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2013 cch basic principles ch17 2013 cch basic principles ch17 Presentation Transcript

  • Chapter 17 Federal Estate Tax, Federal Gift Tax, and Generation- Skipping Transfer Tax©2012 CCH. All Rights Reserved.4025 W. Peterson Ave.Chicago, IL 60646-60851 800 248 3248www.CCHGroup.com
  • Chapter 17 Exhibits 1. Formula for Computing Estate Tax Liability 2. Definition of Terms 3. Community Property vs. Common Law States 4. Forms of Ownership in Real Estate—Tenancy by the Entirety 5. Tenancy by the Entirety—Example 6. Forms of Ownership in Real Estate—Joint Tenancy 7. Joint Tenancy—Example 8. Forms of Ownership in Real Estate—Tenancy in Common 9. Power of Appointment 10. Insurance Proceeds—General Rules 11. Insurance Proceeds—Example 1 12. Insurance Proceeds—Example 2 13. Insurance Proceeds—Example 3Chapter 17, Exhibit Contents A CCH Federal Taxation Basic Principles 2 of 103
  • Chapter 17 Exhibits14. Annuities and Lump-Sum Survivor Benefits15. Annuities and Lump-Sum Survivor Benefits—Examples16. Gift Tax Paid Within 3 Years of Death17. Inter Vivos Transfers—Types18. Inter Vivos Transfers—Examples19. Medical Insurance Reimbursements20. Dower and Curtesy21. Valuing the Gross Estate22. Deductions from the Gross Estate23. Casualty Losses24. Charitable Contributions25. Marital Transfers26. Marital Transfers—ExamplesChapter 17, Exhibit Contents B CCH Federal Taxation Basic Principles 3 of 103 View slide
  • Chapter 17 Exhibits 27. Post 1976 Gifts 28. Post 1976 Gifts—Example 29. Computing Estate Tax and Credits 30. Estate Tax Return 31. Formula for Computing Gift Tax Liability 32. Gift Tax—Overview 33. Gift Loans—General Rules 34. Gift Tax—Exclusions 35. Gift Tax—Deductions 36. Gift Tax Liability—Short Formula 37. Gift Tax Filing RequirementsChapter 17, Exhibit Contents C CCH Federal Taxation Basic Principles 4 of 103 View slide
  • Formula for Computing Estate Tax Liability Testamentary transfers (i.e., fair market value (FMV) of assets + transferred by reason of the death of the taxpayer) Inter vivos transfers in which some incident of ownership is reserved for the transferor (i.e., FMV of gifts in which some control + over corpus or enjoyment of income had been retained by decedent during his/her lifetime) + Gift tax paid on any gifts made within 3 years of death = Gross Estate (“GE”)Chapter 17, Exhibit 1a CCH Federal Taxation Basic Principles 5 of 103
  • Formula for Computing Estate Tax Liability Estate deductions (debts of decedent, funeral expenses and – administrative expenses) Adjusted Gross Estate (“AGE”). (What is the purpose of “AGE”? Answer: If more than 35% AGE consists of a farm or closely held business, estate tax can be postponed for 5 years, then paid over a nine year period, creating = a maximum deferral period of 14 years. Interest on unpaid estate taxes must be paid in each of the 14 years)Chapter 17, Exhibit 1b CCH Federal Taxation Basic Principles 6 of 103
  • Formula for Computing Estate Tax Liability – Marital deduction (property passing to surviving spouse) – Charitable transfers = Taxable estate + Adjusted taxable gifts (i.e., gifts made after 1976, after $13,000 annual exclusions and gift tax deductions) = Estate tax base x Estate tax rates (see Appendix at end of text) = Tentative estate taxChapter 17, Exhibit 1c CCH Federal Taxation Basic Principles 7 of 103
  • Formula for Computing Estate Tax Liability – Credit for gift tax actually or deemed paid on post-1976 gifts – Unified credit ($1,772,800 in 2012, ignoring any portion previously applied to gifts) – State tax credit – Credit for prior transfers – Foreign tax credit = Estate tax liabilityChapter 17, Exhibit 1d CCH Federal Taxation Basic Principles 8 of 103
  • Definition of Terms Estate Purpose. An estate is created upon the death of every individual. The entity is charged with collecting and conserving all of the individual’s assets, satisfying all liabilities and distributing the remaining assets to the heirs identified by will or by state law.Chapter 17, Exhibit 2a CCH Federal Taxation Basic Principles 9 of 103
  • Definition of Terms Estate Key Persons. An estate involves three parties:  Decedent, all of whose probate assets are transferred to the estate for disposition.  Executor, who is appointed under the decedent’s valid will (or the administrator, if no valid will exists). The executor or administrator holds the fiduciary responsibility to operate the estate as directed by the will, applicable state law, and the probate court.  Beneficiaries of the estate, who are to receive assets or income from the estate, as the decedent has indicated in the will.Chapter 17, Exhibit 2b CCH Federal Taxation Basic Principles 10 of 103
  • Definition of TermsGross Estate (GE) Broad Scope. Recall the broad definition of gross income: all income from whatever source derived. Code Sec. 61(a). Just as income tax law defines “income” broadly, estate tax law defines “property” broadly. No property is excluded, however small, be it real or personal, tangible or intangible, U.S. or foreign, as long as the decedent owned a beneficial interest at the time of death. Even tax-free municipal bonds are included in the gross estate, since estate tax is levied on the transfer of property, not the property itself.Chapter 17, Exhibit 2c CCH Federal Taxation Basic Principles 11 of 103
  • Definition of TermsGross Estate Examples. GE items include: cash, personal residence, household belongings, securities, real estate investments, collector items, notes, dividends declared prior to death (if the decedent was the stockholder of record), sole proprietorships and partnership interests.Chapter 17, Exhibit 2d CCH Federal Taxation Basic Principles 12 of 103
  • Community Property vs. Common Law States The difference between community property and common law state systems centers around the property rights possessed by married persons. Community Property States. In community property states, a spouse’s earnings, or income from property acquired after marriage by one spouse, is deemed owned equally by both spouses. Common Law States. In common law states, such earnings or income is not deemed owned equally.Chapter 17, Exhibit 3a CCH Federal Taxation Basic Principles 13 of 103
  • Community Property vs. Common Law States Tax effect. If the spouses file separate returns, each spouse’s return will be different, depending upon the state in which the earnings or property income is realized. (There is no tax effect if the spouses file joint returns.) Community property income would be shared equally; common law income would be taxed in full by the earner or owner of the property.Chapter 17, Exhibit 3b CCH Federal Taxation Basic Principles 14 of 103
