The Big Picture (slide 1 of 3)• Over his lifetime, Peter Hood started and purchased numerous automobile dealerships that he eventually transferred to a newly formed entity, Hood Corporation.• Upon his death in 2000, the stock in Hood Corporation passed in equal shares to Peter’s surviving spouse, Martha, and their adult children, John and Helen.
The Big Picture (slide 2 of 3)• For John Hood, 2011 proved to be an eventful and final tax year.• Among the major happenings were the following. – In January, John’s divorce from his first wife, Hannah, became final. – In February, he married Ashley, the manager of one of the Hood car dealerships. – He made various gifts to family members. – In July, his mother died of a heart condition, and John served as executor of her estate.
The Big Picture (slide 3 of 3)• Among the major happenings were the following. (Cont’d) – In late November, he was seriously injured in a car accident (caused by another motorist). – In early December, he carried out some predeath planning. – John died of his injuries in mid-December.• What are some of the tax problems (i.e., income, gift, and estate taxes) that might be encountered as a result of these events?• Read the chapter and formulate your response.
Transfer Taxes (slide 1 of 2)• Federal law imposes a tax on the gratuitous transfer of property in one of two ways: – Estate tax – Gift tax
Transfer Taxes (slide 2 of 2)• Estate tax – Imposed on decedent’s entire estate – Tax on the right to pass property at death• Gift tax – Tax on inter vivos (lifetime) transfers for less than full and adequate consideration – Payable by the donor
Tax Legislation Affecting Transfer Taxes (slide 1 of 2)• Tax Relief Reconciliation Act of 2001 made substantial changes to the unified transfer tax – Lowered top tax rates applicable to estates and gifts – Effectively eliminated the estate tax by 2010 but retained the gift tax – For budget reasons, eliminated all changes made by the Act after 12/31/2010 • Referred to as a “sunset” provision
Tax Legislation Affecting Transfer Taxes (slide 2 of 2)• In late 2010, Congress enacted the Tax Relief Act of 2010 (TRA).• TRA postponed the sunset provisions until after 2012. – The legislation added some generous estate and gift tax provisions (maximum rate of 35% and a credit of $5 million).• TRA is effective for 2011 and 2012. – If the sunset provisions come into play after 2012, the rates will increase to a maximum of 55%, and the credit will decrease to $1 million.
Unified Tax Credit (slide 1 of 3)• Allows donors and decedents to transfer modest amounts of wealth without being subject to gift and estate taxes – Exemption equivalent is amount that can be transferred tax-free through the unified tax credit
Unified Tax Credit-Applicable Only to Gift Taxes (slide 2 of 3)• The Tax Relief Reconciliation Act of 2001 froze the unified transfer tax credit applicable to the gift tax at $345,800 through 2009 – This is the exemption equivalent of $1 million that can be transferred tax-free• The Tax Relief Act of 2010 lowered the top tax rates and increased the exclusion amount to $5,000,000 for 2011 and 2012.
Valuation for Estate and Gift Tax Purposes (slide 1 of 2)• The value of property on date of transfer generally determines the amount subject to gift or estate tax• Under certain conditions, however, an executor can elect to value estate assets on the alternate valuation date – Six months after death or – On the date of disposition if this occurs earlier
Valuation for Estate and Gift Tax Purposes (slide 2 of 2)• The alternate valuation date election is not available unless: – The estate must file a Form 706 (Estate Tax Return), and – The election decreases the value of the gross estate and the estate tax liability
Key Property Concepts• When property is transferred by gift or death, the form of ownership can have a direct bearing on transfer tax consequences – Undivided Ownership—Can fall into any of four categories: • Joint tenancy • Tenancy by the entirety • Tenancy in common, or • Community property – Partial Interests—Interests in assets can be divided in terms of rights to income and principal
Gift Tax (slide 1 of 3)• Persons subject to tax: – Citizen or resident of the U.S. on all transfers by gift of property wherever located – Nonresident alien, if the gifted property was situated in the U.S.
