2)).
4-8
Note: Recent final regulations reduce the reporting burden on certain trustees by expanding the exceptions to filing a Form 1041 to other trusts all of which are treated as owned by one or more grantors or other persons under the grantor trust rules (Reg. §1.671-4, §1.6012-3 and §301.6109-1). Thus, considerably more trustees are required to file a Form 1041.
Thus, a grantor who is also acting as trustee (or co-trustee) of his or her revocable trust, claims all deductions and credits available to the trust. All dividends, rents, interest, depreciation, capital gains or losses, or other tax items are reported on the grantor’s income tax return (Reg. §1.671-4(b)).
Note: Transferring assets to a revocable trust is not a taxable event. For example, the transfer of an installment obligation to a revocable trust is not a disposition under IRS regulations. However, the transfer of an installment obligation to an irrevocable trust of which the grantor is not treated as the owner is a taxable event.
No income tax return is filed for the trust. No tax identification number is obtained. The trustor’s social security number is used as the trust’s tax number (Reg. §301.6109-1(a)(2)). During the grantor’s life, the income from the trust is taxed to the grantor just as if the trust did not exist. This is true whether the income is paid to the grantor, retained in the trust, or turned over to someone else.
Note: The personal taxation required by the grantor trust rules can be an advantage. For example, if a residence is transferred to a revocable trust when the home is sold, the special tax rules for excluding gain on the sale of a residence continue to exist. If the home were transferred to any other type of trust, these benefits could be lost.
Grantor Retained Income Trust
A grantor retained income trust (GRIT) is structured to pay income to the grantor for a pre-determined time period, with the remainder interest later transferred to heirs. Such a trust is a grantor trust under §677 and is not primarily designed to save income tax but rather estate tax.
Under a GRIT, the grantor places assets into an irrevocable trust and retains the enjoyment of the trust income for a specified term. At the end of the term, trust principal passes to heirs. If the grantor lives out the term, none of the assets are included in the grantor’s estate be-cause the grantor has retained no interest in the trust asset at death (§2036). However, if the grantor dies before the term expires, the date of death value of the property will be included3 in the grantor’s estate (§2036(a)(1)).
The gift to the remainderman is valued using a table that is periodically updated by the IRS to reflect current interest rates. Since the gift is a future interest, it does not qualify for the annual gift tax exclusion. However, because the income right retained by the grantor reduces the value of the gift, a large amount of property can be transferred to heirs with only a rela-tively small reduction in the unified credit.
3 If there is estate inclusion, §2001(b) restores the applicable exclusion amount that was used (for gift purposes).
4-9
Example
Dan sets up a GRIT for the benefit of his son, Ralph, by transferring property valued at $700,000 into the trust but retaining the right to all income for 10 years. The IRS table for that year values his income right at $425,000. Thus, the gift to Ralph is valued at $275,000 ($700,000 minus $425,000) and Dan still has $11,425,000 of his original $11,700,000 applicable exclusion amount for 2021.
Revocable Trusts Included in Estate - §646 & §2652(b)(1)
Both estates and revocable inter vivos trusts can function to settle the affairs of a decedent and distribute assets to heirs. In the case of revocable inter vivos trusts, the grantor transfers property into a trust that is revocable during his or her lifetime. Upon the grantor’s death, the power to revoke ceases and the trustee then performs the settlement functions typically performed by the executor of an estate. While both estates and revocable trusts perform essentially the same func-tion after the testator or grantor’s death, there are a number of ways in which an estate and a revocable trust operate differently. First, there can be only one estate per decedent while there can be more than one revocable trust. Second, estates are in existence only for a reasonable period of administration; revocable trusts can perform the same settlement functions as an estate but may continue in existence thereafter as testamentary trusts.
Numerous differences presently exist between the income tax treatment of estates and revoca-ble trusts, including:
(1) Estates are allowed a charitable deduction for amounts permanently set aside for chari-table purposes while post-death revocable trusts are allowed a charitable deduction only for amounts paid to charities;
(2) The active participation requirement in the passive loss rules under §469 is waived in the case of estates (but not revocable trusts) for two years after the owner’s death; and
(3) Estates (but not revocable trusts) can qualify for §194 amortization of reforestation ex-penditures.
Election for Income Tax Purposes
The tax law provides an irrevocable election to treat a qualified revocable trust as part of the decedent’s estate for Federal income tax purposes. This elective treatment is effective from the date of the decedent’s death until two years after his or her death (if no estate tax return is required) or, if later, six months after the final determination of estate tax liability (if an estate tax return is required). The election must be made by both the executor of the dece-dent’s estate (if any) and the trustee of the revocable trust no later than the time required for filing the income tax return of the estate for its first taxable year, taking into account any extensions. A conforming change is made to §2652(b) for generation-skipping transfer tax purposes.
Note: The election to treat a “qualified revocable trust” as part of the decedent’s estate for income tax purposes must be made both by the executor of the estate and the trustee of the revocable trust.
4-10
For this purpose, a qualified revocable trust is any trust (or portion thereof) which was treated under §676 as owned by the decedent with respect to whom the election is being made, by reason of a power in the grantor (i.e., trusts that are treated as owned by the decedent solely by reason of a power in a nonadverse party would not qualify).
Note: The new election allows a fiduciary to obtain uniform tax treatment for estates and revocable inter vivos trusts, both of which can be used to settle the affairs of a decedent and distribute assets to heirs.
The separate share rule generally will apply when a qualified revocable trust is treated as part of the decedent’s estate.
Irrevocable Trust Taxation
Income taxation is more complex for an irrevocable trust. Generally, income is interest, divi-dends, and net rental income and does not include capital gains. When the trust requires income to be paid to a beneficiary, that beneficiary is taxed on the income.
Example
Years ago, Dan created an irrevocable trust for the benefit of his son, Ralph. This year the trust has $25,000 of interest and dividend income and a fiduciary income tax return must be filed. The trust reports the $25,000 as income but gets a deduction for pay-ments to Ralph. A form is attached to the trust’s return listing Ralph’s name, address, and social security number, and Ralph includes the $25,000 in income on his personal return. If Ralph is entitled to the income, he is taxed on it even if it was not actually paid.
When the trustee has discretion to pay or accumulate income, the income is taxed to the bene-ficiaries who receive it, if any. Income accumulated and kept in the trust is taxed to the trust4.
2021 Trust Income Tax Rates
First $2,650 10%
$2,650 - 9,550 24%
$9,550 - 13,050 35%
Over $13,050 37%
(For trust tax rates see: http://www.smbiz.com/sbrl001.html#pis21 )
Throwback Rules
If the trust accumulated income and later paid that income to a beneficiary, the trust was subject to the “throwback rule.” Under this rule contained in §666, any accumulated income
4 This type of trust is called a “complex trust” and has a $100 per year exemption, but quickly starts to pay tax at high
rates.
4-11
that was later paid out was taxed to the beneficiary as if the beneficiary had received it in the year it was accumulated and taxed to the trust.
However, the Taxpayer Relief Act of 1997 repealed the "throwback rules" with respect to accumulation distributions made by most domestic trusts (as defined in §665(c)) The throw-back rules, nevertheless, still apply to foreign trusts, to domestic trusts that were at one time treated as foreign trusts, and to domestic trusts created before March 1, 1984, that would be treated as multiple trusts under §643(f).
Capital Gains
Some trusts permit the trustee to make payments of principal (as opposed to the income) for a beneficiary’s “health, support, maintenance, and education.” When the trust keeps the gain from the sale of a capital asset, the trust pays the income tax on the capital gain5. If the gain is later distributed, it is not subject to the throwback rule under §666. If current (not accumulated and taxed) gain is distributed, the beneficiary receiving it is taxed on the gain. However, the payment of principal without any taxable disposition does not give rise to any tax.
Example
Ralph has the right to invade the principal of a trust for his health and education and last year he needed $20,000 for tuition. To raise the money the trustee sold $20,000 worth of real estate incurring a $6,000 capital gain. Ralph was taxed on the $6,000 capital gain. The trust was not taxed on the gain. This year, Ralph needs $15,000. How-ever, the trust now has principal funds in excess of this amount and pays Ralph without the sale of any trust assets. Neither Ralph nor the trust is taxable on the $15,000.
Deduction of Estate Planning Expenses
The legal and accounting costs of establishing and operating the trust and trustee’s fees are usu-ally deductible by the grantor for federal income tax purposes. Section 212 provides that all the ordinary and necessary expenses paid for “the production or collection of income,” and for “the management, conservation, or maintenance of property held for the production of income” are deductible on a taxpayer’s return. However, these expenses are subject to the 2% of AGI limita-tion under §67.
Deductibility of Death Expenses
In the case of a revocable living trust, such expenses are deductible on the federal estate tax return or on the estate income tax return as elected by the fiduciary.
Gift Tax
Normally, there is no gift tax involved with a revocable trust. When a grantor transfers property to a revocable trust, there are no immediate gift tax consequences. Any such gift is incomplete since the
5 The trust gets a $100 or $300 exemption depending on the terms of the trust.
4-12
grantor has the right to revoke the trust6. However, a gift does occur when trust property is distrib-uted to a beneficiary.
Example
Dan has a revocable trust. He transfers $20,000 from the trust to his son, Ralph. Be-cause the trust is revocable, Dan is the owner and the transfer is a gift.
When one sets up an irrevocable trust and puts assets in the trust, these assets are subject to gift taxes. However, the trust may qualify for the annual gift tax exclusion depending on its terms. Tes-tamentary trusts that are set up under a will and come into being at death are not subject to gift taxes.
6 Even if the grantor becomes incompetent and no longer able to revoke the trust, the gift does not become complete.
4-13
Review Questions
33. Trusts can be divided into two types based on when they are created. Which type comes into existence at the time of death and results in property having to go through probate?
a. a family trust.
b. a foreign trust.
c. a grantor trust.
d. a testamentary trust.
34. The author lists four disadvantages of a living trust. What is one of these disadvantages?
a. The grantor must transfer assets into the trust.
b. Inheritance taxes apply to the assets in the trust.
c. There are statutory restrictions on bequests of property.
d. It increases the possibility of a will contest.
35. Based on the grantor trust rules, five conditions must be met in order for the grantor to be treated as the trust owner and to have the trust income taxed to them. What is one of these conditions?
a. Neither the grantor nor spouse has the power to dispose of the corpus or trust income.
b. Administrative control of the trust cannot be exercisable mainly for the grantor’s or spouse’s benefit.
c. The corpus cannot revert to the grantor.
d. The trust may be revoked by the grantor’s spouse, and the corpus may be revested.
Estate Tax
If a grantor can revoke a trust, the grantor owns the trust assets under both income and federal estate tax law. Thus, on the grantor’s death, the trust assets are subject to estate tax. In addition, if one is both beneficiary and trustee with the power to use trust principal for his or her benefit (other than for “health, support, maintenance, and education”) the trust assets will be included in his or her estates and subject to estate tax on death.
Note: A marital trust or a qualified terminable interest trust are not subject to estate tax when the first spouse dies, but are taxed on the death of the surviving spouse.
In an irrevocable trust where a beneficiary can direct who gets the assets at death, the trust assets are includable in the beneficiary’s estate and taxable. This right to leave the trust assets to anyone is called a “power of appointment.” There are two types of powers:
1. General power of appointment - This power permits one to leave trust assets to anyone with-out restriction and it is estate taxable (§2041(b)).
4-14
2. Limited power of appointment - Under this power one can only leave trust assets to a limited group of people and it is not estate taxable (§2041(b)).
Example
Dan creates a trust for his wife, Daphne, giving her the right to transfer trust assets to their children or grandchildren as she wishes on her death. On Daphne’s death, the assets would not be taxable in her estate.
Unlimited Marital Deduction
Under §2056, a deduction is permitted for all assets passing to a surviving spouse at death. For-merly, the maximum allowable deduction was fifty percent of the adjusted gross estate; how-ever, with the passage of the 1981 Revenue Act a deduction is allowed for all property passing to the spouse - i.e., a 100% deduction. Thus, if either husband or wife dies and leaves all assets to the survivor, no federal estate tax is due, regardless of the amount. This marital deduction can be obtained in a number of different ways.
Outright to Spouse
Assets left outright to a spouse qualify under the marital deduction and pass tax-free. “Out-right” transfers can be made by:
(1) Joint tenancy,
(2) Will,
(3) Intestate succession,
(4) Beneficiary designation,
(5) Living trust, or
(6) Any other method provided there is no restriction on the surviving spouse.
Marital Deduction Trust
A marital deduction trust qualifies for the marital deduction (§2056(b)(5))). Under this trust, the first spouse to die leaves his or her assets in trust for the survivor’s benefit. The survivor is required to receive all the trust’s income and have a general power of appointment over the assets at death. Such a trust eliminates tax on the first death but causes the assets to be taxed on the second spouse’s death.
Qualified Terminable Interest Property (QTIP) Trust
This is also a trust for the spouse’s benefit. Here, the spouse can get all the trust income for life, but at death, the surviving spouse cannot direct who will get the trust assets ((§2056)(b)(7)). With the terminable interest trust, you can delay tax until the second spouse’s death and still control the final disposition of the assets.
4-15
Types of Marital TrustsTypes of Marital Trusts
Estate Trust:
Remainder interest passes to surviving
spouse’s estate on surviving spouse’s
death
Power of Appointment Trust:
Surviving spouse receives income for life
with GPOA over trust assets
QTIP Trust:
Life income to surviving spouse,
Assets includable in surviving spouse’s
estate, and
Executor make proper election
Charitable QTIP Trust:
Surviving spouse is income beneficiary
of CRT
4-16
“Qualified terminable interest property” is defined as property that passes from the dece-dent, in which the surviving spouse has a qualifying income interest for life, and for which the decedent’s executor makes an election7 to have the property qualify (§2056(b)(7)(B)(i)).
The surviving spouse has a “qualifying income interest for life” if he or she is entitled to all of the income from the property, payable at least annually, and no person has a power to ap-point any part of the property to anyone other than the surviving spouse, except that the surviving spouse (or some other person) may be granted a power of appointment if this power is exercisable only at or after the surviving spouse’s death (§2056(b)(7)(B)(ii)).
“A-B” Format
The funded revocable living trust permits the taxpayer to avoid probate on both deaths, avoid federal death tax on the first death and eliminate or reduce to a minimum federal death tax on the death of the second spouse.
To avoid or reduce death taxes on the second death something has to be created that does not die. This takes the form of a trust. In the example given the trust, along with the accompanying wills, would be created while both spouses were alive. The trust is thus called a living (or inter vivos) trust. Since only assets in the living trust at death avoid probate it is recommended that the trust is “funded” by having the spouses make lifetime transfers to the trust. However, during the joint lives of the spouses, the assets can be withdrawn from the trust at any time. This makes the trust revocable. On the death of the first spouse (normally the husband), the original living trust automatically divides itself into two trusts - the survivor’s trust known as “TRUST A” and the decedent’s trust known as “TRUST B”. Typically, the surviving spouse has control over TRUST A and can withdraw assets or even revoke the trust in its entirety8. However, in order to reduce or eliminate death taxes on the second death, TRUST B must be irrevocable and only limited powers over it can be given to the survivor.
Permitted Powers: Nevertheless, these powers are substantial and are as follows:
7 The election must be made on the estate tax return (for the decedent) filed by the executor and, once made, the
election is irrevocable (§2056(b)(7)(B)(v)). 8 Sometimes TRUST A is unfairly made irrevocable to the surviving spouse (i.e., the wife) supposedly to prevent her from
transferring the assets to a second husband or sexual equivalent. If the surviving spouse doesn’t consent to this he or
she is frequently denied benefits under TRUST B
4-17
A-B Living Trust
Husband’s
Will
Husband’s
WillWife’s
Will
Wife’s
Will
Living
Trust-------------------
-------------------
-------------------
--------------------
Living
Trust-------------------
-------------------
-------------------
--------------------
RIGHT TO REVOKE
OR WITHDRAW
WATCH FOR
FORCED WIDOW’S
ELECTION
RIGHT TO REVOKE
OR WITHDRAW
WATCH FOR
FORCED WIDOW’S
ELECTION
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
L.P.O.A.
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
L.P.O.A.
R.I.P.
Normally
Husband
Dies First
CURRENT SUPPORT BUT
ASSETS HELD UNTIL
CHILD IS MATURE
CURRENT SUPPORT BUT
ASSETS HELD UNTIL
CHILD IS MATURE
R.I.P.
Death
of
Wife
CHILDREN’S TRUST
SURVIVOR’S TRUST DECEDENT’S TRUST
“ A” “ B”
POUR OVER
PROVISION
POUR OVER
PROVISION
LIFETIME
TRANSFERS
LIFETIME
TRANSFERS
PERSONAL ITEMS WILLED TO SURVIVING SPOUSE
4-18
1. Right to All Income - the survivor can receive all the income generated by TRUST B;
2. Right to Invade Principal - the survivor can withdraw from the principal of the trust for health, maintenance, and support;
3. Five Percent or $5,000 Power - annually the survivor can withdraw the greater of 5% of the trust principal or $5,000;
4. Limited Power of Appointment - the survivor can retain the power to readjust the chil-dren’s or other heirs’ shares after the death of the first spouse;
5. Trusteeship - the survivor can have one or more (in fact all) the above powers and still be trustee over both TRUST A and TRUST B.
All these powers can be granted without any effect on the living trust’s ability to save death taxes.
Estate Size: Frequently, the “A-B” format is recommended for moderate size estates that are in excess of the applicable exclusion amount. This is because $11,700,000 (in 2021) can pass death tax-free from TRUST A to the CHILDREN’S TRUST and a like amount plus growth9 can pass to the CHILDREN’S TRUST from TRUST B.
Note: After TRUIRJCA, portability now makes it unnecessary to use Trust B to preserve the first spouse’s federal applicable exclusion amount. Since 2011, surviving spouses can add the unused applicable exclusion amount of the spouse who died most recently to their own applicable exclusion amount.
Children’s Trust: On the death of the second spouse, the assets of TRUST A and TRUST B are held in a CHILDREN’S TRUST which normally distributes income to the children and permits them to invade principal for health, maintenance, and support. When a child reaches a certain age the amount held for his or her benefit is distributed to them.
Wills: Although the living trust is the primary document under this format, the wills are also im-portant. In addition to naming the executor, the guardian for any minor children and authorizing a variety of necessary actions, the wills permit the passing of personal items (e.g. household fur-nishings, clothes, and small incidentals) that are not worth going through the trust and collect all valuable assets (under the “pour over” provision) that were not put into the trust and transfers them into trust on the first death. The “pour-over” provision is a “fail-safe” clause used to pick up forgotten assets. It doesn’t avoid probate. The ideal goal is to have all the major assets trans-ferred to the living trust prior to the first death and never have to invoke the “pour over” provi-sion.
“A-B-C” (QTIP) Format
For those estates above twice the applicable exclusion amount, the “A-B-C” living trust should be considered. Instead of dividing into two trusts upon the first death as in the “A-B” format, it di-vides into three (A, B, and C).
TRUST A is again the survivor’s trust and remains revocable by the surviving spouse. The former TRUST B (i.e. the decedent’s trust) is divided between a new TRUST B and TRUST C. The TRUST B is a “bypass” trust that is funded by and takes advantage of the applicable exclusion amount. The
9 Normally, an amount equal to the deceased spouse’s applicable exclusion amount is put into TRUST B. This sum plus
what it grows to during the life of the survivor can pass death tax free from TRUST B to the CHILDREN’S TRUST.