  • Community Property vs. Common Law States Two types of community property states are: 1. States where income from pre-marital property is shared. In Texas, Wisconsin, Idaho and Louisiana, income from property owned before marriage IS owned equally between two spouses if it is realized after marriage. 2. States where income from pre-marital property is kept separate. In California, Arizona, Washington, New Mexico and Nevada, income from property owned before marriage by one spouse is NOT owned equally between spouses, even if it is realized after marriage.Chapter 17, Exhibit 3c CCH Federal Taxation Basic Principles 15 of 103
  • Forms of Ownership in Real Estate— Tenancy by the Entirety Definition. Ownership of real estate by husband and wife under the same deed, with right of survivorship (i.e., unity of person). Tenancies by the entirety have five “unities”: Unity of interest. Husband and wife share one and the same interest equally. Unity of time. Their ownership commences at one and the same time. Unity of title. Their ownership interests are created by a single deed. Neither can encumber the property without the consent of the other.Chapter 17, Exhibit 4a CCH Federal Taxation Basic Principles 16 of 103
  • Forms of Ownership in Real Estate— Tenancy by the Entirety Definition Unity of possession. Husband and wife possess an undivided interest in the whole property, not merely separate divisions of the property. Unity of person. Owners have right of survivorship. If one spouse dies, her ownership passes to the surviving spouse. 50% of the decedent’s joint interest in the property is included in the decedent’s gross estate, without regard to who paid for it.Chapter 17, Exhibit 4b CCH Federal Taxation Basic Principles 17 of 103
  • Tenancy by the Entirety—Example FACTS: Greg and Sue are married in 1994. In 2005, they purchase an office building for $1 million. $900,000 of the purchase price is funded from the sale of stock that Sue had owned before they were married. $100,000 is funded from the sale of stock that Greg had owned before marriage. Ownership is in the form of a tenancy by the entirety. Greg dies in 2012 when the building’s FMV is $1,500,000. QUESTION: What are the estate tax consequences?Chapter 17, Exhibit 5a CCH Federal Taxation Basic Principles 18 of 103
  • Tenancy by the Entirety—Example ANSWER: Greg’s 50% share, i.e., $750,000, is included in his gross estate but is subject to the unlimited marital deduction in the amount of $750,000. Thus his taxable estate would not include the value of the building. Sue, as surviving spouse, automatically gets Greg’s 50% interest, stepped-up to fair market value (FMV) on the date of his death. Thus, ignoring depreciation, the building’s basis increases from $1 million to $1.25 million (i.e., 50% of original cost + 50% of the $1.5 million FMV on the date of Greg’s death). When Sue eventually dies, her taxable estate will include 100% of the building’s value as of the date of her death (or as of the 6-month alternative date if so elected), unless she chooses to sell it before she dies.Chapter 17, Exhibit 5b CCH Federal Taxation Basic Principles 19 of 103
  • Forms of Ownership in Real Estate—Joint Tenancy Definition. Ownership of property by unmarried joint tenants is similar to tenancies by the entirety, except the owners have no automatic right of survivorship (also known as “unity of person”). The gross estate of the decedent includes the full value of property held as joint tenants, except to the extent of any part shown to have originally belonged to the other person and for which adequate and full consideration was not provided by the decedent. (i.e., the other tenant provided consideration).Chapter 17, Exhibit 6 CCH Federal Taxation Basic Principles 20 of 103
  • Joint Tenancy—Example FACTS: Albert and Olga are single individuals. In 20x2, they purchase an office building for $1 million. $900,000 of the purchase price is funded from the sale of stock that the Olga had owned. $100,000 is funded from the sale of stock that Albert had owned. Ownership is in the form of a tenancy by the entirety. Albert dies in 20x9 when the building’s FMV is $1,500,000. QUESTION: What are the estate tax consequences?Chapter 17, Exhibit 7a CCH Federal Taxation Basic Principles 21 of 103
  • Joint Tenancy—Example ANSWER: Since Albert contributed 10% of the purchase price, 10% of the building’s value, i.e., $150,000 is included in his gross estate. If Albert’s executor were unable to show that Olga had funded 90% of the purchase price, then 100% of the building’s value, or $1,500,000 would be included in Albert’s gross estate. If Olga were the beneficiary of Albert’s 10% interest, she would get a step-up in basis on 10% of the building value (50% if they had been married). Thus, ignoring depreciation, the building’s basis would increase from $1 million to $1.05 million (i.e., 90% of original cost + 10% of the $1.5 million FMV on the date of Albert’s death). When Olga eventually dies, her taxable estate will include 100% of the building’s value as of the date of her death (or as of the 6-month alternative date if so elected), unless she chooses to sell it before she dies.Chapter 17, Exhibit 7b CCH Federal Taxation Basic Principles 22 of 103
  • Forms of Ownership in Real Estate— Tenancy in Common Definition. A form of ownership whereby each owner holds an undivided interest in property. Here, there is only unity of possession, i.e., an undivided interest in the whole property, not merely separate divisions of the property. Titles are separate and distinct. The owners have a shared ownership interest in the common areas, but upon the death of one owner, his/her ownership interest passes to the heirs, not to the surviving owners (i.e., no right of survivorship by the surviving owners). 100% of the decedent’s undivided interest in the property is included in the decedent’s gross estate. The reason: tenancies in common have no right of survivorship.Chapter 17, Exhibit 8a CCH Federal Taxation Basic Principles 23 of 103
  • Forms of Ownership in Real Estate— Tenancy in Common Example. Condominium owners have a common interest in the coin-operated laundry mat and elevator lobby of their building. The condominium owners have varying ownership interests, commencing at different times, under separate deeds. However, they enjoy the same rights to the common areas, such as the laundry mat and elevator lobby. If one owner dies, his ownership interest passes to his heirs, not to a common owner (unless specifically bequested or made part of a separate buy-out agreement).Chapter 17, Exhibit 8b CCH Federal Taxation Basic Principles 24 of 103