Gift Tax (slide 2 of 3)• Requirements for a gift: – The donor is competent to make the gift and the donee is capable of receiving and possessing the property – Donative intent of the donor – Actual or constructive delivery of property to donee or donee’s representative and acceptance of gift by the donee
Gift Tax (slide 3 of 3)• A transfer is not a gift if the transfer is incomplete – e.g., Funds may be transferred to a trust • If terms of the trust allow the transfer to be revoked for any reason, the transfer is not a gift
Excluded Transfers• Federal gift tax does not apply to: – Transfers to political organizations – Tuition payments made to an educational organization on another’s behalf – Amounts paid on another’s behalf for medical care • The payments must be made directly to the provider (e.g., physician, hospital, college) – Satisfying an obligation of support
The Big Picture – Example 15 Certain Excluded Transfers (slide 1 of 2)• Return to the facts of The Big Picture on p. 18-2.• After Peter died in 2000, his widow, Martha, continued to live in the family home and refused to move in with either of her children (John or Helen). – As Martha’s health and mental condition deteriorated, her children did everything possible to keep the family housekeeper from quitting.
The Big Picture – Example 15 Certain Excluded Transfers (slide 2 of 2)• Helen paid for the housekeeper’s gallbladder operation.• John paid the college tuition of her oldest son.• Neither Helen nor John has made gifts to the housekeeper or her son. – Gifts would have occurred, however, if Helen and John had reimbursed the housekeeper for the amounts involved, instead of paying the providers (i.e., physician, hospital, college) directly.
The Big Picture – Example 18 Certain Property Settlements (§ 2516)• Return to the facts of The Big Picture on p. 18-2.• Recall that John and Hannah’s divorce became final in January 2011.• After extended but amicable negotiations, in September 2010 John and Hannah had agreed on a property settlement. – In return for the receipt of $200,000 and title to their home, Hannah released all of her marital rights. – Shortly thereafter, John made the transfer.• Under § 2516, the property settlement resulted in no gift tax consequences to John.
The Big Picture – Example 19 Disclaimers (§ 2518)• Return to the facts of The Big Picture on p. 18-2.• Recall that Martha died in July of a heart condition.• Under her will, her estate passes in equal parts to her son and daughter or, if they disclaim, to their children. – Helen disclaims her share of the inheritance, and the assets pass to her children.
The Big Picture – Example 20 Disclaimers (§ 2518)• Assume the same facts as in Example 19.• John’s share of his inheritance from Martha also includes the family hunting lodge. – Except for the hunting lodge, John disclaims his share of the inheritance, and the remaining assets pass to his children.
Annual Exclusion• The first $13,000 of gifts made to any person during any calendar year is excluded in determining the total amount of gifts for the year – Applies to all gifts of a “present” interest• Spouses may elect to “split” gifts – e.g., Allows one spouse to give $26,000 to each donee during a year, even if the assets were only owned by one spouse. Allows gift to be treated as being made 1/2 by each spouse eliminating any transfer tax on the gift
Taxable Gift Example (slide 1 of 4)• During the current year, Jane and Harry, a married couple, make the following transfers in 2011: – $22,000 cash to son Hal – $20,000 tuition for daughter Beth – $60,000 to the American Diabetes Foundation, a qualified charity – $10,000 to the “Young for Governor” campaign – $200,000 to a revocable trust for the benefit of their two children – $30,000 for medical care and medical insurance for Jane’s mother – $60,000 car to Harry’s brother, subject to a liability of $30,000
Taxable Gift Example (slide 2 of 4)• Which of these transfers are treated as gifts for gift tax purposes?• What is the amount of taxable gifts for the year if Jane and Harry elect to split gifts?