4-19
survivor’s property goes into TRUST A as before and the balance goes into TRUST C - the QTIP trust.
Example: In an equal and joint estate of $28,000,000 in 2021, $14,000,000 would go into TRUST A. The decedent’s half would go $11,700,000 (the exclusion amount in 2021) into TRUST B (the bypass trust) and the balance ($2,300,000) would go into TRUST C - the QTIP trust.
The decedent’s portion is not subject to federal death tax because of the applicable exclusion amount (for TRUST B) and the unlimited marital deduction (for TRUST C). As a result of ERTA, assets that go into TRUST C (i.e., the QTIP trust) qualify for the unlimited marital deduction.
The “A-B-C” format does not necessarily increase the amount which can pass tax-free to the CHILDREN’S TRUST but does give the added flexibility of being able to pay part of the death taxes on the death of the first spouse and part on the death of the second spouse. In some instances, this can result in material tax savings. Paying the death tax entirely on the second death can be far greater than paying in installments on the first and second deaths. In any event, the “A-B-C” format gives the taxpayer the choice.
Valuation & Tax Basis
The transfer of property into a revocable living trust does not change the stepped-up basis treat-ment it receives on the grantor’s death. Property acquired from a decedent, including property from a revocable trust, receives a new basis equal to its fair market value at the date of death or its value at the alternate valuation date.
Note: Community property transferred to a revocable trust with provision that it retain its commu-nity character, gets a new stepped-up basis on both spouse’s shares.
4-20
A-B-C Living Trust
R.I.P.
Normally
Husband
Dies First
CURRENT SUPPORT BUT
ASSETS HELD UNTIL
CHILD IS MATURE
CURRENT SUPPORT BUT
ASSETS HELD UNTIL
CHILD IS MATURE
R.I.P.
Death
of
Wife
CHILDREN’S TRUST
Husband’s
Will
Husband’s
WillWife’s
Will
Wife’s
Will
Living
Trust-------------------
-------------------
-------------------
--------------------
Living
Trust-------------------
-------------------
-------------------
--------------------
POUR OVER
PROVISION
POUR OVER
PROVISION
LIFETIME
TRANSFERS
LIFETIME
TRANSFERS
PERSONAL ITEMS WILLED TO SURVIVING SPOUSE
RIGHT TO REVOKE
OR WITHDRAW
WATCH FOR
FORCED WIDOW’S
ELECTION
RIGHT TO REVOKE
OR WITHDRAW
WATCH FOR
FORCED WIDOW’S
ELECTION
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
SURVIVOR’S TRUST QTIP TRUST
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
L.P.O.A.
INCOME TO SPOUSE
H.M.S.E. INVASION
$5,000 - 5% POWER
L.P.O.A.
DECEDENT’S TRUST
“A” “B” “C”
4-21
Alternate Valuation
When a grantor transfers property during life to a revocable living trust, it can have the entire six months for alternate valuation. However, if the same property was in the grantor’s estate at death and was then distributed to the trust during the first six months following the grantor’s death, the alternate valuation date of such assets is the date they were distributed by the exec-utor to the trust.
In probate, the executor can control the timing of distributions during the first six months and maximize the alternate valuation election. However, when a revocable living trust is required to distribute assets on the death of the grantor, there may not be any timing opportunity, because the alternate valuation date and the date of death would be the same.
When a trust becomes irrevocable on the grantor’s death and the assets are divided into two or three trusts, such as in the “A-B” or “A-B-C” marital deduction formats, is this division a distribu-tion for alternate valuation? The Service holds that distribution occurs on the physical division of the trust. Thus, the alternate valuation does not occur until the trustee makes a physical distri-bution of the assets. With proper planning, therefore, the alternate valuation election is not lost by the use of a funded revocable living trust.
Fundamental Provisions - Revocable Living Trust
Drafting a trust involves serious legal considerations and should be done in conjunction with compe-tent legal and tax advisors. However, there are certain fundamental provisions that should be in any trust.
Identification Clause
This clause identifies the grantor, trustee, co-trustee, successor trustee, and beneficiaries. Also stated are where they live and where the trust is created.
Recital Clause
This provision identifies the property and states the purpose of the trust agreement and the use and disposition of the property.
Property Transfer Clause
This provision declares what property is currently transferred to the trust and is the key to avoiding probate. Because the property is transferred to a trustee, the grantor does not own it as a part of his or her probate estate.
Income & Principal Clause
A trust agreement often refers to the “income” and directs that it be paid to some beneficiary. Gen-erally, “income” refers to what the trust earns in interest, dividends, and net rental income. It does not include capital gains on the sale of a trust asset.
4-22
The income can be paid to one or more people, can be accumulated, or can be paid out under some sort of standard of need. Moreover, income can be paid out, monthly, quarterly, or annually depend-ing upon the trust terms and the amount of income.
Example
Dan creates a trust for his wife, Daphne, and directs that the entire net income from the trust estate be paid to her. The income is taxed to the wife as beneficiary, not to the trust.
Payments of principal can be made to anyone, not just the recipient of the trust income.
Revocation & Amendment Clause
Since the grantor created a “revocable” living trust, the grantor should clearly have the right to com-pletely cancel the trust or change it in any way.
Trustee Clause
To create a trust you must name a trustee and should name a successor trustee. This person will hold title to all trust property after the death of the grantor.
Trustee’s Acceptance
Creating a trust agreement means exactly that; there must be an agreement between the parties. The selected trustee, co-trustee, or successor trustee must sign the document indicating that they truly agree to the terms and conditions set forth in it.
Choice of a Trustee
A trustee can be an individual, several individuals, a bank, a trust company, or a combination of indi-viduals and institutions. The trustee becomes the legal owner of the property transferred to the trust until such time as the trust agreement indicates dissolution by payments of principal to the named beneficiaries. In the meantime, the trustee runs the trust by making investment decisions, collecting the income, rents, and interest, making payments to the trust beneficiaries, keeping records, and filing the annual income tax returns for the trust.
The trustee is entitled to compensation for his or her services. A bank or trust company normally charges 1% of the value of the trust per year. If the trust is very large, the percentage declines. The trustee’s fee is an income tax deductible expense.
Factors for Corporate Trustees
1. They don’t die or become disabled - permanence.
2. They are financially accountable for their mistakes.
3. They are impartial as to the children. This may prevent the children from becoming bitter to-wards an individual trustee who happens to be a friend or relative, and who doesn’t make distri-butions whenever the children ask for something.
4-23
4. They have investment expertise, tax, and accounting abilities, and computer capabilities. Stud-ies show that they save many dollars in the average estate.
5. They refuse loans to “hard-up friends” of the trustee.
6. They keep current with the constant changes in the law.
Factors for Individual Trustees
1. A relative or friend may not charge a fee.
2. A relative or friend may have a more personal interest.
3. A relative or friend may have special investment expertise.
Some people prefer the use of an Individual and a Corporate Trustee, as co-trustees, to obtain the advantages of each.
Choice of Executor or Trustee
Who To Consider Factors
Individual
1. Surviving Spouse 2. Adult Children in order of: a. Age b. Maturity, or c. Financial Expertise 3. Relatives 4. Business Associates 5. Professional Advisors a. Attorney b. CPA 6. Any Combination of 1-5
1. Family Relationships (prior marriage) 2. Expense to Estate 3. Experience 4. Reliability 5. Integrity 6. Availability 7. Conflicts of Interest 8. Knowledge of Testator’s Affairs 9. Age 10. Emotional Stability 11. Tax Consequences
Corporate 1. Bank 2. Trust Company
1. Size of Trust or Estate 2. Reputation of the Company 3. Convenience to Surviving Heirs 4. Acceptance of Document: Powers, Obliga-tions & Limitations 5. Type of Assets: a. Cash b. Real Estate c. Stocks & Bonds d. Business Assets 6. Experience & Management Talent 7. Investment Philosophy & Performance 8. Fees & Recordkeeping 9. Personnel Qualifications
Trust Termination Clause
A trust cannot last forever. Under the “Rule against Perpetuities," a trust can last no longer than for the lifetime of all of the designated people living when the trust creator dies, plus another 21 years.
4-24
Thus, by their terms trusts must terminate at some time, and the assets pass to designated individ-uals.
Note: If a charity is involved, a trust can continue indefinitely.
Example
Dan sets a trust and dies. The trust can run for the lifetime of Dan’s children, grand-children, and great-grandchildren, who are alive when Dan dies. However, the trust must terminate no later than 21 years after the death of the last descendant who was alive when Dan died.
A trust can terminate at a certain date, when a beneficiary dies or when a beneficiary attains a certain age. Whatever the provisions, a fixed termination event or date must be set out, as well as the name or group of people who receive the trust assets.
4-25
Review Questions
36. One type of trust requires that the surviving spouse receive all of the income in the trust and have a general power of appointment over the assets at death. What is this trust called?
a. living trust.
b. marital deduction trust.
c. revocable trust.
d. testamentary trust.
37. A qualified terminable interest trust may be used for a surviving spouse’s benefit. What is one characteristic of a qualified terminable interest?
a. It is a way to obtain a charitable deduction at death under §2055.
b. The surviving spouse cannot receive interest income.
c. Children can be the sole lifetime beneficiaries.
d. It must be composed of property that passes from the decedent.
38. Another type of trust that can be established is a living “A-B” revocable trust. What is a char-acteristic of this type of trust?
a. The surviving spouse controls Trust A from which assets may be withdrawn.
b. The surviving spouse cannot revoke Trust A in its entirety.
c. The surviving spouse cannot receive any of the income generated from trust B.
d. For purposes of health, the surviving spouse cannot draw the principal of the trust.
39. A simple will can be used to transfer a taxpayer’s entire estate on death. However, what can result when taxpayers with large estates use a simple will?
a. minor death taxes on the survivor’s death.
b. increased probate avoidance.
c. severe death taxes on the first death.
d. stacking the surviving spouse’s estate.
40. An “A-B-C” trust separates into three separate trusts upon the death of the first spouse. Who should consider establishing an “A-B-C” living trust?
a. those who want to avoid the applicable exemption amount.
b. those whose estates are over double the applicable exclusion amount.
c. those with moderate size estates that are in excess of the unified credit equivalent.
d. those with small estates.
41. In a revocable living trust, the grantor should include certain basic provisions. Which provision names the property that is held within the trust, and identifies the intention of the trust agree-ment and how the property is to be used and disposed?
a. the identification clause.
b. the income clause.
c. the property transfer clause.
d. the recital clause.
4-26
42. Choosing a trustee can be complicated. Why might someone choose an individual trustee over a corporate trustee?
a. financial accountability.
b. impartiality to children.
c. permanence.
d. personal interest.
4-27
Learning Objectives
After reading Chapter 5, participants will be able to:
1. Identify tax and legal title formats naming differences among these entity formats by:
a. Specifying the advantages and disadvantages of holding property individually and through a sole proprietorship or a corporation stating how to avoid associated title pit-falls;
b. Selecting primary groups of C corporations specifying the estate-planning problems associated with each; and
c. Recalling the advantages that partnerships can have over corporations.
2. Determine S corporation rules stating tax advantages and disadvantages and also spec-ify disadvantages and advantages of incorporating a farm.
3. Identify title holding benefits of trusts, co-tenancy, partnerships, and limited liability companies and the tax characteristics of each.
4. Specify types of retirement plans used to provide lifetime benefits to a business owner and to employees, identify how title can be held on behalf of minors and the tax treatment of custodianships, and recall the tax treatment of a probate estate.
5-1
CHAPTER 5
Post-Mortem Planning & Tax Return Require-ments
After Death Planning
Obviously, most estate planning should be done before death. However, many estates have little or no planning, the planning was faulty, or additional administration is necessary.
In some cases, planning opportunities only arise after the decedent’s death. Here, the executor and beneficiaries must act to take full advantage of these opportunities.
Alternate Valuation Election
Instead of valuing assets as of the date of death, the executor may elect to value the estate as of an alternate valuation date. Under §2032, the executor is given an election to value the estate assets either at the date of the decedent’s death or at the “alternate valuation date.” When the alternate date is elected, all assets included in the gross estate are valued as of six months after the decedent’s death, except that any assets sold, distributed, exchanged, or otherwise disposed of during the six months following death are valued as of the date of their disposition (Reg. §20.2032-1(a)).
The executor’s election to value assets at the alternate valuation date must be made on the estate tax return. Once made, the election is irrevocable and affects all assets (Reg. §20.202-1(b).
Special Use Valuation
For estate tax purposes, an executor may elect to value certain real property used in farming or other closely held business operations at its current use value rather than its highest and best use value. Under §2032A, the decrease in the value of the gross estate because of this election is limited to $1,190,000 in 2021.
Election to Defer Payment
An executor may elect to have the estate pay the federal estate tax attributable to the value of a closely held business in two to ten equal annual installments beginning five years after the due date of the federal estate tax return. Interest only is payable for the first four years. In addition, a very low interest rate is payable on the amount of estate tax due but unpaid.
5-2
Note: The executor remains personally liable for payment of the deferred tax unless a written ap-plication for discharge is made and the required form is furnished or a special lien is elected.
An interest in a closely held business may consist of an interest in a sole proprietorship, partnership, or corporation.
Final Medical Expenses
At the election of the executor, unpaid medical bills after death may be deducted from either the estate tax or the income tax return - but not from both. Medical expenses paid from the estate within one year after death may be deducted on the decedent’s income tax return. However, the right to deduct such expenses for federal estate tax purposes must be waived and they must exceed 7.5% of the decedent’s AGI.
Administration Expenses
Administration expenses may be claimed as tax deductions from the gross estate. However, the ex-ecutor may elect to take such items as deductions for income tax purposes instead. If used for income tax purposes, an appropriate waiver of the right to claim them as estate tax deductions must the filed timely. Such a waiver is irrevocable.
QTIP Election
Section 2056(b)(7) allows the marital deduction in the case of “qualified terminable interest prop-erty.” However, an affirmative election by the decedent’s executor is a requirement for allowance of this deduction. This election must be made on the estate tax return filed by the executor and once made is irrevocable. A fractional or percentile election is permitted.
Disclaimers
Any heir may disclaim his or her rights within nine months of the decedent’s death. The law provides that a proper disclaimer is the same as the heir dying before the decedent. Such a disclaimer may save income, estate, gift, and generation-skipping taxes on large estates.
A disclaimer is an unqualified refusal to accept a transfer of property. Although other persons may acquire an interest in property as a result of the disclaimer, an effective disclaimer is not a taxable transfer (Reg. §25.2511-1(c)). To be effective, a disclaimer must be an irrevocable and unqualified refusal to accept an interest in property that satisfies four conditions under §2518(b):
(1) The disclaimer must be in writing;
(2) The disclaimer must be received by the donor (or the donor’s estate) within nine months of the date of the transfer creating the interest (or within nine months of the day on which the donee attains age 21);
(3) The donee must not have accepted the interest or any of its benefits; and
(4) As a result of the refusal to accept the property, the interest must pass to a person other than the disclaimant without any direction on the part of the disclaimant.
Note: A disclaimer may be made of an undivided portion of an asset. Subject to certain limitations, a partial disclaimer is valid for federal tax purposes (Reg. §2518-3(a)).
5-3
Disclaimers can be an important estate planning tool. They can be used to:
(1) Bypass a generation that does not need the inheritance;
(2) Permit a surviving spouse to increase the assets transferred to the bypass trust, and
(3) Pay estate taxes upon the death of the first spouse and avoid stacking assets in the second spouse’s estate at higher death tax rates.
Federal Returns
Form 1040 - Decedent’s Income Tax
This form is due three and a half months after the close of the decedent’s taxable year, without regard to his or her death, i.e., April 15th of the year following his or her death.
Form 1041 - Estate’s Income Tax
The estate’s fiduciary income tax return is Form 1041. It is due three and a half months after the end of the estate’s taxable year and is required for any taxable year in which the estate’s gross income is $600 or more.
Form 706 - Decedent’s Estate Tax
The federal estate tax return is Form 706. It is due nine months after the decedent’s death, although a six-month extension is available. In late 2018, the IRS released a revised Form 706 which can be obtained at http://www.irs.gov/pub/irs-pdf/f706.pdf.
Carryover Basis Election & Information Return For 2010
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (“TRUIRJCA”) permitted the executor of the estate of a decedent who died after December 31, 2009, and before January 1, 2011 (i.e., a decedent who died in 2010), to elect to apply the Code as if the reinstatement of the estate tax had not occurred. Under such an election, the estate tax did not apply to the estate and the carryover basis rules applied to assets transferred. Thus, an executor of an estate of a dece-dent who died in 2010 could have elected to apply the §1022 carryover basis rules instead of applying the TRUIRJCA estate tax rules. Once made, the election was revocable only with IRS consent.
Even if the election was made, the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") required executors to file an information return (Form 8939) if the property acquired from the decedent exceeded $1.3 million or if the decedent acquired certain property by gift within three years of death. The information return was used to report the carryover basis of the decedent’s property and the allocation of the basis increase allowed under the §1022 basis rules.
While no Form 706 was required, the information return was originally scheduled to be due with the decedent’s final Form 1040 income tax return. This would have meant that for decedents dying in 2010, the due date would have been April 18, 2011. However, IR-2011-91 extended the Form 8939 filing date to January 17, 2012. Failure to file this information return could have resulted in a penalty of $10,000.
5-4
Note: IR-2011-91 also provided that most 2010 estates that timely filed a Form 4768 extension had until March 19, 2012, to file Form 706 or Form 706-NA. For estates of those dying late in 2010 (after Dec. 16, 2010, and before Jan. 1, 2011), the due date was 15 months after the date of death. No penalties were due but, interest was charged on any estate tax paid after the original due date.
In addition, EGTRRA required executors to provide to each beneficiary a written statement that listed the information reported on the Form 8939 information return with respect to the property that beneficiary acquired from the decedent. The executor had to furnish the beneficiaries with this state-ment no later than 30 days after the filing of the estate information return. Failure to provide each beneficiary with this statement could have resulted in a penalty of $50 for each failure.
Note: Publication 4895, Basis of Inherited Property Held by Decedents Who Died in 2010, explains some of the impact on heirs when an executor makes this election (See http://www.irs.gov/pub/irs-pdf/p4895.pdf ).
Decedent’s Estate Tax - Form 706
The executor of a decedent’s estate uses Form 706 to figure the estate tax. This tax is levied on the entire taxable estate, not just the share received by a particular beneficiary. Form 706 is also used to compute the generation-skipping transfer tax.
In August 2013, the IRS released a revised Form 706 for use by estates of decedents dying after De-cember 31, 2012. Changes reflected in the revision included law and indexing changes.
Filing Requirements
Form 706 must be filed by the executor for the estate of every U.S. citizen or resident where the value of the gross estate on the date of death exceeds $11,700,000 in 2021 (§6018(a)(1)).
For purposes of determining this $11,700,000 (in 2021) value, the gross estate must be increased by:
(i) The adjusted taxable gifts (under §2001(b)) made by the decedent after December 31, 1976, and
(ii) The specific exemption (under §2521 before its repeal) of gifts made after September 8, 1976, and before January 1, 1977.
The obligation to file is on the executor of the estate (§6018(a)(1)). Executor means the personal representative or administrator of the estate. If none of these are appointed or qualified in the U.S., then every person in actual or constructive possession of any property of the decedent (i.e., the beneficiaries) must file a return (§6018(b)). However, if one is executor because no other person was appointed or qualified in the U.S., his or her liability is limited to the value of the property in his or her possession.