  • Power of Appointment Definition. A power of appointment (POA) is a power to determine who shall own or enjoy, presently or in the future, the property subject to the power. POAs fall into one of two classifications: general and special. General POA’s Are Includible in the Gross Estate (GE). A general POA is one in which the decedent could have appointed himself, his creditors, his estate, or the creditors of his estate an unlimited right to invade or consume property subject to the power. The value of property interests over which the decedent had a general POA is included in the decedent’s GE.Chapter 17, Exhibit 9a CCH Federal Taxation Basic Principles 25 of 103
  • Power of Appointment Special POA’s ARE NOT Includible in the GE. A “special” POA enables the holder to appoint to others but NOT to herself, her creditors, her estate, or her estate’s creditors, an unlimited right to the property subject to the power. Also, if a holder has a limited right to the property, such as the right to invade or consume the property for the specific purpose of the holder’s health, education, welfare, or happiness, (commonly referred to as “ascertainable standards”) the right is deemed to be a special POA and is not included in the holder’s GE when she dies.Chapter 17, Exhibit 9b CCH Federal Taxation Basic Principles 26 of 103
  • Power of Appointment Example 1: General vs. Special POA’s P has the power to designate how the principal of a trust will be distributed among A, B and C. At this point, P’s power is only a special POA. However, if P is given the further right to appoint the principal to herself, what was a special POA becomes a general POA.Chapter 17, Exhibit 9c CCH Federal Taxation Basic Principles 27 of 103
  • Power of Appointment Example 2: Special POA (holder has no rights to property) Mother leaves her property in trust, life estate to Son and remainder to whichever of Son’s children he decides to appoint in his will. Son’s power is not a general POA because he cannot “invade” the corpus, only the income. Thus, regardless of whether Son exercises the power or not, none of the trust property subject to the power is included in his estate when he dies.Chapter 17, Exhibit 9d CCH Federal Taxation Basic Principles 28 of 103
  • Power of Appointment Problem 3: Special POA (limited right under ascertainable standard) Assume the same facts as in Problem 2. In addition to having the testamentary power to appoint the beneficiary of the remainder interest, Son is given a power to direct the trustee to pay to him from time to time as much of the principal as he might request “for his support.” Although Son now has a power to invade the corpus, it is not a general POA. The power is limited to an ascertainable standard, “maintenance.” Thus none of the property subject to these powers would be included in Son’s estate when he dies.Chapter 17, Exhibit 9e CCH Federal Taxation Basic Principles 29 of 103
  • Insurance Proceeds—General Rules Insurance proceeds on the decedent’s life are included in the gross estate (GE) if any of the following conditions exists: 1. The insurance proceeds are payable to or for the estate (including “payable to the executor”). 2. The decedent had any incident of ownership in the policy at death, such as the right to change beneficiaries, the right to terminate the policy, or the right to borrow against the policy. 3. The decedent had transferred all incidents of ownership within 3 years of death. [This point is explained in the following table.]Chapter 17, Exhibit 10a CCH Federal Taxation Basic Principles 30 of 103
  • Insurance Proceeds—General Rules Tax Treatment for the Transfer of an Insurance Policy Before Death * Time Between Estate Tax Treatment Transfer & Death 3 Years or Less: Proceeds other than those allocable to premiums paid by a third party within 3 years of insured’s death (i.e., Includible Amount = (a) - [(a) x (b) ÷ (c)], where, (a) = 100% insurance proceeds; and (b) = Premiums paid by third party within 3 years of death (c) = Total premiums paid on life insurance policy. More Than 3 Years: None included in insured’s GE (however, premiums paid by insured within 3 years of death are included in his/her GE) * i.e., Time between: 1. Date that policy is transferred by insured to a third party and 2. Date of insured’s death.Chapter 17, Exhibit 10b CCH Federal Taxation Basic Principles 31 of 103
  • Insurance Proceeds—Example 1 Example 1: Estate Treatment for Insurance Proceeds FACTS: In 1986, Albert pays a single $200,000 premium for a $1 million whole life insurance policy. (A whole life policy insures a person for his/her “whole life”. Premiums may be paid in a single payment, or over a specified period, or for life.) Albert stipulates that his nephew will be the beneficiary. In 1997, Albert transfers all incidents of ownership in the policy to his daughter (i.e., she could change the beneficiary, borrow against the policy, liquidate the policy, or exercise any other incidents of ownership). Fourteen years after the transfer, Albert dies and $1 million is transferred to the nephew.Chapter 17, Exhibit 11a CCH Federal Taxation Basic Principles 32 of 103
  • Insurance Proceeds—Example 1 QUESTION: How much of the $1 million proceeds should be included in Albert’s gross estate?Chapter 17, Exhibit 11b CCH Federal Taxation Basic Principles 33 of 103
  • Insurance Proceeds—Example 1 SOLUTION: None of the $1 million not included in Albert’s gross estate because: 1. The insurance proceeds are not payable to or for Albert’s estate; 2. Albert had no incidents of ownership in the policy upon his death; 3. Albert had transferred all incidents of ownership more than 3 years before his death. Also, no premiums are included in Albert’s gross estate, since he paid no premiums within 3 years of his death. The nephew excludes the $1 million from gross income since these proceeds were paid by reason of death of the insured. Code Sec. 101(a).Chapter 17, Exhibit 11c CCH Federal Taxation Basic Principles 34 of 103
  • Insurance Proceeds—Example 2 Example 2: Estate Treatment for Insurance Proceeds FACTS: Same as Example 1, except that Albert’s estate, not the nephew, is the named beneficiary. QUESTION: How much of the $1 million proceeds should be included in Albert’s gross estate?Chapter 17, Exhibit 12a CCH Federal Taxation Basic Principles 35 of 103
  • Insurance Proceeds—Example 2 SOLUTION: All of the $1 million is included in Albert’s gross estate because the insurance proceeds are payable to Albert’s estate. (However, the $1 million proceeds are not taxable as income to the estate since these proceeds were paid by reason of death of the insured. Code Sec. 101(a).Chapter 17, Exhibit 12b CCH Federal Taxation Basic Principles 36 of 103