Taxable Gift Example (slide 3 of 4)• Several of these transfers are not included in gross gifts: – The $20,000 tuition payment, $30,000 medical care and $10,000 political contribution are not gifts by definition – The $200,000 transfer to the trust is not a completed gift since the trust is revocable – The car transferred to Harry’s brother is 50% a sale for $30,000 (amount of liability) and 50% a gift of $30,000. Harry may have taxable gain (for income tax purposes) on the $30,000 sale
Taxable Gift Example (slide 4 of 4)Taxable Gifts calculation: Cash to Charity $60,000 Cash to Hal 22,000 Car to Harrys brother 30,000 Total gross gifts $112,000 Less: charitable deduction (60,000) Less: annual exclusion ($13,000 each for Harry and Jane, for each donee (Harrys brother and ltd. to $22,000 for their son Hal)) (48,000) Taxable gifts $ 4,000
Taxable Gift Example #2 (slide 1 of 5)Mel (an unmarried individual) made the following transfers during2011: Child support payment for son Marvin $ 25,000 Qualified transfer in trust for Marvin, age 12 (Marvin has no access to the funds until he is 21, but funds may be used on his behalf) $450,000 Transfer of stocks to an irrevocable trust. Mel retains the income for his life. His mother will receive the principal on Mel’s death. Assume the income interest value is $140,000 and the remainder value is $60,000. $200,000
Taxable Gift Example #2 (slide 2 of 5)• Mel made prior taxable gifts of $750,000 and paid $248,300 tax• What is Mel’s total taxable gifts for 2011and total of current and past taxable gifts?
Taxable Gift Example #2 (slide 3 of 5)Taxable gifts in 2011: Transfer in trust for Marvin $ 450,000 Transfer in trust for mother 60,000 Total current taxable transfers $ 510,000 Less: annual exclusion –13,000 Current taxable gifts $ 497,000 Prior taxable gifts 750,000 Total of current and past taxable gifts $1,247,000
Taxable Gift Example #2 (slide 4 of 5)• Comments regarding taxable gift calculation: – Child support payments are not a gift for gift tax purposes in most cases – The transfer in trust for Marvin qualifies as a present interest under §2503 • The $13,000 annual exclusion is available for this transfer
Taxable Gift Example #2 (slide 5 of 5)• The transfer in trust for Mel’s mother is a completed transfer since the trust is irrevocable• Only the remainder interest is a gift since Mel keeps the income interest for his life• This is a gift of a future interest – The $13,000 annual exclusion is not available
Gross Estate (slide 1 of 3)• The Gross Estate includes all property owned by the decedent subject to the Federal estate tax, valued at FMV, including the following: – Personal effects, jewelry, furniture – Stocks, bonds and other investments – Rights to receive dividends or interest (if accrued at the date of death), and – The value of businesses owned by the decedent
Gross Estate (slide 2 of 3)• The Gross Estate includes the proportionate value of any asset owned by a decedent and another person, if both parties paid – e.g., A decedent jointly owns a boat with his son. Both parties paid one-half the initial purchase price. • Only one-half the value of the boat is included in the Gross Estate
Gross Estate (slide 3 of 3)• Asset values are determined at: – The date of death, or – The alternate valuation date (AVD), 6 months later, if elected by the executor • AVD must reduce gross estate and estate tax liability if used
The Big Picture – Example 32 Property Owned By The Decedent (§ 2033) (slide 1 of 2)• Return to the facts of The Big Picture on p. 18-2.• At the time of his death, John was the president of Hood Corporation.• John’s estate receives a distribution from Hood’s qualified pension plan of $1.1 million consisting of the following: Hood’s contributions $450,000 John’s after-tax contributions 350,000 Income earned by the plan 300,000
The Big Picture – Example 32 Property Owned By The Decedent (§ 2033) (slide 2 of 2)• John’s estate also receives $150,000 from Hawk Insurance Company. – The payment represents the maturity value of term life insurance from a group plan Hood maintains for its employees.• As to these amounts, John’s gross estate includes $1,250,000($1,100,000 + $150,000).• For income tax purposes, however, – $750,000 ($450,000 + $300,000) is subject to tax, – $500,000($350,000 + $150,000) is not.
The Big Picture – Example 33 Property Owned By The Decedent (§ 2033)• Return to the facts of The Big Picture on p. 18-2.• Recall that John’s death ultimately resulted from injuries suffered in a car accident caused by another motorist. – In addition, John’s auto was destroyed in the accident.• Presuming the other driver is solvent or carries casualty insurance – John’s gross estate should include the present value of any expected settlement that could result from possible legal action. – At the least, his estate must include the recovery expected from his own casualty policy.