If the executor is unable to make a complete return for any property interest in the gross estate, the executor must include on the return the names of everyone holding a legal or beneficial interest in that property and furnish a description of the property. If notified by the district director, anyone holding a legal or beneficial interest in this property must file a return for that part of the gross estate.
The estate tax return is due nine months after death (§6075(a)). For missing persons, the due date is nine months after the date set by local statute for declaring a missing person dead (R.R. 80-347). A
5-5
six-month1 extension of time to file is available by filing Form 4768 (§6018(a)). However, an extension of time for filing a return does not extend the due date for paying the tax.
Form 706 is filed with the Internal Revenue Service Center for the state in which the decedent was domiciled at the time of his or her death (§6091(b)(3)).
If the decedent was neither a resident nor a citizen of the U.S., the executor must file Form 706NR, if the value of the gross estate located in the U.S. is more than $60,000.
If the estate tax return is not filed timely, the IRS will impose a penalty of .5% of the estate tax liability per month, up to a maximum of 25%, until the return is filed, unless the estate representative can show that the failure to file is due to reasonable cause and not to willful neglect (§6651(a)(1)). If the failure to file is shown to be fraudulent, the penalties range from 25% to a maximum of 75% (§6151(f)).
Paying the Estate Tax
Payment of the estate tax is due at the same time as the return is filed (i.e., nine months after death) unless:
(i) An extension of time to pay was granted under §6161,
(ii) The estate has properly elected under §6166 to pay in installments, or
(iii) An election under §6163 has been made to postpone the part of the tax attributable to a reversionary or remainder interest.
The executor must pay the entire estate tax, even if some of the property of the gross estate is not in the executor’s possession. All checks should be made to the “Internal Revenue Service” and con-tain the decedent’s name and social security number.
Failure to pay the tax with the return can cause the imposition of a penalty of .5% of the estate tax liability for each month or part of a month that the tax remains unpaid, up to a maximum of 25% (§6651). This penalty is in addition to the late-filing penalty.
In cases where the failure to pay is after notice and demand by the IRS, the penalty is increased to 1% per month (§6651(d)).
Where both the failure to file penalty and failure to pay penalty apply, the failure to file penalty is reduced by the amount of the failure to pay penalty (§6651(c)(1)).
Section 6161
An extension of time to pay can be obtained by filing a Form 4768 and showing reasonable cause (§6161(a)(2)), such as when:
(i) The estate includes a claim subject to a lawsuit,
(ii) Liquid assets are not within the executor’s control, and
(iii) When the majority of estate assets are rights to receive payments in the future.
While the extension to pay can be for up to ten years, the extension allowed is generally for 12 months. File two copies of Form 4768 if requesting only an extension of time to pay the tax. If also requesting an extension of time to file the return, file four copies of Form 4768.
1 Additional time may be permitted if the executor is abroad
5-6
Note: An extension of time to pay does not relieve the estate from liability for paying interest on the balance due during the period of the extension.
If a request for an extension of time is denied, a written appeal may be made to the regional commissioner. This appeal must be made within 10 days after the denial is mailed.
Section 6166
If the gross estate includes an interest in a closely held business, the executor may be able to elect to pay part of the estate tax in installments.
Section 6166 is available where the interest in the closely held business exceeds 35% of the adjusted gross estate (gross estate less estate expenses and losses).
Section 6163
If the gross estate includes the value of a reversionary or remainder interest, the executor may elect to postpone the payment of the tax attributable to that interest until 6 months after the preceding interests in the property have ended. The executor elects this extension in Part 3 on page 2 of Form 706.
Note: Prepayment of the tax attributable to such property is allowed without the payment of ac-crued interest or acceleration of the remaining estate tax (R.R. 83-103).
If at the end of the 6 months, the executor shows reasonable cause, the Service may grant addi-tional time of up to 3 years for payment of the tax attributable to these interests.
5-7
Review Questions
43. When an interest is held in a closely held business, an executor may make an election to defer payment of any federal estate due to the value of the interest. What does this election allow?
a. fifteen annual installments payments.
b. a deferment of fifteen years.
c. low interest rate on unpaid estate tax owed.
d. payments of only interest in the first nine years of payment.
44. Heirs may disclaim their rights to a transfer of property from a decedent. What is one of the four conditions that such a disclaimer must meet in order to qualify under §2518(b)?
a. The disclaimant may not direct who will receive the property.
b. The disclaimant must orally refuse acceptance.
c. The donor must receive the disclaimer within 3 months of the transfer date.
d. The donee must have accepted some of the benefits of the interest.
45. There is an exception to the rule that estate taxes must be paid when the return is filed. Under §6166, a taxpayer may elect to pay a portion of this tax in installments if a closely held business interest surpasses _____ of the adjusted gross estate.
a. .5%
b. 1%
c. 25%
d. 35%
Overview of the Form 706
The Federal Estate Tax Return - Form 706 is made up of five parts and more than two dozen schedules and sub-schedules. Completing Form 706 requires the preparer to work backward by filling out the schedules first and then the front pages of the form. The schedules are used to report assets, deduc-tions, tax credits, and additional taxes if any.
5-8
Overview of Form 706
• Form 706 has six parts:
– Part 1 - Decedent & Executor
– Part 2 - Tax Computation
– Part 3 - Elections by the Executor
– Part 4 - General Information
– Part 5 - Recapitulation
– Part 6 - Portability of Deceased Spousal Unused Exclusion (DSUE)
• Schedules A - I = Gross estate
• Schedules J - O = Deductions
• Schedule P - Foreign Death Tax Credit
• Schedule Q - Tax on Prior Transfers Credit
• Schedule R - Generation-Skipping Transfer Tax
• Schedule T - Qualified Family-Owned Business Interest
• Schedule U - Qualified Conservation Easement Exclusion
5-9
Definitions
There are a number of concepts that are unique to the estate tax return. While many of these concepts were discussed earlier, here is a brief review for Form 706 purposes:
Gross Estate: the value of all property retained by the decedent at death and certain property transferred during the decedent’s life (§2031).
Valuation Date: the date of death or the alternate valuation date six months after the date of death unless there is an intervening disposition (§§2031 and 2032). The purpose of this requirement is to prevent the estate from increasing the income tax basis of estate assets when there is no federal estate tax payable.
Note: The alternate valuation date can be elected only if it reduces the size of the gross estate and the estate tax liability (§2032(c)).
Taxable Estate: the gross estate less allowable deductions (§2051).
Note: Deductions include expenses of the estate (including debts of the decedent, mortgages, and liens), losses of the estate, gifts to charity, and certain transfers to or for the benefit of a surviving spouse (§§2053, 2054, 2055, 2056A, and 2056).
Tentative Tax: estate tax figured on taxable estate plus adjusted taxable gifts (§2001(b)(1)).
Gross Estate Tax: tentative tax less the gift tax payable on gifts after December 31, 1976.
Net Estate Tax: gross estate tax less allowable credits.
Balance Due: net estate tax, plus other taxes (e.g., generation-skipping transfer tax), less any tax payments (e.g., flower bonds).
Preparing Form 706
What follows is a discussion of the basic sections and schedules of Form 706 in the order in which they are typically filled out.
Form 706, Part 1, Page 1 - Decedent & Executor
This section solicits basic information regarding:
(1) Decedent’s name, address, social security number, domicile at the time of death, the year that domicile was established, dates of birth and death,
(2) Executor’s name, address, and social security number,
(3) Court where the estate is being probated or administered (including case number),
(4) Whether the decedent died testate,
(5) Whether an extension of time to file and/or pay tax was obtained, and
(6) Whether the return includes a generation-skipping transfer tax.
Form 706, Part 3, Page 2 - Elections by the Executor
The executor may elect to make the following elections:
(1) The alternate valuation (see earlier discussion),
Note: If the alternate valuation is elected, then throughout the return both the date of death value and the alternate value for each item must be shown.
5-10
(2) The special use valuation under §2032A,
(3) Installment payment of estate tax under §6166, and
(4) Postponement of taxes attributable to reversionary or remainder interests under §6163.
Note: Some elections are made elsewhere on the return. Elections affecting the marital deduction are made on Schedule M. The election by a beneficiary to report lump-sum distributions is on Schedule I.
Form 706, Part 4, Pages 2 & 3 - General Information
This section requests a variety of information. Special items to note when completing Part 4 are:
(1) A Form 2848 must be filed for someone other than the executor to enter into a closing agreement for the estate, and
Note: Form 8821 has replaced Form 2848-D.
(2) This is where the attorney, accountant, or enrolled agent who prepared the return signs.
Schedule A, Page 5 - Real Estate
Schedule A is used to report the value of all real estate, including foreign real estate, which is part of the gross estate (§2031). The full value of the real estate is reported and there is no reduction for homestead, dower, or curtsey. If the estate is liable for a mortgage on the property, describe the mortgage but deduct the mortgage on Schedule K.
Some real estate is reported elsewhere on the return:
(1) Jointly owned property is reported on Schedule E,
(2) Property owned by a sole proprietorship is reported on Schedule F,
(3) Property includible under §§2035 through 2038 is reported on Schedule G, and
(4) Property subject to a power of appointment is reported on Schedule H.
Describe the property in detail and indicate what the valuation is based on. If a special valuation election is made, Schedule A-1 must also be completed.
Schedule A-1, Pages 6 thru 9 - Section 2032A Valuation
The requirements under §2032A for special valuation have been discussed earlier. Some special items to note are:
(1) The property must pass to a qualified heir, who must sign the agreement for special use valuation,
(2) The property must have been devoted to a qualified use on the date of death,
Note: Qualified use means farm or business use for an aggregate of five out of eight years prior to the date of death.
(3) The adjusted value of the real and personal property used in farming or a closely held business must constitute at least 50% of the adjusted value of the gross estate,
(4) The executor must elect the special use valuation and the heir must agree to it, and
Note: A protective election may be used when it is not clear whether all requirements are satisfied (Reg. §20.2032A-8(b)).
5-11
(5) Recapture will occur if the property ceases to be used in a qualified use or is disposed of outside the family within 10 years.
Note: Form 706-A is used to report the recapture of these tax benefits.
Schedule B, Page 10 - Stocks and Bonds
Schedule B is used to report the value of all stocks and bonds included in the gross estate. In doing so, some special items include:
(1) Group and denote any stocks or bonds subject to foreign death taxes,
(2) Be sure to include even tax-exempt securities,
(3) Treat interest and dividends separately from the securities to which they relate,
(4) If the stocks are publicly traded, valuation is based on selling price, and
Note: Flower bonds are included at their face or par value. The author is not aware of any flower bonds being available after 1998.
(5) If the securities are not publicly traded, special rules apply including potential minority discounts and the effect of buy-sell agreements.
Schedule C, Page 11 - Mortgages, Notes, and Cash
Schedule C is used to report cash and all items owed to the decedent at the time of death. Mort-gages and notes are valued based on their unpaid principal plus accrued interest unless special circumstances (e.g., below-market interest rate or insolvency of the debtor) permit a lower val-uation (Reg. §20.2031-4).
Schedule D, Page 12 - Insurance on Decedent’s Life
All insurance on decedent’s life whether or not includible in the gross estate is listed on Schedule D. This includes insurance receivable:
(1) By or for the benefit of the estate, and
(2) By beneficiaries other than the estate from a policy in which the decedent possessed in-cidents of ownership.
Note: Incidents of ownership include (i) the right of the insured or his or her estate to economic benefits, (ii) the power to change beneficiaries, (iii) the power to assign the policy, (iv) the power to borrow on the policy, or (v) a reversionary interest of more than 5% of the policy’s value.
Include the name of each insurance company, the number of the policy, and attach Form 712. Lump-sum payments are on line 24 of Form 712. Installment payments are on line 25.
Schedule E, Page 13 - Jointly Owned Property
In Part 1, report qualified jointly owned interests owned with his or her spouse as tenants by the entirety or as joint tenants. In Part 2, report interests owned with other tenants. The full value of all property must be included unless there is proof that the other tenant furnished some or all the consideration.
There are some joint interests that are not reported on Schedule E, for example:
(1) Tenancy in common (Schedule A),
5-12
(2) Community property (Schedules A through I), and
(3) Partnership interests unless the interest itself is held jointly (Schedule F).
Schedule F, Page 14 - Other Miscellaneous Property
This is the catchall schedule and includes:
(1) Unincorporated business and partnership interests,
(2) Insurance on the life of another
(3) QTIP property in the estate of the surviving spouse under §2044,
(4) Household goods and personal effects,
(5) Claims (e.g., refunds of federal and state income tax),
(6) Rights, royalties, leaseholds, judgments, autos, and shares in a trust,
(7) Reversionary or remainder interests, and
(8) Farm products and growing crops, livestock, and farm equipment.
Schedule G, Page 15 - Transfers During Decedent’s Life
There are five types of transfers reported on the Schedule G:
(1) Gift tax paid on transfers within 3 years of death by the decedent or his or her spouse,
(2) Transfers within three years of death under §2035(a),
(3) Transfers with a retained life estate under §2036,
(4) Transfers taking effect at death under §2037, and
(5) Revocable transfers under §2038
Schedule H, Page 15 - Powers of Appointment
Reported on this schedule is the value of property for which the decedent had a general power of appointment at death (§2041). Limited powers are not included.
Schedule I, Page 16 - Annuities
Under §2039, annuities payable to someone on the death of the decedent are included in the gross estate and reported on this schedule if four requirements are met:
(1) The contract or agreement is not a policy of life insurance on the decedent,
(2) The contract or agreement was entered into after March 3, 1931,
(3) The annuity is receivable because of having survived the decedent, and
(4) The annuity had been payable to the decedent.
Schedule J, Page 17 - Funeral and Administration Expenses
This schedule lists estate tax deductions for:
(1) Funeral expenses under §2053(a)(1),
Note: Deductible expenses include tombstone, monument, mausoleum, burial lot, and cost of transportation to the cemetery (§2055(a)(1)). In community property states the amount deductible depends on whether the community or the decedent’s estate was responsible for the cost.
5-13
(2) Administration expenses2 incurred to administer estate property subject to claims,
(3) Executors’, accountants’ and attorneys’ fees, and
Note: If the executor is the primary beneficiary, he or she should consider waiving his or her fees depending on a comparison of his or her individual tax bracket versus the estate’s bracket.
(4) Miscellaneous expenses such as appraisals, probate fees, cost of collecting assets, and selling expenses.
Executors’, attorneys’, and accountants’ fees, administration, and other miscellaneous expenses can be claimed as a deduction on the estate’s income tax return, Form 1041 if a waiver is filed on Form 706. Typically, there is no double deduction.
However, it is possible to get a double deduction for such items as interest, taxes, business ex-penses, and other §691(b) deductions in respect of a decedent, provided the items were accrued and unpaid at death (§642(g)). For example, interest paid on federal estate taxes is a proper ex-pense of administration and the double deduction rule applies.
While estates using the maximum marital deduction may benefit by claiming expenses on Form 1041, it is impossible to generalize when the waiver is advisable.
Note: When the entire estate is left to the surviving spouse, there will be no tax savings by deduct-ing administration expenses on the estate tax return.
Schedule K, Page 18 - Debts of Decedent, and Mortgages and Liens
This Schedule reports all valid debts owed by the decedent at death (§2053(a)(3)). This can in-clude:
(1) Past due alimony,
(2) Medical expenses of last illness incurred for the care of the decedent and paid by the estate within one year of death,
Note: An election can be made to claim these expenses on the decedent’s final income tax return, Form 1040, instead of Form 706. However, no double deduction is allowed. Compare income and estate tax rates before deciding since there is a “Catch-22.” Using the medical expenses on the decedent’s final income tax return reduces the decedent’s final income tax liability, which in turn reduces the estate tax return’s deduction of that income tax liability. If the expense is used on the estate tax return, there is more income tax on the final return but a larger tax liability deduction on the estate tax return. Got it!
(3) Outstanding utility bills and credit card charges on date of death,
(4) Income taxes unpaid but attributable to income earned while alive,
(5) Property taxes accrued prior to death, and
(6) Mortgages and liens.
Schedule L, Page 19 - Net Losses During Administration and Expenses Incurred in Administering Property Not Subject to Claims
Items here include:
2 Any portion of administrative expenses which are attributable to the surviving spouse’s community property, may be
deducted on the spouse’s individual income tax return, but not by the estate.
5-14
(1) Casualty and theft losses (not claimed on the estate’s income tax return), and
(2) Expenses incurred in administering property not subject to claims.
Schedule M, Page 20 - Bequests to Surviving Spouse
This Schedule computes the deduction for property passing to the surviving spouse that is not terminable interest property. Part 1 is for interests not subject to the QTIP election. Part 2 is for property interest subject to the QTIP election. Part 3 is a reconciliation that totals parts 1 and 2.
Schedule O, Page 21 - Charitable Gifts and Bequests
This schedule permits a full deduction for the value of amounts passing to charity (§2055). The property must pass to the federal, state, or local government for exclusively public purposes or to a charitable institution or fraternal society approved by the IRS. Charitable remainder trusts qualify for the charitable deduction.
Schedule P, Page 22 - Credit for Foreign Death Taxes
This Schedule allows a credit for estate, inheritance, legacy, and succession taxes paid to a foreign country (§2014). Complete a separate Schedule P for each country to which foreign taxes paid.
Schedule Q, Page 22 - Credit for Tax on Prior Transfers
A credit is permitted on this schedule for estate taxes on property where the property was taxed in another estate within the last 10 years. If the prior decedent predeceased the current decedent by more than two years, the credit is reduced by 20% for each full two years the original dece-dent’s death preceded the current decedent’s death.
Schedules R & R-1, Pages 23 thru 27 - Generation-Skipping Transfer Tax
The GST is due on direct skips occurring at death (§2601 et seq.). If the tax is payable by the estate, file Schedule R. If the tax is payable by a trust includible in the estate, file Schedule R-1.
Old Schedule T Gone - Qualified Family-Owned Business Interest
This Schedule was based on §2057 and allowed a deduction (formerly an exclusion) for the value of certain family-owned business interests from the gross estate. The election to use the deduc-tion (assuming the interest qualifies) was made by filing Schedule T, attaching all required state-ments, and deducting the value of the interest in Part 5, Recapitulation. This provision expired in 2004 and Schedule T is no longer part of Form 706.
Note: You can only deduct the value of property that was also reported on Schedules A, B, C, F, G, or H.
Schedule U, Page 28 - Qualified Conservation Easement Exclusion
This Schedule is based on §2031(c) and permits an election to exclude a portion of the value of land that is subject to a qualified conservation easement. The election is made by filing Schedule U with all the required information and excluding the applicable value of the land that is subject to the easement in Part 5, Recapitulation.
5-15
Note: To elect the exclusion, you must include on Schedules A, B, E, F, G, or H, as appropriate, the decedent’s interest in the land that is subject to the exclusion.
Form 706, Part 5, Page 3 - Recapitulation
The recapitulation is completed by totaling the gross estate items (Schedules A-I) and the allow-able deductions (Schedules J through T).
Form 706, Part 6, Page 4 - Portability of Deceased Spousal Unused Exclusion (DSUE)
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 author-ized estates of decedents dying after December 31, 2010, to elect to transfer any unused exclu-sion to the surviving spouse. The amount received by the surviving spouse is called the deceased spousal unused exclusion, or DSUE, amount. If the executor of the decedent’s estate elects trans-fer, or portability, of the DSUE amount, the surviving spouse can apply the DSUE amount received from the estate of his or her last deceased spouse against any tax liability arising from subsequent lifetime gifts and transfers at death.