  • Insurance Proceeds—Example 3 FACTS: Ten years before his death, Mike purchases a $1 million term insurance policy, with premiums to be paid in 10 equal annual installments in the amount of $10,000 each. (Term insurance insures a person for a specified “term”. If the person outlives the term, then no proceeds are payable. Term insurance is often renewable, but at higher premiums than under the previous term.) Two years before his death, Mike irrevocably transfers the policy and all incidents of ownership to a trust which pays the last two years’ premiums. QUESTION: How much of the $1 million proceeds should be included in Mike’s gross estate?Chapter 17, Exhibit 13a CCH Federal Taxation Basic Principles 37 of 103
  • Insurance Proceeds—Example 3 SOLUTION: Mike’s gross estate should include $800,000, computed as follows: Includible Amount = (a) - [(a) x {(b) ÷ (c)}], where, (a) = $1 million = 100% insurance proceeds. (b) = $20,000 = Premiums paid by third party within 3 years of death (i.e., 2 yrs. x $10,000). (c) = $100,000 = Total premiums paid on life insurance policy (i.e., 10 years x $10,000).Chapter 17, Exhibit 13b CCH Federal Taxation Basic Principles 38 of 103
  • Annuities and Lump-Sum Survivor Benefits The gross estate of a decedent includes the commercial value of survival benefits for three types of annuities:  Joint and survivor annuities, whereby, payments continue to be made to a surviving spouse after the first spouse dies.  Self and survivor annuities, whereby payments continue to be made to a beneficiary after the death of the buyer.  Minimum guarantee annuities, whereby a refund feature provides for a lump-sum payment upon the death of the annuitant, unless the annuitant survives a minimum period of time.Chapter 17, Exhibit 14a CCH Federal Taxation Basic Principles 39 of 103
  • Annuities and Lump-Sum Survivor Benefits Formula for computing includible value in decedent’s gross estate: (a) = (b) x [(c) ÷ (d)], where, (a) = Amount includible in deceased annuitant’s gross estate. (b) = Commercial value of survivor benefits. (c) = Decedent’s contribution to purchase of annuity contract. (d) = Total purchase price of the annuity contract. In the case of a straight-life annuity, nothing is included in the gross estate of the annuitant at death because the annuitant’s interest in the contract is terminated by death (i.e., no survival benefits).Chapter 17, Exhibit 14b CCH Federal Taxation Basic Principles 40 of 103
  • Annuities and Lump-Sum Survivor Benefits— Examples Example 1. Annuities FACTS: Kathy purchases a straight-life annuity that will pay her $10,000 a month when she reaches age 65. Kathy dies at age 70. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: Except for the payments she received before her death, nothing relating to this annuity affects Kathy’s gross estate.Chapter 17, Exhibit 15a CCH Federal Taxation Basic Principles 41 of 103
  • Annuities and Lump-Sum Survivor Benefits— Examples Example 2. Annuities FACTS: Same facts as Example 1, except that the annuity contract provides for Craig, her husband, to be paid $5,000 a month for life as a survivorship feature. Craig is 72 years of age when Kathy dies. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: Under these circumstances, Kathy’s gross estate includes the commercial value (i.e., “cost”) of a comparable contract that provides an annuity of $5,000 per month for the life of a male, age 72.Chapter 17, Exhibit 15b CCH Federal Taxation Basic Principles 42 of 103
  • Annuities and Lump-Sum Survivor Benefits— Examples Example 3. Annuities FACTS: Same facts as Example 2, except that Kathy paid for only 25% of the annuity contract. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: 25% of the commercial value of a comparable annuity contract that provides an annuity of $5,000 per month for the life of a male, age 72.Chapter 17, Exhibit 15c CCH Federal Taxation Basic Principles 43 of 103
  • Gift Tax Paid Within 3 Years of Death Gross-up Procedure. Including gift tax paid within 3 years of death in the gross estate is called the “gross-up” procedure. It prevents the gift tax amount from escaping the estate tax.Chapter 17, Exhibit 16 CCH Federal Taxation Basic Principles 44 of 103
  • Inter Vivos Transfers—Types The gross estate (GE) includes assets transferred “during life” in which the decedent retained any of the following interests: Retained life estate. Income interest or control over enjoyment of the assets or income derived. Here, the logic is easy to follow: One should not be able to escape estate tax at death after having remained in a position to enjoy some or all of the fruits of ownership during life.Chapter 17, Exhibit 17a CCH Federal Taxation Basic Principles 45 of 103
  • Inter Vivos Transfers—Types More-than-5% reversionary interest. If repossession by the transferor-decedent of property (not merely income from the property) is conditioned upon surviving the beneficiary- decedent, then such property would be included in the transferor-decedent’s GE. Revocable trust. The value of property interest transferred by the decedent is includible in the GE if the enjoyment of the property transferred was subject, at the date of the decedent’s death, to any power of the decedent to alter, amend, revoke or terminate the transfer.Chapter 17, Exhibit 17b CCH Federal Taxation Basic Principles 46 of 103
  • Inter Vivos Transfers—Types Interest in a qualified terminable interest property trust (QTIP). A QTIP is a bequest of property to a surviving spouse in the form of a terminable interest life estate. To “qualify” as a QTIP trust, two requirements must be met:  ALL income from the trust must be distributed at least annually to the donee spouse (i.e., the trust must be “simple”).  No one can have a power to appoint any portion of the principal or income to anyone other than the spouse during the spouse’s lifetime.Chapter 17, Exhibit 17c CCH Federal Taxation Basic Principles 47 of 103
  • Inter Vivos Transfers—Types Election to Claim Marital Deduction. An election exists to convert the terminable interest into nonterminable property eligible for the marital deduction. The result of the election is that the marital deduction is available to the donor- spouse’s estate for the full market value of the property in the trust, regardless of to whom the remainder goes, e.g.,, the children, charity, etc. This benefit carries a price tag: the full value as of the death of the donee-spouse is included in his/her gross estate.Chapter 17, Exhibit 17d CCH Federal Taxation Basic Principles 48 of 103
  • Inter Vivos Transfers—Examples Example 1: Retained Life Estate Travis transfers income-producing property into trust for his daughter Betty, but retains the income from the property for his lifetime. Upon Travis’s death, the total fair market value of the property will be included in his gross estate.Chapter 17, Exhibit 18a CCH Federal Taxation Basic Principles 49 of 103