Adjustments for Gifts Within 3 Years of Death - §2035 (slide 1 of 2)• The Gross Estate includes any gift tax paid on gifts made within three years of death – Called the gross-up procedure – Prevents the gift tax amount from escaping the estate tax
Adjusted for Gifts Within 3 Years of Death - §2035 (slide 2 of 2)• The Gross Estate also includes any property interests transferred by gift within 3 years of death that would have been included in the gross estate, including – Transfers with a retained life estate – Transfers taking effect at death – Revocable transfers – Proceeds of life insurance
The Big Picture – Example 36 Transfers With A Retained Life Estate (§ 2036)• Return to the facts of The Big Picture on p. 18-2.• Before Peter Hood died in 2000, he established several trusts.• One trust grants John an income interest for life (i.e., a life estate), and upon his death, the trust passes to his children (i.e., remainder interest).• On John’s death, none of the trust property is included in his gross estate. – Although he held a life estate, he was not the transferor (Peter was) of the property placed in trust.
The Big Picture – Example 37Transfers With A Retained Life Estate (§ 2036)• Return to the facts of The Big Picture on p. 18-2.• Immediately after inheriting the family hunting lodge from his mother, John transfers it to a newly created trust. – Under the terms of the trust instrument, he retains a life estate, remainder to his children and Helen (John’s sister).• Upon John’s death, the property in the trust will be included in his gross estate under § 2036.
The Big Picture – Example 44 Joint Interests• Return to the facts of The Big Picture on p. 18-2.• During his lifetime, Peter Hood purchased timberland listing title as follows: ‘‘John and Helen Hood as equal tenants in common.’’ – John’s basis in the property is one-half of Peter’s cost.• Upon John’s death, one-half of the value of the timberland is included in his gross estate.
The Big Picture – Example 45 Joint Interests• Return to the facts of The Big Picture on p. 18-2.• In her will, Martha leaves the Hood family residence to her children (John and Helen) as joint tenants with right of survivorship. – John’s income tax basis is one-half of the value on Martha’s death.• On John’s later death, one-half of the value at that time will be included in his gross estate. – Keep in mind that under the right of survivorship, outright ownership goes to Helen and none of the property passes to John’s heirs.
The Big Picture – Example 46 Joint Interests• Return to the facts of The Big Picture on p. 18-2.• Recall that after his divorce from Hannah, John married Ashley.• Since Hannah kept his prior home as part of the property settlement, John purchased a new residence. – He listed title to the property as ‘‘John and Ashley Hood, tenancy by the entirety with right of survivorship.’’• Upon John’s death, only one-half of the value of the property is included in his gross estate. – If Ashley had died first, one-half of the value of the residence would have been included in her gross estate even though she made no contribution to its cost.
The Big Picture – Example 58 Transfers To Charity• Return to the facts of The Big Picture on p. 18-2.• In early December, John reviewed his financial affairs with his attorney and executed a new will.• His prior will, drawn up several years ago, contained a bequest to the Hood Scholarship Foundation (HSF), an organization created by Peter (John’s father). – As HSF’s qualified status had never been evaluated by the IRS. • The attorney agreed to apply for a determination letter. – John’s new will kept the bequest, but only if the IRS approved HSF’s qualified status.• John arranged to have all of his medical expenses paid as incurred and made a substantial payment on his property taxes and state income taxes.
The Big Picture – Example 59 Marital Deduction• Return to the facts of The Big Picture on p. 18-2.• In reviewing John’s prior will, the parties discovered that one of the main beneficiaries was Hannah, John’s first wife.• The new will substituted Ashley (John’s present wife) for Hannah, thereby salvaging a marital deduction.
Gross Estate Example (slide 1 of 5)1. Marcia owned a $100,000 life insurance policy on her son George’s life. The cash surrender value (CSV) of the policy was $25,000 when Marcia died this year.2. George purchased and owned a $100,000 life insurance policy on Marcia’s life (his mother), which he collected when Marcia died
Gross Estate Example (slide 2 of 5)3. For $30,000, Marcia purchased $100,000 of insurance on her life. She gave this policy to her husband Milford four years before she died.4. For $35,000, Marcia purchased an additional $100,000 of insurance on her life. She gave this policy to son George one year before she died, and paid gift tax of $5,000 on the transfer.