Form 706, Part 2, Page 1 - Tax Computation
Total deductions are subtracted from the total gross estate. Adjusted taxable gifts are added. The gross estate tax is computed and credits are applied. For 2012, the estate tax applicable exclusion amount was $5.12 million. For 2021, the estate tax applicable exclusion amount was inflation ad-justed to $11.7 million. Amounts exceeding the applicable exclusion amount are taxed at 40% (up from 35% in 2012). As a result, the applicable exclusion amounts and their credit equivalents are as follows:
Year of death Exclusion Amount Credit Equivalent
2012 5,120,000 1,772,800
2013 5,250,000 2,045,800
2014 5,340,000 2,081,800
2015 5,430,000 2,117,800
2016 5,450,000 2,125,800
2017 5,490,000 2,141,800
2018 11,180,000 4,360,200
2019 11,400,000 4,505,800
2020 11,580,000 4,577,800
2021 11,700,000 4,625,800
Schedule PC, Pages 29 - 31 - Protective Claim for Refund
A protective claim for refund preserves the estate’s right to a refund of tax paid on any amount included in the gross estate which would be deductible under §2053 but has not been paid or otherwise will not meet the requirements of §2053 until after the limitations period for filing the claim has passed (see §6511(a)).
Note: Only use Schedule PC for §2053 protective claims for refund being filed with Form 706. If the initial notice of the protective claim for refund is being submitted after Form 706 has been filed, use Form 843, Claim for Refund and Request for Abatement, to file the claim.
5-16
Schedule PC may be used to file a §2053 protective claim for refund by estates of decedents who died after December 31, 2011. It also will be used to inform the IRS when the contingency leading to the protective claim for refund is resolved and the refund due the estate is finalized. The estate must indicate whether the Schedule PC being filed is the initial notice of protective claim for refund, notice of partial claim for refund, or notice of the final resolution of the claim for refund.
Discharge from Personal Liability
Under §2204, an executor may make written application to the IRS for early determination of the amount of estate tax and discharge from personal liability. The IRS must respond within 9 months of the application notifying the executor of the estate tax. On payment of the noticed amount the ex-ecutor is discharged from personal liability.
5-17
Review Questions
46. On the federal estate tax return, taxpayers must familiarize themselves with several im-portant concepts. What term is defined as the gross estate minus deductions such as the estate’s expenses, losses, and charitable gifts?
a. gross estate tax.
b. net estate tax.
c. taxable estate.
d. tentative tax.
47. On Form 706, part 3, page 2 - Elections by the Executor, up to four elections may be made. What is one of these elections that may be made?
a. one that affects the marital deduction.
b. one that is made by a beneficiary to report lump-sum distributions.
c. one to exclude a portion of the value of land that is subject to a qualified conservation easement.
d. one to use the special use valuation under §2032A.
48. On Form 706, taxpayers must report how much cash the decedent had at the time of death and also what was owed to the decedent. What schedule should be used to report these amounts?
a. Schedule B.
b. Schedule C.
c. Schedule D.
d. Schedule E.
49. On Form 706, taxpayers must report all QTIP property in the surviving spouse’s estate under §2044. What schedule is used to report this information in addition to reversionary or remainder interests?
a. Schedule F.
b. Schedule G.
c. Schedule H.
d. Schedule I.
50. Under §642(g), a double deduction may be available for certain expenses so long as the de-cedent accrued, but had not paid, these expenses. What type of expenses may qualify for this double deduction?
a. business expenses.
b. executors’, attorneys’, and accountants’ fees.
c. funeral expenses.
d. medical expenses of last illness incurred for the care of the decedent and paid by the estate within one year of death.
5-18
51. On Form 706, property qualifies for a credit for estate taxes if it has been included and taxed in another estate within the last ten years. On what schedule is this credit taken?
a. Schedule O.
b. Schedule P.
c. Schedule Q.
d. Schedule T.
52. Expenses can be reported in a variety of ways. Under §642(g), estate administration expenses are reported on:
a. Form 706 only.
b. Form 706 or Form 1041.
c. Form 706 or Form 1041 or split.
d. Forms 706 and 1041.
53. An estate income tax return must be filed for certain estates. What is a filing requirement of this Form 1041, Estate Income Tax Return?
a. Income, age, and filing status of a decedent determine the sections needed to be com-pleted.
b. It is to be filed no later than the 15th day of the 4th month subsequent to the end of the tax year for the estate.
c. The beneficiaries must file the form.
d. It must be filed on time - no extension of time will be granted.
Estate Income Tax Return - Form 1041
An estate is a separate taxable entity that comes into existence on the death of a decedent. The estate continues to exist until the final distribution to heirs and other beneficiaries. Income from estate assets must be reported on a fiduciary tax return. The tax is generally figured in the same manner and on the same basis as for individuals, with certain differences in the computation of de-ductions and credits.
Filing Requirements
Fiduciaries are required to file an income tax return on Form 1041 for the following estates of do-mestic decedents:
(1) Estates that have a gross income of $600 or more for the taxable year, or
(2) Estates where any beneficiary is a nonresident alien.
The fiduciary responsible for filing Form 1041 may be the executor, administrator, or personal rep-resentative of the estate. When an estate has an ancillary representative, that representative is also required to file a fiduciary return for the activities in his or her jurisdiction.
5-19
Note: The fiduciary must file a written notice of fiduciary relationship, Form 56, with the IRS. This notice should be filed as soon as possible after the fiduciary is appointed. However, if the fiduciary is required to file a tax return, the notice can be filed with the first return. The Service will then deal directly with the fiduciary and will send him or her notices of any prior tax deficiencies and assess-ments. After filing this notice, the fiduciary is personally responsible for taxes owed by the estate or trust only if he or she violates the rule regarding payment of other debts ahead of the taxes. When fiduciary capacity is ended, a notice of that fact should also be mailed.
Form 1041 must be filed by the 15th day of the 4th month following the close of the estate’s tax year. The IRS will grant a reasonable extension of time for filing the estate’s income tax return if the fiduciary shows reasonable cause and files Form 2758. The extension is generally limited to 60 days. In hardship cases, an estate may be able to obtain an extension of time for payment by filing Form 1127.
Note: An estate is required to make estimated income tax payments for any tax year ending two or more years after the date of the decedent’s death.
A fiduciary for a nonresident alien estate with U.S. source income, including any income that is ef-fectively connected with the conduct of a trade or business in the United States, must file Form 1040NR, U.S. Nonresident Alien Income Tax Return, as the income tax return of the estate.
Schedule K-1
A personal representative must also file a separate Schedule K-1 (Form 1041) for each benefi-ciary. These schedules are filed with Form 1041. Each beneficiary’s taxpayer identification num-ber must be shown. A $50 penalty is charged for each failure to provide the identifying number of each beneficiary unless reasonable cause is established for not providing it.
Note: When the executor assumes duties as the personal representative, he or she should request each beneficiary to give their taxpayer identification number. However, it is not required of a non-resident alien beneficiary who is not engaged in a trade or business within the United States or of an executor or administrator of the estate unless that person is also a beneficiary.
A personal representative must also furnish a Schedule K-1 to the beneficiary on or before the date on which Form 1041 is filed. Failure to provide this payee statement can result in a penalty of $50 for each failure. This penalty also applies if the executor omits information or includes incorrect information on the payee statement.
Tax Computation
The estate’s taxable income generally is figured the same way as an individual’s income. Gross in-come of an estate consists of all items of income received or accrued during the tax year. It includes dividends, interest, rents, royalties, gain from the sale of property, and income from business, part-nerships, trusts, and any other sources.
Since the income tax rates on estates and trusts are the worst in the Code, the executor should con-sider distributing estate income to the surviving spouse in the year of the decedent’s death. When the surviving spouse files a joint income tax return with the decedent, this income may be taxed at a lower rate than if taxed in the estate.
5-20
Exemption Deduction
Personal and dependent exemptions formerly available to individuals are not available to an es-tate or trust. However, an estate may claim a personal exemption of $600 in figuring its taxable income (§642(b). No exemption for dependents is allowed to an estate. Even though the first return of an estate may be for a period of less than 12 months, the exemption is $600. If, how-ever, the estate was given permission to change its accounting period, the exemption is $50 for each month of the short year.
Contributions
An estate qualifies for a deduction for amounts of gross income paid or permanently set aside for qualified charitable organizations. The adjusted gross income limitations for individuals do not apply. However, to be deductible by an estate, the contribution must be specifically provided for in the decedent’s will. If there is no will, or if the will makes no provision for the payment to a charitable organization, then a deduction will not be allowed even though all of the beneficiar-ies may agree to the gift.
Statute of Limitations
Generally, the IRS can assess additional tax at any time within three years of the time the return was filed. However, the taxpayer can agree with the Service to extend the statute on Form 872. When the taxpayer omits income exceeding 25% of the gross income stated in the return, the statute of limitations is increased to six years. False or fraudulent returns and failure to file a return can result in suspension of the statute.
Accounting Methods
An estate or trust may use any of the tax accounting methods available to individuals. The method of accounting used by the decedent does not carry over to the estate or trust. However, once the method has been adopted, any change is subject to IRS approval.
Taxable Year
The executor can elect to report the estate’s income on a fiscal or calendar year3. If a fiscal year is desired, the election must be made within three and one-half months after the close of the fiscal year selected (§441). Absent such a timely election, the estate must use the calendar year.
Note: Careful selection of the tax year can spread income and reduce overall tax liability. For exam-ple, since beneficiaries are taxable on distributions for the year in which the estate’s tax year ends, a fiscal year may push taxable income for the beneficiaries into a later year.
Double, Split & Solo Deductions
Some expenses may be deducted on Form 1041 only if not deducted from the gross estate on Form 706. These deductions may be split between the two returns in any manner desired.
3 All trusts must use the calendar year.
5-21
Certain debts paid after death are deductible for both federal estate tax (Form 706) and fiduciary income tax (Form 1041) purposes. These are often referred to as “double deductions” and are enu-merated in §691(b).
Finally, medical expenses may be claimed on Form 706 the Form 1040, while funeral expenses may only be claimed on Form 706.
5-22
Deduction Alternatives
Description 706*
& 1041
706 or
1041 or
split
706 or
1040 706 only
Trade or business ex-penses (§162)
YES NO NO NO
Interest (§163) YES NO NO NO
Taxes (§164) YES NO NO NO
Expenses for the pro-duction or collection
of income (§212) YES NO NO NO
Expenses for the management and maintenance of
income-producing property (§212)
YES NO NO NO
Expenses in connec-tion with the deter-mination, collection, or refund of any tax
(§212)
YES NO NO NO
Alimony (§215) YES NO NO NO
Estate Administration Expenses (§642(g)
NO YES NO NO
Medical Expenses of Decedent Paid Within
One Year (§213(d)) NO NO YES NO
Funeral Expenses (§2053(a))
NO NO NO yes
Casualty or Theft Losses (§165)
No Yes No no
* Items are deductible on both returns only if they are expenses in respect of a decedent, except for alimony.
5-23
Decedent’s Final Income Tax Return - Form 1040
Unless the decedent died on December 31st while mailing his or her federal income tax return early, a final income tax return (Form 1040) is due for the year of death if the decedent received any income in excess of the filing limit. The personal representative must file the final income tax return of the decedent for the year of death and any returns not filed for preceding years.
Note: A personal representative of an estate is an executor, administrator, or anyone who is in charge of the decedent’s property. Generally, an executor (or executrix) is named in a decedent’s will to administer the estate and distribute properties as the decedent has directed. An administra-tor (or administratrix) is usually appointed by the court if no will exists, if no executor was named in the will, or if the named executor cannot or will not serve.
Preceding Year Return
If an individual dies after the close of the tax year, but before the return for that year was filed, the return for the year just closed is not the final return. The return for that year is a regular return and the personal representative must file it.
Example
Dan died on March 21, 2022, before filing his 2021 tax return. His personal representa-tive must file his 2021 return by April 15, 2022. His final tax return is due April 15, 2023.
Filing Requirements
The income, age, and filing status of a decedent generally determine the filing requirements. In gen-eral, filing status depends on whether the decedent was considered single or married at the time of death. Gross income usually means money, goods, and property an individual received on which he or she must pay tax. It includes gross receipts from self-employment minus any cost of goods sold. It does not include nontaxable income.
Refund
A return should be filed to obtain a refund if tax was withheld from salaries, wages, pensions, or annuities, or if estimated tax was paid, even if the decedent is not required to file.
Form 1310
Any person who is filing a return for a decedent and claiming a refund must file a Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer, with the return. However, if the person claiming the refund is a surviving spouse filing an original joint return with the decedent, or a court-appointed or certified personal representative filing an original return for the dece-dent, Form 1310 is not needed.
5-24
Joint Return with Surviving Spouse
Generally, the personal representative and the surviving spouse can file a joint return for the decedent and the surviving spouse. However, the surviving spouse alone can file the joint return if no personal representative has been appointed before the due date for filing the final joint return for the year of death.
Note: If no fiduciary is appointed by the time of filing, then just the spouse signs. The surviving spouse writes “Filing as Surviving Spouse” in the signature area, and writes “Deceased” and the date of death next to the decedent’s name in the name and address area.
This also applies to the return for the preceding year if the decedent died after the close of the preceding tax year and before the due date for filing that return. The income of the decedent that was includible on his or her return for the year up to the date of death and the income of the surviving spouse for the entire year must be included in the final joint return.
Note: A final joint return with the deceased spouse cannot be filed if the surviving spouse remarried before the end of the year of the decedent’s death. The filing status of the deceased spouse is “married filing separate return.”
If the court subsequently appoints a personal representative, that person may revoke an election to file a joint return that was previously made by the surviving spouse alone. This is done by filing a separate return for the decedent within one year from the due date of the return (including any extensions). The joint return made by the surviving spouse will then be regarded as the sep-arate return of that spouse by excluding the decedent’s items and refiguring the tax liability.
There may be a substantial tax break in filing a joint return4 since the income and deductions are split equally between two taxpayers, especially if one spouse earns more than the other. More-over, one spouse’s deductions (e.g., a capital loss or NOL) may be of benefit when applied against the other’s income.
Request for Prompt Assessment
The IRS ordinarily has 3 years from the date an income tax return is filed, or its due date, whichever is later, to charge any additional tax due. However, the fiduciary may request a prompt assessment of tax after the return has been filed. Form 4810 is used for making this request. This request can be made for any income tax return of the decedent and for the income tax return of the decedent’s estate.
Included Income
The decedent’s return must include all income and deductions to the date of death, based on the accounting method (cash or accrual) used by the decedent when alive. All items of income actually or constructively received prior to death must be included. The following instances illustrate this inclusion:
(1) A check mailed before death is payment;
(2) Expenses charged to a bank credit card are treated as paid at the time of the charge;
4 If a joint return is filed, the estate will be jointly and severally liable for any tax.
5-25
(3) Uncashed checks received before death are constructively received;
(4) Interest is constructively received if it is subject to withdrawal;
(5) Interest from coupons on bonds that matured before death but were uncashed is construc-tively received; and
(6) Dividends are constructively received when made subject to shareholder demand.
Partnership Income
The death of a partner generally does not close the partnership’s tax year before it normally ends. It continues for both the remaining partners and the deceased partner. Even if the partnership has only two partners, the death of one does not terminate the partnership or close its tax year, provided the deceased partner’s estate or successor continues to share in the partnership’s prof-its or losses.
If the surviving partner terminates the partnership by discontinuing its business operations, the partnership tax year closes as of the date of termination. If the deceased partner’s estate or suc-cessor sells, exchanges, or liquidates its entire interest in the partnership, the partnership’s tax year with respect to the estate or successor will close as of the date of the sale or exchange or the date the liquidation is completed.
The decedent’s final return must include the decedent’s distributive share of partnership income for the partnership’s tax year ending within or with the decedent’s last tax year (i.e., the year ending on the date of death).
The final return does not include the distributive share of partnership income for a partnership’s tax year ending after the decedent’s death. In this case, partnership income earned up to and including the date of death is income in respect of the decedent. Income earned after the date of death to the end of the partnership’s tax year is income to the estate or successor in interest.
Example
Dan is a partner in the XYZ partnership that has a calendar year. If Dan dies on any day other than December 31, none of his share of partnership income or loss is included on his final return. If Dan’s estate is the successor in interest to his partnership interest, the estate will include all of the income earned by the partnership for the entire year. Partnership income earned up to and including the date of death is income in respect of a decedent.
Example
Dan was a partner in XYZ partnership and reported his income on a tax year ending December 31. The partnership uses a tax year ending June 30. Dan died August 31, 2021, and his estate established its tax year ending August 31. The distributive share of taxable income from the partnership based on the decedent’s partnership interest is reported as follows:
(1) The final return for the decedent for period January 1 through August 31, 2021, includes income from the XYZ partnership year ending June 30, 2021, and
5-26
(2) The income tax return of the estate for the period September 1, 2021, through August 31, 2022, includes income from the XYZ partnership year ending June 30, 2022.
The portion of income from the partnership for the period July 1, 2021, through August 31, 2021, is income in respect of a decedent.
If the partnership agreement provides for a sale or exchange of the decedent’s interest at the date of death, the taxable year of the partnership closes upon the date of death with respect to the deceased partner.
S Corporation Income
If the decedent was a shareholder in an S corporation, the final return must include the dece-dent’s share of S corporation income for the corporation’s tax year that ends within or with the decedent’s last tax year (year ending on the date of death). The final return must also include the decedent’s pro-rata share of the S corporation’s income for the period between the end of the corporation’s last tax year and the date of death.
Note: If a shareholder dies during an S corporation’s tax year, his or her pro-rata share of the cor-poration’s income is included in the decedent’s final return. Income is allocated proportionally to the decedent according to the number of days in the corporation’s tax year prior to death, without regard to income or loss actually incurred by the corporation throughout the tax year. However, if all shareholders agree, the corporation may elect to allocate income or loss as if the year consisted of two short years — one ending at the date of death and the other ending on the last day of the corporate year.
The income for the part of the S corporation’s tax year after the shareholder’s death is income to the estate or other person who has acquired the stock in the S corporation.
Self-Employment Income
Self-employment income actually or constructively received or accrued is included in the final return.
For self-employment tax purposes only, the decedent’s self-employment income will include the decedent’s distributive share of a partnership’s income or loss through the end of the month in which death occurred. For this purpose only, the partnership’s income or loss is considered earned ratably over the partnership’s tax year.
Community Income
If the decedent was married and was domiciled in a community property state, half of the income received and half of the expenses paid during the decedent’s tax year by either the decedent or spouse may be considered to be the income or expense of the other.
Interest & Dividend Income
Payers of interest and dividends report amounts on Form 1099 using the identification number of the person to whom the account is payable. After a decedent’s death, Form 1099 must reflect the identification number of the estate or beneficiary to whom the amounts are payable. The personal representative handling the estate must furnish this identification number to the payer.
5-27
A Form 1099 should be received for the decedent reporting interest and dividends that were includible on his or her return before death. A separate Form 1099 should be received showing the interest and dividends includible on the returns of the estate or other recipient after the date of death and payable to the estate or other recipient. Corrected Form 1099 can be requested if these forms do not properly reflect the right recipient or amounts.
Exemptions & Deductions
Generally, the rules for exemptions and deductions allowed to an individual also apply to the dece-dent’s final income tax return. The final return should show deductible items the decedent paid be-fore death (or accrued, if the decedent reported deductions on an accrual method).
Prior to 2018, the personal exemption could be claimed in full on a final income tax return. If the decedent was another person’s dependent (i.e., a parent’s), the personal exemption could not be claimed on the decedent’s final return. However, from 2018 through 2025, personal exemptions are now suspended.