  • Inter Vivos Transfers—Examples Example 2: More than 5% Reversionary Interest. Travis transferred property into trust giving a life estate to Betty with the remainder to Cathy if Travis predeceases Carla. However, if Betty predeceases Travis, the remainder would revert to Travis. The value of the reversionary interest would be included in Travis’ estate if it exceeded 5% of the value of the property at the time of transfer into the trust.Chapter 17, Exhibit 18b CCH Federal Taxation Basic Principles 50 of 103
  • Inter Vivos Transfers—Examples Example 3: Revocable Trust Travis establishes a lifetime revocable trust naming his mother Betty as beneficiary. Travis designates himself as trustee. The transfer is incomplete as he has retained the power to revoke the trust. Upon his death, the present value of the reversionary interest would be includible in his GE.Chapter 17, Exhibit 18c CCH Federal Taxation Basic Principles 51 of 103
  • Inter Vivos Transfers—Examples Example 4: QTIP (with and without election) When Travis died, he left $2,000,000 in trust to his wife Betty. All future income (except capital gains) derived from the $2,000,000 is to be distributed to her annually for life. The remainder goes to charity.Chapter 17, Exhibit 18d CCH Federal Taxation Basic Principles 52 of 103
  • Inter Vivos Transfers—Examples Example 4 (continued) Without the QTIP election. If Travis’ executor did not make the QTIP election: (a) $2,000,000 would be included in Travis’s gross estate; (b) The marital deduction would not be allowed; (c) The trust would not be included in Betty’s GE when she died. With the QTIP election. If Travis’ executor did make the QTIP election: (a) $2,000,000 would be included in Travis’s GE (same as above); (b) The marital deduction would be allowed; (c) If on Betty’s death, the trust is valued at $5,000,000, the full value would be included in her GE.Chapter 17, Exhibit 18e CCH Federal Taxation Basic Principles 53 of 103
  • Medical Insurance Reimbursements Tax Treatment. If unpaid but receivable by the decedent at death, they are treated as property in which the decedent had an interest and are therefore included in the gross estate.Chapter 17, Exhibit 19 CCH Federal Taxation Basic Principles 54 of 103
  • Dower and Curtesy Tax Treatment. The gross estate (GE) also includes the value of the surviving spouse’s interest in property as dower or curtesy. Dower and curtesy are common-law rights, recognized in only a few states, usually in modified form. They entitle a surviving spouse to some portion of the decedent’s estate, even though the decedent may have willed a smaller portion to this person.Chapter 17, Exhibit 20a CCH Federal Taxation Basic Principles 55 of 103
  • Dower and Curtesy  Dower entitles a surviving wife to a portion of real property her husband owned and possessed during their marriage.  Curtesy entitles a surviving husband to a life estate in all of his wife’s land if they had children.Chapter 17, Exhibit 20b CCH Federal Taxation Basic Principles 56 of 103
  • Dower and Curtesy Dowers and curtesies, although included in the gross estate of a decedent spouse, are “zeroed out” of the decedent spouse’s taxable estate by the marital deduction. Unless the property is “consumed” by the surviving spouse, it is included in the surviving spouse’s taxable estate at fair market value on the date of death (or the six-month alternative date.)Chapter 17, Exhibit 20c CCH Federal Taxation Basic Principles 57 of 103
  • Valuing the Gross Estate Date of death. Value is the fair market value (FMV) of the property at date of death unless a special valuation rule is used. Real property is usually valued at its highest and best use.Chapter 17, Exhibit 21a CCH Federal Taxation Basic Principles 58 of 103
  • Valuing the Gross Estate Alternative valuation date. The executor may elect to value the estate at an alternate valuation date, which is 6 months after the date of death. If the election is made and property is distributed before the 6-month date, then the value on the day after the date of distribution will apply. Thus, there are 3 possible dates for valuing an estate:  Date of death, or,  If elected by executor (not heir), the earlier of: (a) 6 months after date of death, or (b) Date received by heir if before 6 months.Chapter 17, Exhibit 21b CCH Federal Taxation Basic Principles 59 of 103
  • Valuing the Gross Estate The alternative valuation date carries three requirements:  It is irrevocable.  It applies to all property of the estate (i.e., the executor cannot “pick and choose” which property to elect).  It can be made only if it results in a reduction in BOTH the value of the GE and the sum of estate tax and the generation-skipping transfer tax.Chapter 17, Exhibit 21c CCH Federal Taxation Basic Principles 60 of 103
  • Deductions from the Gross Estate Examples. Deductions are subtracted from the gross estate (GE) in computing the taxable estate (TE). Typical expenses include: funeral expenses, administrative expenses, debts of the decedent, claims against the estate, casualty losses and allocations of deductions on returns. Funeral Expenses. Deductible from the GE, even if they if incurred in a foreign country, or if they go beyond the “necessary.”Chapter 17, Exhibit 22a CCH Federal Taxation Basic Principles 61 of 103
  • Deductions from the Gross Estate Administrative Expenses. These include fees paid to the executor, lawyer, accountant, and appraiser. They are deductible if:  Allowable by local law; and  Necessary for administering the estate (i.e., for selling or distributing assets, paying debts, etc.) Administrative expenses incurred for the convenience of a beneficiary are disallowed.Chapter 17, Exhibit 22b CCH Federal Taxation Basic Principles 62 of 103
  • Deductions from the Gross Estate Debts of the Decedent and Claims Against the Estate. All enforceable claims against the estate are deductible if paid. This includes:  Accrued interest expense as of the date of death.  Unpaid federal, state & local income taxes, property and gift taxes, but not estate tax itself. The property taxes are deductible only if the property is included in the GE.  Nonrecourse mortgages are deductible up to the amount of the property value included in the GE.Chapter 17, Exhibit 22c CCH Federal Taxation Basic Principles 63 of 103
  • Casualty Losses Tax Treatment. If sustained by the estate, they are deductible from the gross estate (GE):  Without regard to the 10% AGI floor; and  Based on estate tax value (i.e., fair market value at date of death or alternative valuation date), without regard to basis. Note that casualty losses sustained prior to death are deductible on the decedents final 1040 return and, if sustained after distribution, then deductible by the beneficiary.Chapter 17, Exhibit 23 CCH Federal Taxation Basic Principles 64 of 103