Gross Estate Example (slide 3 of 5)5. Marcia and son George jointly owned real estate valued at $600,000. Marcia paid $45,000 of the original cost and George paid $15,000.6. Marcia and husband Milford jointly own additional real estate valued at $1,200,000. Milford paid the entire $680,000 purchase price. (Assume this is not community property).
Gross Estate Example (slide 4 of 5)7. Marcia established a revocable trust with son George as remainder beneficiary. The value of assets was $60,000 when the trust was created and $200,000 when Marcia died.8. Marcia owned a vacation residence and transferred title to George six years ago, but she (and Milford) continued to use the property valued at $500,000 each summer. (No one else uses the property.)
Gross Estate Example (slide 5 of 5)9. Marcia and Milford jointly own cash, stocks, personal effects and other real estate valued at $2,000,000.10. Marcia has a life estate in a trust created by her father’s will. Son George is the remainder beneficiary. The value of trust assets is $1,250,000. Marcia has an income interest and can use trust assets for her support, health, education, or maintenance.
Marcia’s Gross Estate (slide 1 of 5)1. $25,000 CSV is included. This is insurance on another person’s life, and is not matured, so its only value is the replacement cost, or the cash into which the policy can be converted. (George is still alive, so Marcia’s estate does not have access to $100,000, it can only receive $25,000 if it cashes in the policy on George.)2. $ -0- is included, since George bought and owned the policy.
Marcia’s Gross Estate (slide 2 of 5)3. $ -0- is included, since this policy was gifted more than three years prior to Marcia’s death (also, marital deduction would apply if included).4. $105,000 is included: the value of the life insurance plus the $5,000 gift tax since the transfers were less than 3 years before death. (The estate will get credit for the $5,000 gift tax paid.)
Marcia’s Gross Estate (slide 3 of 5)5. $450,000 is included since Marcia originally paid 75% of the cost. Note that Marcia made a $15,000 gift when they bought the property. Assume gift splitting was used and no tax was paid at that time.6. $600,000 is included. One-half the value of property held jointly by spouses is included regardless of who purchased the property.
Marcia’s Gross Estate (slide 4 of 5)7. $200,000 is included. The trust was revocable so it is Marcia’s property.8. $500,000 is included since she retained the right to use the property.9. $1,000,000, or one-half the value of these jointly held assets, is included in Marcia’s gross estate.
Marcia’s Gross Estate (slide 5 of 5)10. $ -0- is included since Marcia does not have a general power of appointment over these assets. Her rights to the income of the trust terminate at Marcia’s death. Note: if the trust has accrued income which is rightfully Marcia’s at her death, that amount should be distributed to her estate and included in the gross estate.Total Gross Estate: $2,880,000
Refocus On The Big Picture (slide 1 of 2)• By making use of § 2516, John was able to carry out a property settlement with Hannah without incurring any gift tax consequences (see Example 18).• Both Helen and John acted wisely when they chose to disclaim most of their inheritance from their mother. – By making the disclaimers, they were able to pass the property to their children without a transfer tax being imposed (see Examples 19 and 20).• Section 2033 operates to include in the gross estate not only John’s retirement plan benefits but also any settlement from a potential lawsuit (see Examples 32 and 33).
Refocus On The Big Picture (slide 2 of 2)• Section 2036 did not apply to the trust that John’s father (Peter) created, but it did apply to the one John set up (see Examples 36 and 37). – The difference in treatment occurs when it is the owner who retains an interest in the property, thereby making the transfer incomplete.• John’s predeath planning was highly advantageous: – By drawing up a new will, the loss of the charitable and marital deductions was avoided (see Examples 58 and 59). – By prepaying state and local property and income taxes and staying current on medical expenses, John improved his Federal income tax position (see Example 58). – He also avoided any estate taxes on the amounts used to pay these expenses.