If deductions are not itemized on the final return, the full amount of the appropriate standard de-duction is allowed regardless of the date of death.
Medical Expenses
Medical expenses paid before death by the decedent are deductible on the final income tax re-turn if deductions are itemized. This includes expenses for the decedent as well as for the dece-dent’s spouse and dependents.
Election for Decedent’s Expenses
Medical expenses that are not deductible on the final income tax return are liabilities of the estate and are shown on the federal estate tax return (Form 706). However, if medical ex-penses for the decedent are paid out of the estate during the 1-year period beginning with the day after death, an election can be made to treat all or part of the expenses as paid by the decedent at the time they were incurred.
When the election is made, all or part of the expenses can be claimed on the decedent’s income tax return rather than on the federal estate tax return (Form 706). Expenses incurred in the year of death can be deducted on the final income tax return. An amended return (Form 1040X) should be filed for medical expenses incurred in an earlier year unless the stat-utory period for filing a claim for that year has expired.
Making the Election
The election is made by filing with the decedent’s income tax return, or amended return, a statement in duplicate that the amount has not been claimed as an estate tax deduction, and that the estate waives the right to claim the amount as a deduction. This election applies only to expenses incurred for the decedent, not to expenses incurred to provide medical care for dependents.
5-28
AGI Limit
The amount deductible on the income tax return is the amount in excess of 7.5% (in 2021) of adjusted gross income. The amounts not deductible because of this percentage cannot be claimed on the federal estate tax return.
Example
Dan used the cash method of accounting and filed his return on a calendar year ba-sis. He died on June 1, 2022, after incurring $800 in medical expenses. Of that amount, $500 was incurred in 2021 and $300 was incurred in 2022. Dan filed his 2021 income tax return before April 15, 2022. The personal representative of the estate paid the entire $800 liability in August 2021.
The personal representative may then file an amended return (Form 1040X) for 2021 claiming the $500 medical expense as a deduction. The $300 of expenses incurred in 2022 can be deducted on the final income tax return, although it was paid after Dan’s death. The personal representative must file a statement in duplicate with each return stating that these amounts have not been claimed on the federal estate tax return (Form 706), and waiving the right to claim such a deduction on Form 706 in the future.
Medical Expenses Not Paid By Estate
Medical expenses for the care of the decedent paid by a survivor who can claim the decedent as a dependent are deductible on the survivor’s income tax return for the tax year in which paid, whether or not they are paid before or after the decedent’s death. If the decedent was a child of divorced or separated parents, the medical expenses are usually deductible by both the custodial and noncustodial parent to the extent paid by each parent during the year.
Insurance Reimbursements
Insurance reimbursements of previously deducted medical expenses due a decedent at the time of death and later received by the decedent’s estate are includible in the income tax return of the estate (Form 1041) for the year the reimbursements are received. The reim-bursements are also includible in the decedent’s gross estate.
Deduction for Losses
A decedent’s net operating loss from prior-year business operations and any capital losses (in-cluding a capital loss carryover) can only be deducted on the decedent’s final income tax return. Any unused net operating loss or capital loss cannot be deducted on the estate’s income tax return. However, a net operating loss carryback resulting from a net business loss on the dece-dent’s final income tax return can be carried back to prior years.
At-Risk Loss Limits
Special at-risk rules apply to most activities that are engaged in as a trade or business or for the production of income. These rules limit the amount of deductible loss to the amount for which the decedent was considered at risk in the activity.
5-29
Passive Activity Rules
In general, if a passive activity interest is transferred because of the death of a taxpayer, the accumulated unused passive activity losses are allowed as a deduction against the decedent’s income in the year of death. However, losses are allowed only to the extent they are greater than the excess of the transferee’s (recipient of the interest transferred) basis in the property over the decedent’s adjusted basis in the property immediately before death. The portion of the losses that is equal to the excess is not allowed as a deduction for any tax year.
Example
Dan had suspended passive losses of $150,000 from his passive activities at the time of his death. The passive activities received a step up in basis of $100,000 (the fair market value at the date of death). $50,000 of suspended losses may be claimed on Dan’s final return.
5-30
Review Questions
54. The decedent's gross income must be reported on a final income tax return, Form 1040. What is excluded from this amount?
a. stock dividends.
b. self-employment income.
c. municipal bond income.
d. property received for services.
55. A taxpayer who files a decedent’s final income tax return and claims a refund is required to file another form. What form must be sent with the tax return?
a. a separate Schedule K-1.
b. Form 1040X.
c. Form 1099.
d. Form 1310.
56. When applicable, partnership income must be included on the decedent’s return. If a surviv-ing partner terminates the partnership’s business operations, when does the partnership tax year close?
a. as of the date of death.
b. as of the date of termination.
c. as of the date of the liquidation.
d. as of the date of the sale or exchange.
57. The decedent’s self-employment income includes the decedent’s distributive portion of a partnership’s income or loss for the entire month in which the decedent died:
a. for community income purposes.
b. for partnership tax purposes only.
c. for S corporation tax purposes only.
d. for self-employment tax purposes only.
58. Taxpayers may make an election to treat all or a portion of a decedent’s medical expenses as paid by the decedent when incurred. Which expenses fail to qualify for this election?
a. expenses incurred for the decedent.
b. expenses incurred to provide medical care for dependents.
c. expenses that are not deductible on the final income tax return.
d. the amount in excess of 10% of adjusted gross income.
5-31
Gift Tax Return - Form 709
The Federal gift tax applies to any transfer by gift of real or personal property, whether tangible or intangible, made directly or indirectly, in trust, or by any other means to a donee. In other words, all transactions in which property or property interests are transferred to another without adequate consideration constitute gifts subject to gift tax.
Note: The gift tax is not imposed on the receipt of gift property, but rather upon the donor’s act of making a completed gift.
A gift is complete if a donor has parted with dominion and control over the transferred property or property interest, leaving the donor without the power to change its disposition, whether for the benefit of the donor or for the benefit of others.
Penalties
Penalties similar to those applicable to the estate tax return (see earlier discussion) may be incurred for failure to file the return or to pay the tax when due. For example, a penalty of one-half percent per month of the unpaid balance, up to 25%, will be charged on the failure to pay, unless reasonable cause can be shown.
Filing
The donor is required to file a return, Form 709, reporting both gifts of present and future interests. Form 709 is filed on an annual basis with the due date the 15th day of the 4th month following the close of the calendar year of the gift.
Note: For a calendar year in which the donor dies, the gift tax return is required to be filed no later than the due date for filing the donor’s estate tax return, Form 706, including extensions (§6075(b)).
Form 709 is filed with the Internal Revenue Service Center serving the state in which donor’s legal residence or principal place of business is located. If the donor has no legal residence or principal place of business in the United States, the return is filed with the Internal Revenue Service Center, Philadelphia, PA 19255.
However, no gift tax return is due for:
(1) A transfer that is not more than the annual exclusion (i.e., a present interest of $15,000 (in 2021) or less),
(2) A qualified transfer for educational or medical expenses, or
(3) A spousal transfer that qualifies for the unlimited marital deduction.
The donor must submit certain documents with the return. Copies of instruments executed for trans-fers of property, statements by insurance companies (Form 712), and copies of appraisals of real property must be submitted. If shares of stock in closely held corporations are listed on the return, the documents used to value the shares, such as balance sheets, profit and loss statements for each of the 5 years preceding the valuation date, and statements of dividends paid during that period must be attached.
5-32
Extension of Time to File
An extension of time to file a gift tax return (up to 6 months) may be requested from the District Director or Service Center for the donor’s area. The reason for the delay must be fully explained. An extension of time to file does not extend the time to pay the tax. No form is provided for this request.
Note: An extension of time to file an income tax return for any tax year that is a calendar year automatically extends the time for filing the annual gift tax return for that calendar year until the due date of the income tax return.
Extension of Time to Pay
The tax shown on the gift tax return must be paid by the person required to file the return at the time and place fixed for filing. However, at the request of the donor, a reasonable extension of time, up to 6 months, may be granted by the Service Center for the payment of the tax shown on the return. The extension may exceed 6 months if the donor is abroad.
Note: For a deficiency, an extension of time for up to 18 months may be granted. In an exceptional situation, another 12 months may be granted.
Interest must be paid on any amount of tax that is not paid by the last date prescribed for the payment of the tax. The last date for payment is the due date determined without regard to any extensions of time to pay.
Split Gifts
A gift made by a person to someone other than a spouse may be considered as made one-half by each spouse. This is known as gift splitting and both spouses must consent to its use. Generally, if a gift is split a lower gift tax rate bracket applies to the total taxable gift. In addition, the annual exclu-sion and the applicable exclusion amount ($11,700,000 in 2021) allowable to each spouse applies to the gift.
Form 709 must be filed if a donor and spouse chose to gift-split. In general, if a donor and spouse agree, all gifts either spouse makes to a third party during the calendar year will be considered as made one-half by each spouse.
Note: Form 709-A, United States Short Form Gift Tax Return, previously used by married couples to report nontaxable gifts they consent to split is obsolete.
When the donor and his or her spouse elect gift splitting, then both spouses must file his or her own individual gift tax return. A married couple may not file a joint gift tax return. However, only one spouse must file a return if all the requirements of either of the following exceptions are met:
1. During the calendar year:
a. only one spouse made any gifts,
b. the total value of these gifts to each third-party donee does not exceed $30,000 (in 2021), and
c. all of the gifts were of present interests; or
2. During the calendar year:
5-33
a. only one spouse (the donor spouse) made gifts of more than $15,000 but not more than $30,000 (in 2021) to any third-party donee,
b. the only gifts made by the other spouse (the consenting spouse) were gifts of not more than $15,000 (in 2021) to third-party donees other than those to whom the donor spouse made gifts, and
c. all of the gifts by both spouses were of present interests.
If either of the above exceptions is met, only the donor spouse must file a return and the consenting spouse signifies consent on that return.
Form 709 must be filed by April 15 of the calendar year following the year the donor made the non-taxable split gifts unless an extension of time to file has been granted.
Note: Generally, in community property states the election is not available to spouses who make gifts of community property because both spouses are already considered to own the gift property equally.
Special Applications & Traps
Bargain Sales
The gift tax applies not only to the gratuitous transfer of any kind of property, but also to sales or exchanges, not made in the ordinary course of business, where money or money’s worth is exchanged but, the value of the money received is less than the value of what is sold or ex-changed. In such a case, the tax is imposed only on the value of the excess. However, if a bona fide transfer, sale, or exchange is made at arm’s length in the ordinary course of business, the transaction will be considered a transfer for adequate consideration and not subject to gift tax.
Below Market Loans
Below-market loans have gift tax consequences. The right to use money is the property right being transferred and, if no interest or a low rate of interest is charged, the transfer is for less than adequate consideration. If a below-market loan is a gift loan, it may be subject to the gift tax.
A below-market loan is:
(1) A demand loan on which the interest is payable at a rate less than the applicable federal rate, or
(2) A term loan in which the amount loaned (amount received by the borrower) exceeds the present value of all payments due under the loan.
A gift loan is any below-market loan where the forgone interest is in the nature of a gift. A loan between unrelated persons can qualify as a gift loan.
Foregone interest is the excess of:
(1) The amount of interest that would have been payable for the period if interest accrued at the applicable federal rate and were payable annually on the last day of the calendar year, over
Note: For demand loans, the applicable federal rate is the federal short-term rate in effect for the period for which the amount of foregone interest is being determined, compounded semiannually. The applicable federal rate for a semiannual period (January 1 through June 30 or July 1 through
5-34
December 31) is the short-term rate that is in effect for the first month of that semiannual period (i.e., January or July). In the case of a below-market demand loan of a fixed principal amount that remains outstanding for an entire calendar year, the “blended annual rate” may be used to com-pute foregone interest. For term loans, the applicable federal rate is the federal short-term, mid-term, or long-term rate, based on the term of the loan, in effect on the day the loan was made, compounded semiannually. These federal rates are published monthly.
(2) Any interest payable on the loan properly allocable to that period.
If the gift loan is a below-market demand loan, the foregone interest is treated as transferred (as a gift) by the lender to the borrower. Any foregone interest attributable to periods during any calendar year is treated as transferred on the last day of that calendar year.
If the gift loan is a below-market term loan, the lender is treated as having transferred (as a gift) on the date the loan was made an amount equal to the excess of the amount loaned, over the present value of all payments that are required to be made under the terms of the loan. Present value is determined on the date of the loan by using a discount rate equal to the applicable fed-eral rate.
Exception
These provisions do not apply to gift loans directly between individuals for any day on which the total outstanding amount of loans between these individuals is not more than $15,000 (in 2021). This exception does not apply to any gift loan directly attributable to the purchase or carrying of income-producing assets.
Net Gifts
If a gift is made on the express or implied condition that the donee pays the gift tax, the payment of this tax is deducted from the value of the gift made as partial consideration for the gift. It should be noted that such an agreement does not release the donor from the principal liability of paying the gift tax if, in fact, the tax is not paid. The payment of gift taxes by a donee causes an interrelated or circular computation known as a net gift computation (R.R. 75-72).
Note: If the donee pays the gift tax, the donor realizes taxable income to the extent the gift taxes paid by the donee exceed the donor’s adjusted basis in the property.
Promises to Make a Gift
A promise to make a gift becomes taxable in the year the obligation becomes binding and not when the discharging payments are made. As a result, if one promises to transfer property in the future, the gift becomes taxable as of the first date on which it is possible to determine that the transfer must be made and that it will be of a determinable amount.
Example
Dan creates a trust under the terms of which he can revoke the transfer and revest title in his name, the transfer is an incomplete gift. The same would be true if Dan reserved the power to alter the instrument, enabling him to name new beneficiaries or change the interests of the beneficiaries. The gift would, in either case, become complete at such time as Dan renounces the power, or the right to exercise it ceases, because of some event or contingency or the fulfillment of some condition other than his death.
5-35
The gift would be considered complete if the powers could be exercised only with the consent of a person having a substantial adverse interest.
Checks
If the donor delivers his or her own check to another as a gift, the gift is not complete, for gift tax purposes, until the check is paid, certified, or transferred for value to a third person.
Stock Certificates
If the donor delivers a properly endorsed stock certificate to the donee or to the donee’s agent, the gift is completed, for gift tax purposes, on the date of delivery. However, if the donor delivers the certificate to his or her bank or broker as donor’s agent, or to the issuing corporation or its transfer agent, for transfer to the donee’s name, the gift is only completed on the date the stock is transferred on the corporation’s books.
Promissory Notes
If the donor transfers his or her own promissory note to another as a gift, the gift is completed on the date of the transfer if the promissory note is legally enforceable. The transfer of a legally unenforceable promissory note is an incomplete gift until the note is paid or transferred for value.
Powers of Appointment
A power of appointment is a power to determine who will own or enjoy the property subject to the power. The exercise or complete release of a general power of appointment is treated as a gift unless the exercise or release was for adequate consideration.
5-36
Review Questions
59. A taxpayer may give a gift to a person other than a spouse and have it be treated as made one-half by each spouse. What is this called?
a. bargain sales.
b. gift loaning.
c. gift splitting.
d. powers of appointment.
60. Taxpayers may be required to pay gift tax on gift loans. Under what type of gift loan is fore-gone interest treated as a transferred gift by the lender to the borrower?
a. below-market demand loan.
b. below-market term loan.
c. foregone loan.
d. net gift.
61. A donor can gift stock certificates. For gift tax purposes, if such a gift is delivered to the donee, when is the gift deemed completed?
a. on the delivery date.
b. under the same rules that apply to promissory notes.
c. under the check delivery rules.
d. on the date the stock is transferred on the corporation’s books.
5-37
Answers & Explanations
1. When considering income, gift, and, ultimately, death taxes, taxpayers should attempt to re-duce the overall tax load for the whole family unit. What is this process called?
a. Incorrect. Estate planning tries to encourage wealth building for everyone. Building an estate involves financial and investment planning and goes beyond reducing the overall tax load for the family unit.
b. Incorrect. Once you have made and preserved an estate, you must determine how to distribute it to your heirs. Estate distribution is multifaceted and involves more than family tax reduction.
c. Incorrect. Estate planning is more than just planning for family tax reduction. It includes build-ing an estate during a lifetime, then seeing that those assets are protected in an estate that can be passed to the next generation. It allows you the opportunity to control your success both during life and on death.
d. Correct. Preservation is the process of looking at income, gift, and, ultimately, death taxes to minimize the overall tax burden for the total family unit. [Chp. 1]
2. An accountant, an attorney, a financial planner, and an insurance agent are the professionals most often on an estate planning team. Of these professionals, whose responsibilities include being familiar with the client’s financial affairs and being well-informed on income and estate tax laws?
a. Correct. The accountant should know the financial affairs of the taxpayer, recognize the client’s need for potential estate planning, and be knowledgeable with respect to income and estate tax laws. The accountant should also be able to advise on valuation problems and family income needs.
b. Incorrect. The attorney should decide whether suggestions, recommendations, and phases in the plan have legal substance and merit. A competent attorney must draft the legal documents that are the framework of an effective estate plan. Only a lawyer may legally practice law.
c. Incorrect. The financial planner should be able to advise on investment return, asset manage-ment, and cash flow analysis. The financial planner should also know enough about insurance, estate taxes, and law to suggest possible solutions for the client to discuss with their accountant and attorney.
d. Incorrect. Insurance agents are great motivators in getting persons involved in the estate plan-ning process and can provide excellent advice and ideas. The agent should have specialized knowledge of the many forms of life insurance and know what various policies can and cannot do. [Chp. 1]
3. What procedure must a will go through in order for an executor to carry out the terms set forth by the decedent?
a. Incorrect. While there are many devices for the transfer of assets outside of the probate sys-tem, a will is not one of them. Typically, these probate avoidance arrangements produce no state or federal death tax savings. Their primary rationale is avoidance of probate and transfer conven-ience.
5-38
b. Incorrect. If there’s no will, property in the probate estate is distributed according to the state law of intestacy. When an individual dies intestate, the probate court chooses a person respon-sible for administering the estate and distributing the probate assets.
c. Correct. Upon the decedent’s death, the will must go through the probate process in order to have the instructions carried out.
d. Incorrect. Probate avoidance techniques are transfers that operate independent of one’s will. These transfer devices determine who gets property at the estate owner’s death regardless of the owner’s will or trust. [Chp. 1]
4. Life insurance proceeds are included in a decedent’s estate where the decedent retained inci-dents of ownership over the policy. What planning device can taxpayers use to avoid this in-clusion?
a. Incorrect. Under a payable on death account, or “Totten” trust, a bank account owner names a beneficiary (or payee) who automatically receives the account balance on the death of the owner. Such accounts are not used to hold life insurance policies.
b. Incorrect. A private annuity is where one person transfers property (not a life insurance policy) to another (who is not in the business of selling annuities) for that person’s unsecured promise to make fixed periodic payments to the other for life. Recent regulations have compromised pri-vate annuities.
c. Incorrect. The self-canceling installment note is a device that arose to prevent the inclusion of the installment note in the seller’s estate. This type of installment sale uses a promissory note that by its terms expires on the death of the payee.
d. Correct. Frequently, an irrevocable insurance trust is used to avoid the inclusion of the insur-ance proceeds in the decedent’s estate. In such a case, the incidents of ownership over the life insurance policy are typically transferred to the trust. [Chp. 1]
5. The Crummey trust is based on a court case in which a taxpayer wanted to make gifts through a trust. What is a characteristic of a Crummey trust?
a. Incorrect. Under the Crummey trust, gifts are made to an irrevocable trust.
b. Correct. Under the Crummey trust, if the beneficiaries do not make a withdrawal, the funds remain in the trust and are administered pursuant to its terms. The result is hopefully the use of the annual exclusion with subsequent control of the funds by the trust.
c. Incorrect. Generally, making gifts to a trust presents problems when one also wants to take advantage of the annual exclusion. The annual exclusion requires that any excluded gifts must be present interests, not future - as in a trust. The Crummey trust is meant to overcome this problem.
d. Incorrect. Under the Crummey trust, the beneficiaries are given only a short period of time each year to withdraw the gift from the trust. [Chp. 1]
6. For their heirs, grantors may transfer some assets to an irrevocable trust and, for themselves, they may keep an income or beneficial right in the property. What is such an estate-planning device often called?
a. Incorrect. A buy-sell agreement is a contract between business owners for the disposition of their interests upon the happening of certain events. Whenever two or more people are in busi-ness together it is an absolute necessity that they have a buy-sell agreement.