  • Charitable Contributions Tax Treatment. Bequests to qualified charitable organizations are deductible. Gross-up Requirement. Contributions must be included in estate tax value. The property for which a deduction is taken must be included in the gross-up procedures for gifts.Chapter 17, Exhibit 24a CCH Federal Taxation Basic Principles 65 of 103
  • Charitable Contributions No Ceiling Limitation. The deduction is not subject to the usual 50%/30%/20% AGI ceilings for individuals, rather, 100% of the estate value is deductible, regardless of the property (ordinary or long-term capital gain) and regardless of the charity (public or private).Chapter 17, Exhibit 24b CCH Federal Taxation Basic Principles 66 of 103
  • Charitable Contributions Entire Interest Requirement. The entire interest must be donated. The entire interest of the decedent in the underlying property must generally be donated. Trust interests may enable deductible transfers of partial interests in underlying property. An inter vivos contribution (as opposed to a bequest) may result in exclusion of the property value from the GE and a current deduction from estate income.Chapter 17, Exhibit 24c CCH Federal Taxation Basic Principles 67 of 103
  • Marital Transfers Tax Treatment Estate of first to die. Outright transfers to a surviving spouse are deductible from the gross estate (GE) of the first spouse to die, to the extent the interest is included in the GE. Put differently, marital transfers are both taxable transfers and deductions, resulting is a zero estate tax effect. The deduction is unlimited. Surviving spouse’s estate. The GE of the surviving spouse must include the property that had been subject to a marital deduction by the former spouse’s estate. The value to be included in the surviving spouse’s GE is the value of the property at the surviving spouse’s date of death.Chapter 17, Exhibit 25a CCH Federal Taxation Basic Principles 68 of 103
  • Marital Transfers Qualifying for the Marital Deduction. To qualify for the marital deduction, it is not sufficient that property passes to the surviving spouse. The interest must be nonterminable (i.e. the surviving spouse’s interest in the property must not lapse, expire or terminate, then pass on to a third party.) Examples of nonqualifying terminable interests include: term interest, life estates and certain annuities.Chapter 17, Exhibit 25b CCH Federal Taxation Basic Principles 69 of 103
  • Marital Transfers—Examples Example 1: Wife’s Life Interest Disqualifies Marital Deduction. Travis dies, leaving his wife Betty, the income from property for life, whereupon the property itself passes to the grandchildren. The life interest does NOT qualify for the marital deduction in Travis’s estate, because the interest terminates upon Betty’s death (i.e., she has no control over who gets the remainder).Chapter 17, Exhibit 26a CCH Federal Taxation Basic Principles 70 of 103
  • Marital Transfers—Examples Example 2: Wife’s Remainder Qualifies for Marital Deduction. Travis leaves the property to his mother for life. Upon her death, the remainder passes on to his wife, Betty. The remainder DOES qualify for the marital deduction in Travis’s estate because his wife’s remainder interest is nonterminable, even though she may die before Travis’ mother dies.Chapter 17, Exhibit 26b CCH Federal Taxation Basic Principles 71 of 103
  • Marital Transfers—Examples Example 3: Wife’s Remarriage Restriction Disqualifies Marital Deduction. Travis dies, leaving his wife Betty a life interest in his stock portfolio. If she remarries, the life interest terminates and the stock passes on to his children. However, if she does not remarry, she can will the stocks to anyone. The marriage deduction is not allowed due to possibility, no matter how remote, that she may remarry and terminate her life interest in the stock.Chapter 17, Exhibit 26c CCH Federal Taxation Basic Principles 72 of 103
  • Marital Transfers—Examples Example 4: Wife’s Joint and Survivorship Annuity Qualifies Marital Deduction. Travis purchased a joint and survivorship annuity providing for monthly payments to Travis for life, and then to his wife Betty should she survive. Upon Travis’s death, the annuities become payable to Betty until she dies. The present value of Betty’s future annuities, determined actuarially, are included in Travis’s estate and a marital deduction is allowed. Although Betty’s annuities are, strictly speaking, terminable upon her death, they are nevertheless treated as nonterminable for marital deduction purposes since no other person may enjoy the property after her death.Chapter 17, Exhibit 26d CCH Federal Taxation Basic Principles 73 of 103
  • Post 1976 Gifts Adjusted Taxable Gifts After 1976. Adjusted taxable gifts made after 1976 are added to the taxable estate, resulting in a higher estate tax base. (1) Gross-up procedure. Students often get the false impression that gifts made after 1976 are brought back into the estate to be taxed a second time. In fact, such gifts are used to “gross-up” the estate in order to raise the decedent’s estate tax bracket for determining the tentative estate tax.Chapter 17, Exhibit 27a CCH Federal Taxation Basic Principles 74 of 103
  • Post 1976 Gifts Credit for Gift Tax Paid on Post-1976 Gifts. After the tentative estate tax has been determined, it is reduced by a gift tax credit related to post-1976 gifts. (If gift tax paid on post-1976 gifts is greater than the amount that would have been paid under the current rates, then the current rates are applied to redetermine the gift tax credit. The lower credit amount is called a “deemed paid” gift tax credit.)Chapter 17, Exhibit 27b CCH Federal Taxation Basic Principles 75 of 103
  • Post 1976 Gifts—Example FACTS: Joan makes a qualified gift of land valued at $1 million in 1990. She dies on June 15, 2012, leaving $5.12 million cash, her only remaining asset. Determine the estate tax liability with and without the gross-up procedure. (For the sake of simplicity, ignore the $13,000 gift exclusion, the unified tax credit and the state tax deduction.)Chapter 17, Exhibit 28a CCH Federal Taxation Basic Principles 76 of 103
  • Post 1976 Gifts—Example With Gross-Up Without Gross-Up Procedure Procedure Gift made in 1990 $1,000,000 $1,000,000 Gift tax paid (from the unified transfer tax 345,800 345,800 rate schedule) Gross estate on June 15, 2012 5,120,000 5,120,000 Add back: Gift made in 1990 1,000,000 0 Estate tax base 6,120,000 5,120,000 Tentative estate tax (from the unified transfer $ 2,122,800 $ 1,772,800 tax rate schedule)Chapter 17, Exhibit 28b CCH Federal Taxation Basic Principles 77 of 103