5-39
b. Incorrect. A family limited partnership can be a great income, estate, and gift tax savings de-vice. While senior family members can control property transferred to such a partnership, they may not retain an income or beneficial right in the property.
c. Correct. A grantor retained income trust is an estate planning tool in which a grantor transfers certain property to an irrevocable trust for the benefit of their heirs while retaining for them-selves an income or beneficial right in the property.
d. Incorrect. Minor trusts under §2503 are similar in purpose to Crummey trusts. If properly struc-tured these trusts qualify in whole or in part for the annual gift tax exclusion by law. [Chp. 1]
7. Upon a decedent’s death, numerous tax forms must be filed. Which form is due for the period of January 1 to the date of the decedent’s death?
a. Incorrect. Form 706 is filed for taxes imposed by the federal government on the transfer of assets on death - i.e., estate taxes. This form is due nine months after the decedent's death.
b. Incorrect. Form 709 is filed if the decedent made taxable gifts during his or her lifetime but failed to pay gift taxes. The executor must pay these taxes plus interest and penalty.
c. Correct. A decedent’s final income tax return, Form 1040, must be filed for the period of Janu-ary 1 to the date of death.
d. Incorrect. Form 1041 must be filed and income taxes paid if your estate has any income after your death. [Chp. 2]
8. Federal estate tax is one of eight potential death taxes. What is a distinguishing characteristic of the federal estate tax?
a. Incorrect. Federal estate tax is privilege tax. Apparently, the government feels it is granting you the privilege to receive property.
b. Correct. Federal estate tax is a tax that is imposed on property transfers.
c. Incorrect. Amazingly, the federal estate tax is technically considered an excise tax.
d. Incorrect. - Conceptually, the federal estate tax is not imposed on property itself but on the right to transfer it. [Chp. 2]
9. Estate and inheritance taxes are the two basic types of state death taxes. What is a character-istic of the estate tax used by many states?
a. Incorrect. Most inheritance tax systems apply separate exemptions and rates to the share re-ceived by each heir. Typically, the rates and exemptions vary depending upon the relationship of the heir.
b. Incorrect. Inheritance tax is a tax upon property received by heirs.
c. Correct. Estate tax is basically a tax upon the value of all property owned at death which is transferred to heirs.
d. Incorrect. Even where there is no direct tie, state inheritance taxes are often similar to federal estate tax concerning the property and transfers subject to tax. Thus, federal estate tax planning should achieve suitable state inheritance tax results as well. [Chp. 2]
10. Section 2033 provides that when an interest terminates at death, said interest is excluded from taxation. Under R.R. 75-127, what has also been excluded from taxation?
a. Incorrect. If the insured is dead when the insurance policy owner dies, then any proceeds re-maining at death are taxable.
5-40
b. Incorrect. Income accruing from rental property after death is not included but is income tax-able to the estate or heirs.
c. Incorrect. Income accruing from stocks or bonds after death is not included but is income tax-able to the estate or heirs.
d. Correct. For many years the Service insisted that wrongful death actions were taxable under §2033. However, in R.R. 75-127, the Service reversed itself and agreed that the value of wrongful death claims (or the proceeds) is not taxable. [Chp. 2]
11. If a remainder person dies prior to obtaining a decedent’s property interest, it can be included in the remainder person’s estate. In such a case, what is this interest called?
a. Incorrect. A contingent remainder is an interest that does not come into enjoyment or posses-sion unless a future condition occurs, or can end on the occurrence (or nonoccurrence) of a future event.
b. Incorrect. A curtsey is a statutory provision in a common-law state that directs a certain portion of the estate to the husband.
c. Incorrect. A dower is a statutory provision in a common-law state that directs a certain portion of the estate to the wife.
d. Correct. A vested remainder is included in the estate of a remainder person who dies before obtaining such property interest. However, a remainder interest can be limited to the remainder person’s life. [Chp. 2]
12. Section 2036(a) imposes four requirements for taxation of transfers with a retained life inter-est. What is one of those requirements?
a. Incorrect. Section 2036 does not apply to a power held solely by a person other than the de-cedent, such as an independent trustee. However, if the decedent reserved the power to remove a trustee and appoint himself or herself as trustee, the decedent is considered as having the powers of the trustee.
b. Correct. One of the four requirements specified in §2036(a) for taxation of transfers with a retained life interest is that the decedent must have retained interests in or powers over the property.
c. Incorrect. The entire value of property subject to a retained interest or power is taxable under §2036. The tax is not limited to the value of the specific interest or power. However, where the retained right relates only to a portion of the property, only that portion is taxed.
d. Incorrect. One of the four requirements specified in §2036(a) for taxation of transfers with a retained life interest is that there must have been a lifetime transfer of property. [Chp. 2]
13. According to the author, taxpayers may make charitable contributions in three basic ways. In which method are property interests received by both charitable and noncharitable beneficiar-ies?
a. Incorrect. An immediate contribution is made in cash, by check, or by transferring property to a charitable organization.
b. Incorrect. Life insurance can be used to fund charitable contributions by assigning ownership of an existing policy to a charity, making a charity beneficiary of an existing policy, or making a charity an irrevocable beneficiary of a new policy.
5-41
c. Incorrect. The three primary ways to make a charitable contribution are immediate, split-in-terest, and insurance-related. A pledge is typically a promise to make a future gift.
d. Correct. In a split-interest contribution, interests in the same property are given to both char-itable and noncharitable beneficiaries. Examples of split interests include charitable remainder trusts and partial interests. [Chp. 2]
14. A taxpayer can make a deductible contribution in trust to a charity. What is a planning consid-eration in establishing a charitable remainder trust?
a. Incorrect. A contribution of a remainder interest in tangible personal property is deductible only when all intervening interests are held by parties unrelated to the donor.
b. Incorrect. A contribution of a remainder interest in tangible personal property is deductible only when all intervening interests have expired.
c. Incorrect. Any individual beneficiaries must be alive when the trust is created.
d. Correct. The contribution must be of real property or intangibles. [Chp. 2]
15. Under §§170 and 2055(e), split gifts can be in three formats. In which format does the charity maintain the trust?
a. Incorrect. A charitable lead trust is not one of the three basic formats that can be used to split gifts. However, this type of trust is not maintained by the charity but is maintained by a trustee other than the charity.
b. Incorrect. A charitable remainder annuity trust is a type of annuity trust that can be used for interest splitting purposes. However, the charity that receives interest from this trust does not maintain said trust.
c. Incorrect. A charitable remainder trust is a way to split gifts. However, a trustee other than the charity maintains a charitable remainder trust.
d. Correct. A pooled income fund is a trust maintained by the charity into which each donor trans-fers property. [Chp. 2]
16. In a charitable remainder trust, a taxpayer makes a contribution of property to a trust for the immediate benefit of the taxpayer and the future benefit of a charity. What is fundamentally the opposite of a charitable remainder trust?
a. Correct. A charitable lead trust is essentially the reverse of a charitable remainder trust. The donor gives an income interest to the charity, with the remainder reverting to the donor or named beneficiaries.
b. Incorrect. Under a charitable remainder annuity trust, the trustee annually distributes to the noncharitable beneficiary at least five percent of the original value of the trust assets. On termi-nation of the payments, the remainder interest is transferred to the charity or retained by the trust for the benefit of the charity.
c. Incorrect. A charitable remainder unitrust is a trust where the trustee must distribute annually the lesser of a fixed percentage (at least 5%) of the trust estate (determined annually), or all trust income. A charitable remainder unitrust provides the noncharitable beneficiary a variable payout based on the annual valuation of the trust assets.
d. Incorrect. In a pooled income fund, each donor transfers property into a trust from which each named beneficiary receives an income interest. Donors contribute property to the trust reserving
5-42
a life estate in a share of the total property. The public charity must be the irrevocable remainder. [Chp. 2]
17. Upon the decedent’s death, a marital deduction is allowed for assets that pass completely to the surviving spouse. When is said deduction denied for assets?
a. Incorrect. A marital deduction trust qualifies for the marital deduction. Under this trust, the first spouse to die leaves their assets in trust for the survivor’s benefit.
b. Incorrect. A marital deduction is permitted for property passing to a qualified domestic trust of which the noncitizen surviving spouse is a beneficiary. A qualified domestic trust is a trust that has as its trustee at least one U.S. citizen or U.S. corporation.
c. Incorrect. Assets left outright to a spouse qualify under the marital deduction and pass tax-free.
d. Correct. A marital deduction is denied for property passing to a surviving spouse who is not a citizen of the United States. [Chp. 2]
18. The property basis for an asset can vary based on how it was acquired. In what type of trans-action is the basis the lesser of the original owner's basis or the fair market value on the trans-action date?
a. Incorrect. In a gift later sold at a gain, the basis is the donor’s basis.
b. Correct. In a gift later sold at a loss, the basis is the lesser of the donor’s basis or the fair market value on the date of the gift.
c. Incorrect. In a purchase, the basis is the cost of property plus improvements.
d. Incorrect. In a tax-deferred exchange, the basis is the original basis of property given up, plus “boot” given, plus any net increase in debt. [Chp. 2]
19. The start of a holding period for an asset can depend on how it was acquired. In which of the events below does the holding period for an asset commence on the date of someone's death?
a. Incorrect. For a reversion, the holding period starts on the date the property is received.
b. Incorrect. For a gift a gain, the holding period starts on the date the donor’s holding period started.
c. Correct. In an inheritance, the holding period starts on the date of the decedent’s death.
d. Incorrect. In a seller repossession, the holding period includes the period before and after the seller repossession. [Chp. 2]
20. Under the 2010 special estate election, property received from a decedent was subject to the modified carryover basis rules. According to this legislation, what qualified as an asset that was obtained from the decedent?
a. Incorrect. The modified carryover basis rules applied to property acquired from the decedent, which is property acquired by bequest, devise, or inheritance - not by gift.
b. Incorrect. The modified carryover basis rules applied to property acquired by the decedent’s estate from the decedent. Property acquired by the decedent estate from the surviving spouse would not qualify.
c. Correct. The modified carryover basis rules applied to property acquired from the decedent, which is property passing from the decedent by reason of the decedent’s death to the extent
5-43
such property passed without consideration (e.g., property held as joint tenants with right of survivorship or as tenants by the entireties).
d. Incorrect. The modified carryover basis rules applied to the surviving spouse’s one-half share of certain community property held by the decedent and the surviving spouse as community property. [Chp. 2]
21. Six types of property were ineligible for a modified basis increase under the 2010 special elec-tion. However, what property qualified for a basis increase?
a. Incorrect. Property not eligible for a basis increase included property that constitutes a right to receive income in respect of a decedent. This was one of the six types of property that are ineligible for a basis increase.
b. Correct. In general, the basis of property could be increased above the decedent’s adjusted basis in that property only if the property was owned, or was treated as owned, by the decedent at the time of the decedent’s death. The decedent was treated as the owner of property (which will be eligible for a basis increase) if the property was transferred by the decedent during his lifetime to a revocable trust that pays all of its income during the decedent’s life to the decedent or at the direction of the decedent.
c. Incorrect. Property not eligible for a basis increase included stock of a foreign investment com-pany. This was one of the six types of property that are ineligible for a basis increase.
d. Incorrect. Property not eligible for a basis increase included stock or securities of a foreign personal holding company. This was one of the six types of property that are ineligible for a basis increase. [Chp. 2]
22. The generation-skipping transfer tax (§2601) applies to three basic types of transfers. Which of these transfer types is considered an outright transfer to a second generation family mem-ber?
a. Incorrect. Under, §2601, the generation-skipping transfer tax applies to taxable terminations, taxable distributions, and direct skips.
b. Correct. A direct skip is a transfer subject to gift or estate tax but is made to a second genera-tion family member - i.e., a skip person. However, a transfer to a grandchild is exempt if the parent of the grandchild is dead.
c. Incorrect. A taxable distribution means any distribution from a trust to a skip person and is not made outright.
d. Incorrect. A taxable termination is defined as any termination (by death, lapse of time, release of a power, or otherwise) of an interest in property held in trust, unless: immediately after such termination, a non-skip person has an interest in such property, or at no time after such termina-tion may a distribution be made from such trust to a skip person. It is not made outright. [Chp. 2]
23. Most gifts are subject to gift tax. However, under §2501, what type of transfer is not subject to gift tax?
a. Correct. Under §2501, the gift tax can be imposed on the transfer of property by gift by any individual. This language implies that gift tax cannot apply to entities.
b. Incorrect. Under §2501, the gift tax can be imposed on the transfer of property by gift whether the transfer is in trust or otherwise.
5-44
c. Incorrect. Under §2501, the gift tax can be imposed on the transfer of property by gift whether the gift is direct or indirect.
d. Incorrect. Under §2501, the gift tax can be imposed on the transfer of property by gift whether the property is real or personal, tangible or intangible. [Chp. 2]
24. A gift’s value must be determined for federal gift tax purposes. For which of the following items are IRS tables used to determine present value on the date that the gift is completed?
a. Incorrect. The value of a life insurance policy, issued by a company regularly engaged in the selling of such contracts, is the amount that the issuing company would charge for a comparable contract on the date of the decedent’s death.
b. Incorrect. Generally, the best indication of the value of real property is the price paid for the property in an arms-length transaction on or before the valuation date.
c. Correct. The value of remainders or reversions is generally the present value on the date of the gift determined by IRS tables. The tables and factors used depend on the date of the transfer.
d. Incorrect. The value of stocks and bonds is their fair market value per unit (share or bond) on the date of the gift. If there is a market for stocks and bonds on a stock exchange, in an over-the-counter market, or otherwise, the fair market value per unit is the mean (midpoint) between the highest and lowest quoted selling prices on the date of the gift. [Chp. 2]
25. The portion of a property interest that is transferred to a charity, when the transfer is for com-bined charitable and noncharitable purposes, may qualify for a charitable deduction. Under what circumstance is this deduction allowed for said portion of the interest?
a. Correct. If the donor transfers a qualified real property interest to a qualified organization ex-clusively for conservation purposes, the value of that interest is deductible.
b. Incorrect. An undivided portion of the donor’s entire interest in property must consist of a fraction or a percentage of each interest or right the donor owns in the property, and it must extend over the entire term of their interest in that property or in other property into which the donated property is converted.
c. Incorrect. If the donor transfers the remainder interest, not in trust, in a farm to a qualified charity, the value of that interest is deductible.
d. Incorrect. If the donor transfers for a charitable purpose the remainder interest, not in trust, in their personal residence, the value of the interest is a deductible charitable contribution. [Chp. 2]
26. Six disadvantages of giving gifts are provided in the course material. What is one of these dis-advantages?
a. Incorrect. An advantage of giving gifts is that gifts from one spouse to the other are completely free of gift tax.
b. Incorrect. An advantage of giving gifts is that $14,000 (in 2017) may be transferred free of any transfer tax to any donee, each and every year; the amount may be $28,000 (in 2017) if spouses join in the gifts.
c. Correct. A disadvantage of giving gifts is that gifts can make the donee wealthier than the do-nor, thus making the ultimate tax burdens even higher, and shifting the obligation to pay those taxes from the donor to the donee.
5-45
d. Incorrect. An advantage of giving gifts is that, in a community property state, a gift of low basis separate property to the community (a gift of one-half to the non-owning spouse) may ensure that upon the death of either spouse, the entire property will qualify for a step up in basis. [Chp. 2]
27. A bequest can be used to dispose of assets at death. What type of bequest is actually a dispo-sition of cash?
a. Incorrect. Some people add specific conditions to their will. This frequently cannot be done. Once you will something outright, you cannot add conditions to it.
b. Correct. A general bequest is actually a cash bequest. If there is not sufficient cash in the estate on death, the executor must sell assets to raise the necessary funds.
c. Incorrect. Even if the testator believes he has distributed everything, there still should be a clause that covers the “residue” of the estate. This means everything that is not specifically item-ized will go to someone who really deserves it.
d. Incorrect. A specific bequest (called a specific devise when real property) is the distribution of a specific asset. [Chp. 3]
28. Two individuals, typically spouses, may sign one will in which they dispose of both of their assets. What is such a will called?
a. Incorrect. A living will is a written document that allows an individual to designate a repre-sentative to make medical decisions for him/her if incapacitated due to accident or illness.
b. Correct. A joint will is when two people (usually husband and wife) sign one will disposing of both of their assets. This can be dangerous since there is some question whether such a will can be changed after the death of one of the parties.
c. Incorrect. A statutory will is exactly that - a simple preprinted form established by statute. Normally, you cannot change most provisions.
d. Incorrect. Two or three people must witness a will. The witnesses have to see the will signed by the testator. The testator then declares the document to be their will and asks the witnesses to attest to it by also signing the will. The witnesses should not receive any assets under the will. [Chp. 3]
29. When certain assets are put into a joint tenancy, the transaction can be treated as a gift. Which of the following assets become gifts when put into joint tenancy?
a. Incorrect. Bank accounts do not become gifts when put into joint tenancy.
b. Incorrect. Credit union accounts do not become gifts when put into joint tenancy.
c. Correct. Money market funds become gifts when put into joint tenancy. If the transfer of an asset into joint tenancy is a gift, then the other joint tenant(s) own a proportionate share of the assets and will be taxed on its income.
d. Incorrect. Vehicles do not become gifts when put into joint tenancy. [Chp. 3]
30. Rather than making changes directly on an original will, a separate document can be created. What is the name of such a document?
a. Correct. A codicil is a document that changes a will. It is the same as if the will had been retyped with the changes.
5-46
b. Incorrect. A community property agreement is a document stating that regardless of how a husband and wife have taken title to property, some or all of their assets are to be treated as community property (R.R. 87-98).
c. Incorrect. A will is a legal document executed by a competent person according to the pre-scribed statutes of their state and contains instructions to be followed at death.
d. Incorrect. The original will should not be written on after it is signed. Going through the will crossing out language or making other changes is dangerous. This is referred to as “obliteration” and can completely cancel the will. The will should not be marked in any way after it is signed. [Chp. 3]
31. Individuals can choose from a variety of types of wills. For example, what is a holographic will?
a. Correct. A holographic will is a handwritten will. The majority of states allow such wills if en-tirely in the decedent’s handwriting, dated and signed by the decedent. Normally, witnesses are not required.
b. Incorrect. An oral will is called a nuncupative will and is seldom valid.
c. Incorrect. A simple “I love you will” leaves all assets in small estates to a surviving spouse.
d. Incorrect. A deathbed will is a will that is established and executed when a testator faces im-minent death. [Chp. 3]
32. Three disadvantages of having an estate go through probate proceedings. What is one of these disadvantages?
a. Incorrect. An advantage claimed for probate proceedings is that the costs are deductible for tax purposes.
b. Correct. A disadvantage asserted against probated proceedings is that court proceedings are inherently inflexible.
c. Incorrect. An advantage claimed for probate proceedings is that the court protects the heirs and beneficiaries.
d. Incorrect. An advantage claimed for probate proceedings is that the transfer of title is a public record that prevents problems with title companies. [Chp. 3]
33. Trusts can be divided into two types based on when they are created. Which type comes into existence at the time of death and results in property having to go through probate?
a. Incorrect. Using a family trust, an individual typically sets up an irrevocable trust and appoints a committee to run it. The individual may then attempt to assign all his income (including future income) to the trust. The trust income is then either accumulated or distributed among spouses, children, or other relatives. The trust also pays for and deducts any expenses of the grantor. Such a trust would be created during an individual's lifetime.
b. Incorrect. Under §679, a U.S. citizen or permanent resident, who sets up a foreign trust which can make any payments to a beneficiary in the United States, is the owner for income and estate tax purposes and is taxed on all of the income and capital gains. Such a trust would be created during an individual's lifetime.
c. Incorrect. A grantor trust is a trust that a grantor can revoke or terminate. Trusts that fall in this category are not required to pay income tax or file an income tax return. The reasoning of the grantor trust rule is that if one can revoke a trust, they are the owner of the trust assets for income tax purposes. Grantor trusts are created during lifetime.
5-47
d. Correct. Since the testamentary trust does not come into existence until the time of death, property cannot be put into such a trust while the testator is alive. Property must go through probate to fund this type of trust. After death, there is little difference between a living trust and a testamentary trust. [Chp. 4]
34. The author lists four disadvantages of a living trust. What is one of these disadvantages?
a. Correct. A disadvantage of a living trust is that assets must be transferred into the trust. Indi-viduals often forget to fully fund the living trust and thereby miss the opportunity to take full advantage of it.
b. Incorrect. An advantage of a living trust is that it avoids inheritance taxes. A living trust may also reduce or avoid probate costs.
c. Incorrect. An advantage of a living trust is that it avoids statutory restrictions on bequests of property.
d. Incorrect. A living trust does not increase the possibility of a will contest. In fact, an advantage of a living trust is that it often avoids will contests. [Chp. 4]
35. Based on the grantor trust rules, five conditions must be met in order for the grantor to be treated as the trust owner and to have the trust income taxed to them. What is one of these conditions?
a. Incorrect. Under the grantor trust rules, the grantor will be treated as the owner of the trust and be taxable on the trust income if the grantor, their spouse, or a nonadverse party has powers of disposition over the corpus or income.
b. Incorrect. Under the grantor trust rules, the grantor will be treated as the owner of the trust and be taxable on the trust income if the administrative control of the trust is or may be, exer-cisable primarily for the benefit of the grantor or their spouse.
c. Incorrect. Under the grantor trust rules, the grantor will be treated as the owner of the trust and be taxable on the trust income if the corpus will revert to the grantor or to the grantor’s spouse at any time and the reversionary interest is worth at least 5% of the value of the corpus as of the inception of the trust.
d. Correct. Under the grantor trust rules, the grantor will be treated as the owner of the trust and be taxable on the trust income if the grantor, their spouse, or a nonadverse party has the power to revoke the trust and revest all or a portion of the corpus in the grantor. [Chp. 4]
36. One type of trust requires that the surviving spouse receive all of the income in the trust and have a general power of appointment over the assets at death. What is this trust called?
a. Incorrect. A living trust (sometimes called an “inter vivos” trust) is created during a person’s lifetime. A living trust can be set up by husband and wife, or by a single person. Assets transferred into a living trust avoid probate but must be transferred before death.
b. Correct. Under a marital deduction trust, the survivor is required to receive all the trust’s in-come and have a general power of appointment over the assets at death.
c. Incorrect. A revocable trust can be changed or terminated as the need arises.
d. Incorrect. A testamentary trust is created at death under the provisions of your will. Assets cannot be put into this trust before death, since the trust does not exist until death. To fund such a trust, assets must go through probate. [Chp. 4]
5-48
37. A qualified terminable interest trust may be used for a surviving spouse’s benefit. What is one characteristic of a qualified terminable interest?
a. Incorrect. A qualified terminable interest is a way to obtain the marital deduction under §2056.
b. Incorrect. To be a qualified terminable interest the surviving spouse must have a qualifying income interest for life.
c. Incorrect. A “qualifying income interest for life” exists if: the surviving spouse is entitled to all the income from the property (payable annually or at more frequent intervals) or the right to use property during the spouse’s life, and no person has the power to appoint any part of the prop-erty to any person other than the surviving spouse.
d. Correct. One characteristic of a qualified terminable interest is that it is property that passes from the decedent. [Chp. 4]
38. Another type of trust that can be established is a living “A-B” revocable trust. What is a char-acteristic of this type of trust?
a. Correct. Typically, under a living “A-B” revocable trust, the surviving spouse has control over TRUST A and can withdraw assets from the trust.
b. Incorrect. Typically, under a living “A-B” revocable trust, the surviving spouse can even revoke Trust A in its entirety.
c. Incorrect. Under a living “A-B” revocable trust, the survivor can receive all the income gener-ated by TRUST B.
d. Incorrect. Under a living “A-B” revocable trust, the survivor for purposes of health, mainte-nance, and support can withdraw the principal of the trust. [Chp. 4]
39. A simple will can be used to transfer a taxpayer’s entire estate on death. However, what can result when taxpayers with large estates use a simple will?
a. Incorrect. In larger estates, a simple will can result in severe death taxes on the survivor’s death when the remaining assets are conveyed to the children or other heirs.
b. Incorrect. A simple will may not avoid probate regardless of the size of the estate.
c. Incorrect. Because of the unlimited marital deduction, there should be no death taxes on the death of the first spouse regardless of the size of the estate. However, for larger estates using a simple will, the price of avoiding death taxes on the first death can be greater death taxes on the second death under this simple will format.
d. Correct. In larger estates, a simple will can result in “stacking” the surviving spouse’s estate. Stacking occurs assets are transferred to the surviving spouse, and then when the surviving spouse dies, all remaining assets are passed to the children or other heirs with detrimental tax consequences. [Chp. 4]
40. An “A-B-C” trust separates into three separate trusts upon the death of the first spouse. Who should consider establishing an “A-B-C” living trust?
a. Incorrect. In the A-B-C living trust, TRUST B is a “bypass” trust that is funded by and takes advantage of the applicable exemption amount ($5,700,000 in 2021).
b. Correct. For those estates above twice the applicable exclusion amount ($5,700,000 in 2021), the “A-B-C” living trust should be considered. Federal death tax does not apply to the decedent’s portion because of the applicable exclusion amount for TRUST B and the unlimited marital de-duction for TRUST C. Because of ERTA, TRUST C assets qualify for the unlimited marital deduction.
5-49
c. Incorrect. Frequently, the “A-B” format is recommended for moderate size estates that are in excess of the applicable exemption amount ($5,700,000 in 2021). This is because the applicable exemption amount can pass death tax-free from TRUST A to the CHILDRENS’ TRUST and a like amount plus growth can pass to the CHILDRENS’ TRUST.
d. Incorrect. Those with small estates might consider using only a simple will. [Chp. 4]
41. In a revocable living trust, the grantor should include certain basic provisions. Which provision names the property that is held within the trust, and identifies the intention of the trust agree-ment and how the property is to be used and disposed?
a. Incorrect. The identification clause identifies the grantor, trustee, co-trustee, successor trus-tee, and beneficiaries. Also stated are where they live and where the trust is created.
b. Incorrect. A trust agreement often refers to the income and directs that it be paid to some beneficiary. Generally, income refers to what the trust earns in interest, dividends, and net rental income. It does not include capital gains on the sale of a trust asset.
c. Incorrect. The property transfer clause declares what property is currently transferred to the trust and is the key to avoiding probate.
d. Correct. The recital clause identifies the property and states the purpose of the trust agree-ment and the use and disposition of the property. [Chp. 4]
42. Choosing a trustee can be complicated. Why might someone choose an individual trustee over a corporate trustee?
a. Incorrect. Someone might choose a corporate trustee over an individual trustee because they are financially accountable for their mistakes.
b. Incorrect. Someone might choose a corporate trustee over an individual trustee because they are impartial as to the children. This may prevent the children from becoming bitter towards an individual trustee who happens to be a friend or relative, and who doesn’t make distributions whenever the children ask for something.
c. Incorrect. Someone might choose a corporate trustee over an individual trustee because of permanence—they don’t die or become disabled.
d. Correct. Someone might choose an individual trustee over a corporate trustee because a rela-tive or friend may have a more personal interest. [Chp. 4]
43. When an interest is held in a closely held business, an executor may make an election to defer payment of any federal estate due to the value of the interest. What does this election allow?
a. Incorrect. This election allows the estate to make between two and ten equal annual install-ments.
b. Incorrect. If the election is made, payments may begin five years after the due date of the federal estate tax return.
c. Correct. With this election, the estate receives a very low interest rate on unpaid estate tax owed.
d. Incorrect. Payments of only interest are allowed for the first four years of payment when this election is made. [Chp. 5]
44. Heirs may disclaim their rights to a transfer of property from a decedent. What is one of the four conditions that such a disclaimer must meet in order to qualify under §2518(b)?
5-50
a. Correct. To be effective, a disclaimer must be an irrevocable and unqualified refusal to accept an interest in property that satisfies the following condition under §2518(b): as a result of the refusal to accept the property, the interest must pass to a person other than the disclaimant without any direction on the part of the disclaimant.
b. Incorrect. A disclaimer must be in writing.
c. Incorrect. The disclaimer must be received by the donor (or the donor’s estate) within nine months of the date of the transfer creating the interest (or within nine months of the day on which the donee attains age 21).
d. Incorrect. To be effective, the donee must not have accepted the interest or any of its benefits. [Chp. 5]
45. There is an exception to the rule that estate taxes must be paid when the return is filed. Under §6166, a taxpayer may elect to pay a portion of this tax in installments if a closely held business interest surpasses _____ of the adjusted gross estate.
a. Incorrect. Failure to pay the estate tax with the return can cause the imposition of a penalty of .5% of the estate tax liability for each month or part of a month that the tax remains unpaid.
b. Incorrect. In cases where the failure to pay the estate tax is after notice and demand by the IRS, the penalty is increased to 1% per month.
c. Incorrect. Failure to pay the tax with the return can cause the imposition of a penalty up to a maximum of 25%.
d. Correct. Section 6166 is available where the interest in the closely held business exceeds 35% of the adjusted gross estate. [Chp. 5]
46. On the federal estate tax return, taxpayers must familiarize themselves with several important concepts. What term is defined as the gross estate minus deductions such as the estate’s ex-penses, losses, and charitable gifts?
a. Incorrect. The gross estate tax is the tentative tax less the gift tax payable on gifts after De-cember 31, 1976.
b. Incorrect. The net estate tax is the gross estate tax less allowable credits.
c. Correct. The taxable estate is the gross estate less allowable deductions.
d. Incorrect. The tentative tax is the estate tax figured on taxable estate plus adjusted taxable gifts. [Chp. 5]
47. On Form 706, part 3, page 2 - Elections by the Executor, up to four elections may be made. What is one of these elections that may be made?
a. Incorrect. Elections affecting the marital deduction are made on Schedule M.
b. Incorrect. The election by a beneficiary to report lump-sum distributions is on Schedule I.
c. Incorrect. Schedule U is based on §2031(c) and permits an election to exclude a portion of the value of land that is subject to a qualified conservation easement.
d. Correct. On Form 706, part 3, page 2—Elections by the Executor, the executor may elect to make an election to use the special use valuation under §2032A. [Chp. 5]
48. On Form 706, taxpayers must report how much cash the decedent had at the time of death and also what was owed to the decedent. What schedule should be used to report these amounts?
5-51
a. Incorrect. Schedule B is used to report the value of all stocks and bonds included in the gross estate.
b. Correct. Schedule C is used to report cash and all items owed to the decedent at the time of death.
c. Incorrect. All insurance on decedent’s life whether or not includible in the gross estate is listed on Schedule D.
d. Incorrect. In Part 1 of Schedule E, report qualified jointly owned interests owned with their spouse as tenants by the entirety or as joint tenants. In Part 2, report interests owned with other tenants. [Chp. 5]
49. On Form 706, taxpayers must report all QTIP property in the surviving spouse’s estate under §2044. What schedule is used to report this information in addition to reversionary or remain-der interests?
a. Correct. Schedule F is the catchall schedule and includes all QTIP property in the estate of the surviving spouse under §2044 and reversionary or remainder interests.
b. Incorrect. There are five types of transfers reported on Schedule G but it does not include QTIP property.
c. Incorrect. Reported on Schedule H is the value of property for which the decedent had a gen-eral power of appointment at death (§2041).
d. Incorrect. Under §2039, annuities payable to someone on the death of the decedent are in-cluded in the gross estate and reported on Schedule I if four requirements are met. [Chp. 5]
50. Under §642(g), a double deduction may be available for certain expenses so long as the dece-dent accrued, but had not paid, these expenses. What type of expenses may qualify for this double deduction?
a. Correct. It is possible to get a double deduction for such items as interest, taxes, business ex-penses, and other §691(b) deductions in respect of a decedent, provided the items were accrued and unpaid at death.
b. Incorrect. Executors’, attorneys’, and accountants’ fees can be claimed as a deduction on the estate’s income tax return, Form 1041 if a waiver is filed on Form 706. Typically, there is no dou-ble deduction.
c. Incorrect. Funeral expenses may only be claimed on one of these tax forms, and thus, they do not qualify for a double deduction.
d. Incorrect. An election can be made to claim medical expenses of last illness incurred for the care of the decedent and paid by the estate within one year of death. However, no double de-duction is allowed. [Chp. 5]
51. On Form 706, property qualifies for a credit for estate taxes if it has been included and taxed in another estate within the last ten years. On what schedule is this credit taken?
a. Incorrect. Schedule O permits a full deduction for the value of amounts passing to charity.
b. Incorrect. Schedule P allows a credit for estate, inheritance, legacy, and succession taxes paid to a foreign country.
c. Correct. A credit is permitted on Schedule Q for estate taxes on property where the property was taxed in another estate within the last 10 years. If the prior decedent predeceased the
5-52
current decedent by more than two years, the credit is reduced by 20% for each full two years the original decedent’s death preceded the current decedent’s death.
d. Incorrect. Schedule T, an expired provision, was based on §2057 and allowed a deduction (for-merly an exclusion) for the value of certain family-owned business interests from the gross es-tate. [Chp. 5]
52. Expenses can be reported in a variety of ways. Under §642(g), estate administration expenses are reported on:
a. Incorrect. Funeral expenses are reported on Form 706 only.
b. Incorrect. Medical expenses of decedent paid within one year are reported on either Form 706 or Form 1041.
c. Correct. Under §642(g), estate administration expenses are reported on Form 706 or Form 1041 or split.
d. Incorrect. Trade or business expenses, interest, taxes, expenses for the production or collec-tion of income, expenses for the management and maintenance of income-producing property, expenses in connection with the determination, collection or refund of any tax, and alimony are reported on Forms 706 and 1041. Items are deductible on both returns only if they are expenses in respect of a decedent, except for alimony. [Chp. 5]
53. An estate income tax return must be filed for certain estates. What is a filing requirement of this Form 1041, Estate Income Tax Return:
a. Incorrect. The income, age, and filing status of a decedent generally determine the filing re-quirements of the decedent’s final income tax return, Form 1040.
b. Correct. Form 1041 must be filed by the 15th day of the 4th month following the close of the estate’s tax year.
c. Incorrect. Typically, the executor, administrator, or personal representative of the estate acts as the fiduciary. Said fiduciary is responsible for filing this form. When applicable, an ancillary representative must file a fiduciary return.
d. Incorrect. The IRS will grant a reasonable extension of time for filing the estate’s income tax return, Form 1041 if the fiduciary shows reasonable cause and files Form 2758. The extension is generally limited to 60 days. [Chp. 5]
54. The decedent's gross income must be reported on a final income tax return, Form 1040. What is excluded from this amount?
a. Incorrect. For purposes of filing Form 1040, gross income usually includes stock dividends an individual received on which he or she must pay tax.
b. Incorrect. For purposes of filing Form 1040, gross income includes gross receipts from self-employment minus any cost of goods sold.
c. Correct. For purposes of filing Form 1040, gross income does not include nontaxable income.
d. Incorrect. For purposes of filing Form 1040, gross income usually includes property an individ-ual received on which he or she must pay tax. [Chp. 5]
55. A taxpayer who files a decedent’s final income tax return and claims a refund is required to file another form. What form must be sent with the tax return?
a. Incorrect. A personal representative must file a separate Schedule K-1 (Form 1041) for each beneficiary.
5-53
b. Incorrect. An amended return (Form 1040X) should be filed for medical expenses incurred in an earlier year unless the statutory period for filing a claim for that year has expired.
c. Incorrect. Payers of interest and dividends report amounts on Form 1099 using the identifica-tion number of the person to whom the account is payable. After a decedent’s death, Form 1099 must reflect the identification number of the estate or beneficiary to whom the amounts are payable.
d. Correct. Any person who is filing a final income tax return for a decedent and claiming a refund must file Form 1310, Statement of Person Claiming Refund Due a Deceased Taxpayer, with the return. [Chp. 5]
56. When applicable, partnership income must be included on the decedent’s return. If a surviving partner terminates the partnership’s business operations, when does the partnership tax year close?
a. Incorrect. Even if the partnership has only two partners, the death of one does not terminate the partnership or close its tax year, provided the deceased partner’s estate or successor contin-ues to share in the partnership’s profits or losses.
b. Correct. If the surviving partner terminates the partnership by discontinuing its business oper-ations, the partnership tax year closes as of the date of termination.
c. Incorrect. If the deceased partner’s estate or successor liquidates its entire interest in the part-nership, the partnership’s tax year with respect to the estate or successor will close as of the date the liquidation is completed.
d. Incorrect. If the deceased partner’s estate or successor sells or exchanges, its entire interest in the partnership, the partnership’s tax year with respect to the estate or successor will close as of the date of the sale or exchange. [Chp. 5]
57. The decedent’s self-employment income includes the decedent’s distributive portion of a part-nership’s income or loss for the entire month in which the decedent died:
a. Incorrect. If the decedent was married and was domiciled in a community property state, half of the income received and half of the expenses paid during the decedent’s tax year by either the decedent or spouse may be considered to be the income or expense of the other.
b. Incorrect. The decedent’s final return must include the decedent’s distributive share of part-nership income for the partnership’s tax year ending within or with the decedent’s last tax year (i.e., the year ending on the date of death).
c. Incorrect. The income for the part of the S corporation’s tax year after the shareholder’s death is income to the estate or other person who has acquired the stock in the S corporation.
d. Correct. For self-employment tax purposes only, the decedent’s self-employment income will include the decedent’s distributive share of a partnership’s income or loss through the end of the month in which death occurred. For this purpose only, the partnership’s income or loss is consid-ered earned ratably over the partnership’s tax year. [Chp. 5]
58. Taxpayers may make an election to treat all or a portion of a decedent’s medical expenses as paid by the decedent when incurred. Which expenses fail to qualify for this election?
a. Incorrect. The election for decedent’s medical expenses applies to expenses incurred for the decedent.