  • Post 1976 Gifts—Example With Gross-Up Without Gross-Up Procedure Procedure Credit for 1990 gift tax $(345,800) $0 Estate tax liability 350,000 0 Additional tax attributable to gross-up procedure 0 ($350,000 = $350,000 – $0):Chapter 17, Exhibit 28c CCH Federal Taxation Basic Principles 78 of 103
  • Computing Estate Tax and Credits The estate tax is imposed on the sum of the taxable estate plus gifts subject to the gift tax. However, it is reduced by gift taxes previously paid on those gifts and by the unified credit.Chapter 17, Exhibit 29a CCH Federal Taxation Basic Principles 79 of 103
  • Computing Estate Tax and Credits Quick review: Gross Estate (GE) is the value of all property for which the decedent enjoyed a beneficial interest. GE includes gift taxes paid on gifts made within 3 years of death. Adjusted Gross Estate (AGE) is the GE reduced by deductions. This term is significant only if more than 35% AGE consists of a farm or closely held business. In such instances, estate tax can be postponed for 5 years, then paid over a nine year period, creating a maximum deferral period of 14 years. Interest on unpaid estate taxes must be paid in each of the 14 years. Taxable Estate (TE) is the AGE reduced by the marital deduction for “nonterminable” marital transfers and by unrestricted charitable contributions.Chapter 17, Exhibit 29b CCH Federal Taxation Basic Principles 80 of 103
  • Computing Estate Tax and Credits Estate Tax Base (ETB) is the TE plus gifts made after 1976, after gift exclusions & deductions. Tentative Estate Tax (TET) is the product of ETB and the applicable estate tax rates. The estate tax rates begin at 18% on ETB up to $10,000 and graduate to 35% on ETB over $5.12 million in 2012. Estate Tax Before Credits (ETBC) is the TET reduced by gift taxes on ALL gift taxes paid after 1976, including gift tax on gifts made within 3 years of death.Chapter 17, Exhibit 29c CCH Federal Taxation Basic Principles 81 of 103
  • Computing Estate Tax and Credits Estate Tax Liability is the ETBC reduced by: (a) Unified credit. The unified credit is a base amount of tax ($1,772,800 in 2012) that offsets the estate tax liability that would otherwise be imposed on the first $5,120,000 of taxable estates. (b) Credit for prior transfers. Credit is allowed for estate taxes (but not gift taxes) paid on property transfers by the estates of persons who died within 10 years before, or 2 years after the present decedent’s death. The purpose of this credit is to prevent the diminution of an estate by the imposition of successive estate taxes on the same property within a brief period. The credit percentages are as follows:Chapter 17, Exhibit 29d CCH Federal Taxation Basic Principles 82 of 103
  • Computing Estate Tax and Credits CREDIT FOR ESTATE TAX PAID ON PRIOR TRANSFERS # Yrs. Between Transferor’s Death and Transferee’s Death Credit % Less than 2 years 100% More than 2, but not more than 4 80% More than 4, but not more than 6 60% More than 6, but not more than 8 40% More than 8, but not more than 10 20% (d) Credit for death taxes paid to foreign governments. A credit is provided for U.S. citizens and resident aliens. It applies to property that is subject to both federal and foreign death taxes in order to prevent double taxation. The credit may not exceed the portion of U.S. estate taxes attributed to the property.Chapter 17, Exhibit 29e CCH Federal Taxation Basic Principles 83 of 103
  • Estate Tax Return Minimum gross estate value. The executor is required to file form 706, U.S. Estate tax return, if the gross estate at the decedent’s death exceeds $5.12 million in 2012. Adjusted taxable gifts made by the decedent during his/her lifetime reduce this threshold dollar for dollar. Due date of return. Form 706 is due within 9 months after the date of the decedent’s death. An extension of up to 6 months may be granted. Extension of payment. Time for payment may be extended by a reasonable period, but not by more than 12 months. Showing undue hardship is required.Chapter 17, Exhibit 30a CCH Federal Taxation Basic Principles 84 of 103
  • Estate Tax Return Liability of beneficiaries and executors. Estate tax is charged to estate property. If the tax on part of the estate distributed is paid out of other estate property, equitable contribution from the distributee-beneficiary is recoverable. The executor is ultimately liable for payment of the estate tax.Chapter 17, Exhibit 30b CCH Federal Taxation Basic Principles 85 of 103
  • Estate Tax Return Special deferment for farms and closely held businesses. If more than 35% of a decedent’s adjusted gross estate consists of an interest in a farm or a closely held business, an executor may elect, on a timely filed estate tax return, to defer ALL payment of taxes for 5 years (paying interest only) and thereafter pay the tax in equal installments over the next 10 years (i.E., Years 5 to 14). The maximum deferral period is 14 rather than 15 years because the due date for the last payment of interest coincides with the due date for the first installment of tax.Chapter 17, Exhibit 30c CCH Federal Taxation Basic Principles 86 of 103
  • Estate Tax Return Definition of closely held business. A closely held business includes: (a) A corporation, if it has 45 or fewer shareholders, or if 20% or more in value of the voting stock is included in the gross estate. (b) A partnership, if it has 45 or fewer partners, or if 20% or more in value of the capital interests is included in the gross estate. (c) A sole proprietorship.Chapter 17, Exhibit 30d CCH Federal Taxation Basic Principles 87 of 103
  • Formula for Computing Gift Tax Liability + Gift amount (the fair market value on the gift date, for all gifts in the calendar year. – Exclusions:  Annual exclusion ($13,000 per donee per year)  Exclusion for payments on behalf of another for medical care and education tuition (must be paid directly to the institution) = Includible gift amountChapter 17, Exhibit 31a CCH Federal Taxation Basic Principles 88 of 103
  • Formula for Computing Gift Tax Liability – Deductions:  Marital  Charitable = Adjusted taxable gifts for the current year + Adjusted taxable gifts for all prior years = Adjusted taxable gifts to date x Applicable tax rate (estates and gifts use the same rates) = Tentative gift tax – Prior year gifts x current applicable tax rates – Unified credit: unused portion of $5,120,000 = Gift tax liabilityChapter 17, Exhibit 31b CCH Federal Taxation Basic Principles 89 of 103
  • Gift Tax—Overview Definition. Gift tax is imposed on the donor (giver), not the donee (beneficiary) on the gratuitous transfer of property for less than full and adequate consideration. Giving up dominion and control. A gift transfer is complete (and taxable) when the donor has given over dominion and control such that she is without legal power to change its disposition. Only inter vivos gifts are subject to gift tax. Gifts completed when the donor is living (i.e., inter vivos gifts) are the only ones subject to gift tax. Transfers made in trust are included. Property passing by will or inheritance are not included as gifts, but are generally included in the gross estate.Chapter 17, Exhibit 32 CCH Federal Taxation Basic Principles 90 of 103
  • Gift Loans—General Rules Gift loans are below market interest rate loans made out of love, affection or generosity. Gift loan are subject to the imputed interest if:  Interest charged is less than the applicable Federal rate (AFR);  Sum of all loans between lender and borrower exceeds $10,000; and,  The loan was made after 6/7/84. Note that the “gift” is not the principal portion of the loan, rather, the amount of interest that is below market.Chapter 17, Exhibit 33 CCH Federal Taxation Basic Principles 91 of 103
  • Gift Tax—Exclusions $13,000 Annual Exclusion. The first $13,000 of gifts of present interest (i.e., current, not future dominion and control) to each donee, is excluded by the donor from taxable gift amounts. Future interests. The exclusion does not apply to future interests.Chapter 17, Exhibit 34a CCH Federal Taxation Basic Principles 92 of 103
  • Gift Tax—Exclusions Gift splitting. Each spouse may treat each gift made to any 3rd party as made 1/2 by the donor and 1/2 by the donor’s spouse. Thus a donor could, in effect, get a $26,000 annual exclusion if the donor’s spouse did not make any gifts during the year. (a) They must be married at the time of the gift; (b) They must make a proper election and signify their consent on the gift tax return.Chapter 17, Exhibit 34b CCH Federal Taxation Basic Principles 93 of 103
  • Gift Tax—Exclusions Exclusion for medical and tuition. Amounts paid on behalf of another taxpayer as payment for medical care or tuition to an educational organization can be excluded. 1. Beneficiary. The beneficiary need not be a relative. 2. Direct payment required. The payment must be made directly to the third party, i.e., the medical provider or the educational organization. 3. Tuition requirement. Amounts paid for room, board and books are not excluded.Chapter 17, Exhibit 34c CCH Federal Taxation Basic Principles 94 of 103
  • Gift Tax—Deductions Unlimited marital transfer deduction. The amount of a gift transfer to a spouse is deducted in computing adjusted taxable gifts. The deduction is unlimited, except of course, it cannot exceed the amount included as a taxable gift. Donor and donee must be married at the time of gift.Chapter 17, Exhibit 35a CCH Federal Taxation Basic Principles 95 of 103
  • Gift Tax—Deductions Example: Unlimited Marital Deduction. FACTS: Henry gave his wife Wilma a $5,000 coat and $25,000 cash during 2012. QUESTION: How much are his adjusted taxable gifts for 2012? SOLUTION: $0 (see analysis below) Gift amount for 2012: $30,000 ( = $5,000 + $25,000). Includible gift amount: $17,000 ( = $30,000 - $13,000 annual exclusion). Taxable gift for 2012: $ 0 ( = $17,000 - $17,000 unlimited marital deduction.)Chapter 17, Exhibit 35b CCH Federal Taxation Basic Principles 96 of 103
  • Gift Tax—Deductions Charitable Deduction. The FMV of property donated to a qualified charitable organization is deductible. 1. Contributions must be include in gift tax value. The value of property for which a deduction is taken must be included in the gift amount for the year. 2. No ceiling. The deduction is not subject to the usual 50%/30%/20% AGI ceilings for individuals, rather, 100% of the gift value is deductible, regardless of the property (ordinary or long-term capital gain) and regardless of the charity (public or private). However, the amount of the deduction is the gift amount reduced by the $13,000 annual exclusion with respect to the donee. 3. Entire interest must be donated. The entire interest of the donor in the underlying property must generally be donatedChapter 17, Exhibit 35c CCH Federal Taxation Basic Principles 97 of 103
  • Gift Tax—Deductions Political Contributions. Not subject to gift tax.Chapter 17, Exhibit 35d CCH Federal Taxation Basic Principles 98 of 103
  • Gift Tax Liability—Short Formula The short formula for computing gift taxes for the current year is: Tentative Tax - (Prior Year Gifts x Current Gift Rates) - Unified Credit where 1. Tentative tax is the gift rate applied to adjusted taxable gifts for the current and preceding years. 2. Adjusted taxable gifts for current & prior years represent the total of gifts (at FMV), in excess of exclusions and deductions. The tentative gift tax is reduced by the product of prior years’ adjusted taxable gifts and the current-year rates.Chapter 17, Exhibit 36a CCH Federal Taxation Basic Principles 99 of 103
  • Gift Tax Liability—Short Formula 3. Current gift rates are the same unified transfer tax rates as used for computing estate taxes. The initial rate is 18% for adjusted taxable gifts up to $10,000. The maximum rate is 35% on cumulative gifts in excess of $5.12 million. 4. Unified credit is a base amount of $1,772,800, the equivalent estate or gift tax on the first $5.12 million of taxable transfers.Chapter 17, Exhibit 36b CCH Federal Taxation Basic Principles 100 of 103
  • Gift Tax Filing Requirements A donor is required to file a gift tax return, Form 709, for any gift(s), unless all gift amounts are offset by:  the annual $13,000 exclusion;  the medical and tuition exclusion; or  the marital deduction. Note that charitable contributions must generally be reported as taxable gifts subject to the charitable gift deduction.Chapter 17, Exhibit 37a CCH Federal Taxation Basic Principles 101 of 103
  • Gift Tax Filing Requirements Gift amount (the fair market value on the gift date, for all gifts in the calendar year). Exclusions:  Annual exclusion ($13,000 per donee per year)  Exclusion for payments on behalf of another for medical care and education tuition (must be paid directly to the institution)Chapter 17, Exhibit 37b CCH Federal Taxation Basic Principles 102 of 103
  • Gift Tax Filing Requirements Deductions:  Marital  Charitable  Adjusted taxable gifts for the current year  Adjusted taxable gifts for all prior years  Adjusted taxable gifts to date  Applicable tax rate (estates and gifts use the same rates)  Tentative gift tax  Prior year gifts x current applicable tax rates  Unified credit: unused portion of $1,772,800 in 2012  Gift tax liabilityChapter 17, Exhibit 37c CCH Federal Taxation Basic Principles 103 of 103