5-54
b. Correct. The election for decedent’s medical expenses does not apply to expenses incurred to provide medical care for dependents.
c. Incorrect. Medical expenses that are not deductible on the final income tax return are liabilities of the estate and are shown on the federal estate tax return (Form 706).
d. Incorrect. The amount deductible on the income tax return for medical expenses is the amount in excess of 10% of adjusted gross income. The amounts not deductible because of this percent-age cannot be claimed on the federal estate tax return. [Chp. 5]
59. A taxpayer may give a gift to a person other than a spouse and have it be treated as made one-half by each spouse. What is this called?
a. Incorrect. A bargain sale is a sale or exchange, not made in the ordinary course of business, where money or money’s worth is exchanged, but the value of the money received is less than the value of what is sold or exchanged.
b. Incorrect. A gift loan is any below-market loan where the foregone interest is in the nature of a gift. A loan between unrelated persons can qualify as a gift loan.
c. Correct. A gift made by a person to someone other than a spouse may be considered as made one-half by each spouse. This is known as gift splitting and both spouses must consent to its use.
d. Incorrect. A power of appointment is a power to determine who will own or enjoy the property subject to the power. [Chp. 5]
60. Taxpayers may be required to pay gift tax on gift loans. Under what type of gift loan is foregone interest treated as a transferred gift by the lender to the borrower?
a. Correct. If the gift loan is a below-market demand loan, the foregone interest is treated as transferred (as a gift) by the lender to the borrower. Any foregone interest attributable to periods during any calendar year is treated as transferred on the last day of that calendar year.
b. Incorrect. If the gift loan is a below-market term loan, the lender is treated as having trans-ferred (as a gift) on the date the loan was made an amount equal to the excess of the amount loaned, over the present value of all payments that are required to be made under the terms of the loan.
c. Incorrect. Foregone interest is the excess of the amount of interest that would have been pay-able for the period if interest accrued at the applicable federal rate and were payable annually on the last day of the calendar year, over any interest payable on the loan properly allocable to that period. There's no such thing as a foregone loan under tax law.
d. Incorrect. If a net gift is made on the express or implied condition that the donee pay the gift tax, the payment of this tax is deducted from the value of the gift made as partial consideration for the gift. [Chp. 5]
61. A donor can gift stock certificates. For gift tax purposes, if such a gift is delivered to the donee, when is the gift deemed completed?
a. Correct. If the donor delivers a properly endorsed stock certificate to the donee or to the do-nee’s agent, the gift is completed, for gift tax purposes, on the date of delivery.
b. Incorrect. If the donor transfers his/her own promissory note to another as a gift, the gift is completed on the date of the transfer if the promissory note is legally enforceable. The transfer of a legally unenforceable promissory note is an incomplete gift until the note is paid or trans-ferred for value.
5-55
c. Incorrect. If the donor delivers his/her own check to another as a gift, the gift is not complete, for gift tax purposes, until the check is paid, certified, or transferred for value to a third person.
d. Incorrect. If the donor delivers a certificate to his/her bank or broker as donor’s agent, or to the issuing corporation or its transfer agent, for transfer to the donee’s name, the gift is only completed on the date the stock is transferred on the corporation’s books. [Chp. 5]
5-56
Glossary
Annual exclusion: The exclusion of the first $15,000 of gifts made per donee during each calendar year from gift taxation.
Annuity: An annual payment of money by a company or individual to a person called an annuitant.
Applicable exclusion amount: The amount of a decedent's estate exempt from federal estate tax.
Bequest: A gift of personal property by will.
Bypass trust: A trust fund that passes assets to children or other heirs while giving lifetime economic benefits to a surviving spouse.
Charitable remainder trust: A split interest charitable trust in which limited income is periodically paid to non charitable beneficiaries and a remainder interest is later transferred to a charity.
Complex trust: A trust that made in the income, distribute principal or have a charitable beneficiary.
Conservatorship: A legal process in which an adult is appointed by a Court to make financial and medical decisions for another who is deemed incapacitated or disabled.
Crummey trust: A trust which gives the beneficiary the right to demand a withdrawal funds.
Estate tax: A tax on the value of a decedent's taxable estate after deductions and credits.
Gift tax: A graduated federal tax paid by donors on gifts exceeding $15,000 per year per donee.
Inheritance tax: A tax imposed on the “privilege” of inheriting something that is paid by the recipient.
Irrevocable trust: A living or testamentary trust that is supposedly drafted so that no changes may be made to it.
Marital deduction: A provision that allows for unlimited transfers from one spouse to another with-out having to pay any gift or estate taxes.
Power of appointment: A right given to one person by another to transfer property on death.
Qualified terminal interest property (QTIP): Property that qualifies for the unlimited marital deduc-tion even though it may be transferred through a trust.
Remainder interest: A future interest in an asset.
Revocable trust: A trust that may be changed or terminated by its creator.
Testamentary trust: A trust created within a will that only become effective on the death of the willmaker.
5-a
Index of Keywords & Phrases
A
accidents, 1-10
accounting methods, 5-20
accrual method, 5-27
accrued interest, 2-43, 5-6, 5-11
active participation, 4-9
adjusted basis, 2-46, 2-47, 5-29, 5-34
adjusted gross income, 5-20, 5-28
administration expenses, 2-24, 5-13
administrator, 1-6, 1-10, 3-9, 3-13, 5-4, 5-18, 5-19, 5-23
Agents, 1-6
AGI, 2-24, 4-11, 5-2, 5-28
aliens, 2-4, 2-41, 2-55
alimony, 5-13, 5-22
amortization, 4-9
annual exclusion, 1-22, 2-14, 2-57, 2-58, 2-59, 2-62, 2-65, 2-66,
2-68, 5-31, 5-32
annuity, 1-19, 1-22, 1-24, 2-12, 2-17, 2-18, 2-30, 2-35, 2-50, 2-
56, 2-59, 2-64, 5-12
annuity contract, 2-12, 2-59
applicable exclusion amount, 1-14, 1-15, 1-17, 1-18, 1-23, 2-2,
2-3, 2-4, 2-5, 2-33, 2-41, 2-42, 2-48, 2-50, 2-54, 2-55, 2-57, 2-
58, 4-8, 4-9, 4-18, 4-19, 5-15, 5-32
applicable federal rate, 5-33, 5-34
appraisals, 5-13, 5-31
appreciated property, 1-19, 2-65, 2-68
ascertainable standard, 2-19
assessments, 5-19
at-risk rules, 5-28
B
balance sheet, 5-31
beneficial interest, 2-12, 2-22, 2-55, 5-4
beneficial ownership, 2-12
bequests, 2-36, 2-70, 3-2, 4-6
boot, 2-45
brokerage account, 3-4
burden of proof, 2-40
business expenses, 5-13, 5-22
business interest, 1-18, 1-24, 1-25, 2-41, 2-42, 5-14
buy-sell agreement, 1-24, 5-11
bypass trust, 4-19, 5-3
C
calendar year, 2-7, 2-20, 2-38, 2-40, 2-62, 2-63, 2-66, 5-20, 5-25,
5-28, 5-31, 5-32, 5-33, 5-34
California, 1-26, 2-1, 2-8, 2-38, 3-2, 3-3, 3-4, 3-7, 3-8, 3-14, 3-15
cancellation of indebtedness, 2-68
capital asset, 4-11
capital gains, 2-32, 2-65, 4-3, 4-4, 4-8, 4-10, 4-21
capital interest, 2-42
capital losses, 2-47, 5-28
capitalization, 2-41
carryover basis, 1-18, 2-7, 2-46, 2-47, 5-3
cash method, 5-28
casualty, 2-24
charitable contributions, 2-24, 2-35
charitable lead trust, 2-35
charitable remainder annuity trust, 1-24, 2-30, 2-64
charitable remainder trust, 1-22, 2-27, 2-32, 2-33, 2-35, 2-64
children, 1-10, 1-11, 1-26, 2-15, 2-35, 2-49, 2-63, 2-64, 3-1, 3-3,
3-6, 3-8, 3-9, 3-10, 3-12, 4-2, 4-4, 4-14, 4-18, 4-22, 4-24
citizenship, 2-38
claims against the estate, 1-10, 2-22, 2-24
claims for refund, 5-15
closing agreement, 5-10
clothes, 4-18
community property, 1-25, 1-26, 2-14, 2-18, 2-19, 2-22, 2-46, 2-
47, 2-57, 2-65, 3-4, 3-5, 3-7, 3-8, 3-9, 3-10, 3-15, 5-12, 5-13,
5-26, 5-33
compensation, 4-22
complex trust, 4-10
conservation easement, 5-14
conservatorship, 1-1
copyrights, 2-65
corpus, 2-39, 4-3, 4-7
cost basis, 2-46
cost of goods, 5-23
cost of goods sold, 5-23
credit cards, 1-10
Crummey trust, 1-22, 1-23
custodianship, 2-59
custody, 3-3
5-b
D
death benefits, 1-10, 1-25
death of a partner, 5-25
declaratory judgment, 2-42
deferred tax, 5-2
demand loans, 5-33
direct skip, 2-49, 2-50, 2-52, 5-14
disclaimer, 5-2
dividends, 2-12, 4-8, 4-10, 4-21, 5-11, 5-19, 5-26, 5-27, 5-31
domestic trust, 2-38, 2-39, 4-11
domicile, 1-9, 5-9
drugs, 2-19
E
enrolled agent, 5-10
estate tax, 1-5, 1-6, 1-9, 1-12, 1-13, 1-14, 1-17, 1-18, 1-20, 1-22,
1-23, 1-24, 1-25, 2-1, 2-2, 2-3, 2-4, 2-5, 2-7, 2-8, 2-10, 2-12,
2-14, 2-16, 2-17, 2-18, 2-20, 2-22, 2-24, 2-27, 2-33, 2-36, 2-
38, 2-39, 2-40, 2-41, 2-42, 2-43, 2-46, 2-48, 2-49, 2-50, 2-54,
2-55, 2-58, 2-65, 2-68, 2-70, 3-5, 4-1, 4-4, 4-6, 4-8, 4-9, 4-11,
4-13, 4-14, 4-16, 5-1, 5-2, 5-3, 5-4, 5-5, 5-6, 5-9, 5-10, 5-12,
5-13, 5-14, 5-15, 5-16, 5-21, 5-27, 5-28, 5-31
estimated tax, 5-23
exchange, 1-19, 2-45, 2-56, 5-25, 5-26, 5-33
exclusions, 2-42, 2-56
exemptions, 2-4, 2-7, 5-20, 5-27
extensions, 1-17, 2-3, 2-63, 4-9, 5-24, 5-31, 5-32
F
face value, 2-69
failure to file, 5-5, 5-20, 5-31
failure to pay, 5-5, 5-31
fair market value, 1-18, 1-22, 2-1, 2-7, 2-25, 2-28, 2-30, 2-35, 2-
39, 2-40, 2-41, 2-45, 2-46, 2-48, 2-55, 2-56, 2-64, 2-65, 2-69,
4-19, 5-29
family members, 1-9, 1-13, 1-19, 1-23, 1-24, 1-25, 2-68, 3-1, 3-
10
filing requirements, 5-23
filing status, 5-23, 5-24
final tax return, 5-23
fiscal year, 5-20
foregone interest, 2-62, 5-33, 5-34
foreign taxes, 5-14
Form 1040, 1-9, 2-1, 5-3, 5-13, 5-19, 5-21, 5-23, 5-27, 5-28
Form 1099, 5-26, 5-27
Form 706, 1-9, 2-1, 2-40, 2-41, 3-14, 5-3, 5-4, 5-5, 5-6, 5-7, 5-9,
5-10, 5-11, 5-13, 5-14, 5-15, 5-20, 5-21, 5-27, 5-28, 5-31
Form 709, 1-9, 2-1, 2-40, 2-52, 2-66, 5-31, 5-32, 5-33
funeral expenses, 5-21
future interests, 2-12, 2-57, 5-31
G
generation skipping transfer tax, 1-17, 2-2, 2-3
generation-skipping, 1-17, 2-2, 2-3, 2-33, 2-46, 2-48, 2-49, 2-50,
2-52, 4-9, 5-2, 5-4, 5-9
gift loans, 5-34
gift splitting, 5-32
gift tax, 1-2, 1-9, 1-15, 1-17, 1-23, 2-1, 2-2, 2-3, 2-4, 2-7, 2-14, 2-
24, 2-33, 2-36, 2-39, 2-40, 2-49, 2-50, 2-52, 2-54, 2-55, 2-56,
2-57, 2-58, 2-59, 2-62, 2-63, 2-65, 2-66, 2-68, 2-70, 3-6, 4-8,
4-11, 4-12, 5-9, 5-31, 5-32, 5-33, 5-34, 5-35
grantor trust, 4-6, 4-7, 4-8
grants, 3-13
GRIT, 4-8, 4-9
gross estate, 1-18, 2-10, 2-12, 2-13, 2-14, 2-15, 2-16, 2-17, 2-18,
2-19, 2-20, 2-22, 2-24, 2-27, 2-36, 2-40, 2-41, 2-42, 2-58, 2-
66, 2-70, 4-14, 5-1, 5-2, 5-4, 5-5, 5-6, 5-9, 5-10, 5-11, 5-12, 5-
14, 5-15, 5-20, 5-28
gross income, 1-18, 2-70, 5-3, 5-18, 5-20
gross profit percentage, 2-70
H
highest and best use, 1-22, 5-1
holding period, 2-45
I
improvements, 2-45, 2-56
income in respect of a decedent, 2-48, 2-69, 2-70, 5-25, 5-26
incomplete transfer, 2-66
information return, 5-3, 5-4
inheritance tax, 1-9, 1-12, 2-7, 2-8, 3-5, 4-6
insolvency, 5-11
installment notes, 1-19, 2-12
installment payment of estate tax, 2-42
installment sales, 2-68
insurance trust, 1-13, 1-19, 4-4
inter vivos trust, 4-9, 4-10
intestate succession, 1-6, 1-11, 2-12, 3-9
investment company, 2-48
5-c
IRA, 1-13
irrevocable trust, 1-22, 1-23, 4-3, 4-4, 4-8, 4-10, 4-12, 4-13
J
jewelry, 2-65, 3-8
joint tenancy, 1-13, 1-25, 2-18, 2-19, 3-4, 3-5, 3-6, 3-7, 3-8, 3-
15, 3-17
L
legal fees, 4-5
life estate, 2-12, 2-16, 2-32, 2-56, 2-63, 3-9
life expectancy, 1-19
life insurance, 1-6, 1-13, 1-19, 2-1, 2-17, 2-20, 2-27, 2-30, 2-56,
2-58, 2-59, 2-66, 3-17, 4-5, 5-12
livestock, 5-12
living trust, 1-7, 1-13, 1-14, 3-17, 4-2, 4-3, 4-4, 4-5, 4-6, 4-11, 4-
16, 4-18, 4-19, 4-21, 4-22
M
marital deduction, 1-14, 1-18, 1-25, 2-24, 2-35, 2-36, 2-38, 2-39,
2-58, 2-62, 2-63, 3-9, 4-14, 4-19, 4-21, 5-2, 5-10, 5-13, 5-31
marital deduction trust, 1-14, 1-18, 4-14
marital status, 1-10, 2-35
Medicaid, 4-5
medical expenses, 1-15, 2-62, 5-13, 5-21, 5-27, 5-28, 5-31
mortality tables, 2-16
mortgages, 2-24, 5-9
N
net income, 2-28, 2-30, 4-22
net operating loss, 2-47, 5-28
net worth, 1-27
non-citizen spouse, 2-38, 2-39
noncustodial parent, 5-28
nontaxable income, 5-23
notes, 1-19, 1-27, 2-12, 3-17, 5-11
nursing homes, 4-5
O
ordinary and necessary expenses, 4-11
original basis, 3-8
P
par value, 2-43, 5-11
partnership agreement, 5-26
passive activity, 5-29
passive activity losses, 5-29
patents, 2-63, 2-65
periodic payment, 1-19
personal exemptions, 5-27
personal holding company, 2-48
personal interest, 4-23
personal property, 5-10, 5-31
points, 2-27
pooled income fund, 2-32, 2-64
power of appointment, 2-16, 2-19, 2-48, 2-63, 4-13, 4-14, 4-16,
5-10, 5-12, 5-35
present interests, 1-22, 2-57, 5-32, 5-33
principal place of business, 1-18, 5-31
probate estate, 1-6, 1-10, 1-11, 1-12, 2-24, 3-13, 4-21
Q
QDT, 2-38, 2-39
QTIP, 4-14, 4-18, 4-19, 5-2, 5-12, 5-14
qualified charitable organization, 2-64, 5-20
qualified person, 1-23
qualified personal residence trust, 1-23
qualified tuition, 1-15, 2-70
R
real estate taxes, 2-41
reasonable cause, 2-41, 2-70, 5-5, 5-6, 5-19, 5-31
recapture, 2-46, 5-11
refunds, 5-12
reimbursements, 5-28
related person, 2-69
remainder interest, 1-23, 1-24, 2-13, 2-27, 2-28, 2-30, 2-32, 2-
33, 2-35, 2-50, 2-64, 4-8, 5-5, 5-6, 5-10, 5-12
rental income, 4-10, 4-21
repossession, 2-45
retained life estate, 2-12, 2-66, 5-12
retirement plans, 3-17
reversionary interest, 2-16, 2-17, 4-7, 5-11
revocable trust, 1-14, 2-14, 2-47, 4-8, 4-9, 4-10, 4-11, 4-12, 4-19
royalties, 5-12, 5-19
5-d
S
savings bonds, 3-17
self-employment tax, 5-26
selling expenses, 5-13
selling price, 2-56, 5-11
separate share rule, 4-10
sole proprietorship, 2-42, 5-2, 5-10
special use valuation, 5-10
specific bequest, 1-11, 3-2
standard deduction, 5-27
state death tax credit, 2-2, 2-7, 2-8
statute of limitations, 2-24, 5-20
stepped-up basis, 2-45, 3-7, 3-8, 4-19
surtax, 2-2
suspended losses, 5-29
T
tangible personal property, 2-28
tax credits, 5-7
tax haven, 4-4
tax home, 2-39
tax planning, 1-13, 2-7, 3-14
tax returns, 1-7, 1-9, 4-6, 4-22
tax year, 2-39, 5-19, 5-20, 5-23, 5-24, 5-25, 5-26, 5-28, 5-29, 5-
32
taxable event, 2-38, 4-8
taxable income, 1-14, 5-19, 5-20, 5-25, 5-34
taxable year, 2-70, 4-9, 5-3, 5-18, 5-26
tax-exempt income, 2-33
tax-exempt organizations, 2-70
tenants by the entirety, 3-7, 5-11
tenants in common, 3-4, 3-6, 3-7
term loans, 5-34
testamentary trust, 1-7, 1-14, 3-5, 4-3, 4-4, 4-6, 4-9
theft losses, 2-22, 2-24, 5-14
throwback rules, 4-11
tools, 1-14, 4-1
trust income, 2-15, 2-28, 4-2, 4-3, 4-4, 4-7, 4-8, 4-14, 4-22
U
Uniform Gifts to Minors Act, 1-13, 2-59
Uniform Transfers to Minors Act, 1-13
V
valuation, 1-5, 1-24, 2-28, 2-30, 2-40, 2-55, 2-56, 2-65, 2-68, 3-
11, 4-19, 4-21, 5-1, 5-9, 5-10, 5-11, 5-31
