Bryant - Course 6. Estate Planning. 4. Gross Estate Flashcards
Module Introduction
One of the most tragic events of the 20th century was the unexpected death, at age 36, of Princess Diana on August 31, 1997. After her turbulent divorce, Diana was killed as she and her companion, Dodi Fayed, raced through Paris while being pursued by photographers on motorcycles.
Princess Diana left behind a fortune of approximately $35 million. Her gross estate was composed of stock, jewelry, dresses, and cash, including her $28 million divorce settlement. Most of her fortune was bequeathed to her sons, Prince William and Prince Harry. They will eventually inherit about $11.5 million each, with the inheritance held in trust until that time. However, before they could receive anything, approximately $13.9 million was paid in tax.
Taxes can take a big portion out of large estates, sometimes up to more than half the principal. The good news is that taxes need not take as large a portion of the estate if a financial planner helps the person to value his or her estate properly and take full advantage of the deductions, credits, and estate-planning tools available.
Upon completion of this module you should be able to:
* Define the types of assets included in the gross estate
* Explain how interests in property and life estates affect the gross estate
* State the treatment of jointly-owned property and the treatment of assets owned jointly between spouses and non-spouses
* Understand the importance of powers of appointment
* Explain the significance of valuation planning
* Describe the methods used in valuation of different types of property and interests
Module Overview
The value of the gross estate includes property distributed by the decedent’s will, assets owned & distributed according to the provisions of a living trust, as well as life insurance & retirement accounts. Stocks, bonds, tangible personal property, real property, mortgages, notes, and lifetime transfers that are revocable, or in which the decedent retained an interest, are all included in the decedent’s gross estate.
* Also included in the gross estate is property over which the decedent has a general power of appointment, as well as some lifetime transfers made within three years of the decedent’s death.
To ensure that you have a comprehensive understanding of what is included in the gross estate, the following lessons will be covered in this module:
* Gross Estate Assets
* Other IRC Sections
* Valuation Planning
Section 1 - Gross Estate Assets
The value of the gross estate is not just the total of all property owned by the decedent - it includes the total of all property in which the decedent possessed an interest at the time of death. The value of certain property may be included in the decedent’s gross estate even though someone else holds the legal title to that property. The Internal Revenue Code (IRC) lists the types of assets whose value is to be included in the decedent’s gross estate, as well as the basis on which certain assets may be excluded.
To ensure that you have a solid understanding of what assets are included in the gross estate, the following topics will be covered in this lesson:
* Property Owned Outright (IRC 2033)
* Jointly Owned Property (IRC 2040)
* Dower and Curtesy Interest (IRC 2034)
* Certain Property Transferred (IRC 2035)
* Retained Life Estate (IRC 2036)
* Transfer at Death (IRC 2037)
Upon completion of this lesson, you should be able to:
* List the types of property owned outright by the decedent
* Determine the amount of property included in a joint owner’s estate
* Explain the dower and curtesy interest
* Specify the treatment of property transferred within three years of death
* Identify property in which the decedent has retained life estate
* Describe the handling of lifetime transfers
* Define a reversionary interest
Practitioner Advice:
Practitioner Advice: When the topic of estate planning is initiated during the financial planning process, most clients respond with, “I do not own enough assets to worry about estate planning,” or, “My estate is too small to worry about estate planning.”
* In order to counter this natural resistance to the estate planning process, it is extremely important for the financial planner to have a working understanding of how to determine the value of the client’s estate.
* When they factor in the value of the death benefit proceeds of life insurance policies, retirement plan assets, real estate, and stocks and bonds, many clients will begin to realize that their estate is quite large, requiring the tax planning associated with the estate planning process.
Describe Property Owned Outright (IRC 2033)
Internal Revenue Code Section 2033 is a catchall provision dealing with assets, which are included in the gross estate.
* Effectively, IRC Section 2033 states that the value of all property in which the decedent had an interest on the date of death will be included in the decedent’s gross estate, unless a specific exclusion for the property exists.
* Therefore, only the value of the property interest held by the decedent on the date of death will be included in the gross estate.
Type of property interest:
State law determines the character of a property interest. Therefore, if there is any question as to whether an interest owned by the decedent is property under 2033, state law, not the federal IRC, will deal with this question. In any event, examples of property whose value will be included under 2033 include:
Specific property
* stocks
* bonds,
* real estate, etc.
* Property in which the decedent held a sufficient interest.
* Vested remainder interest, as opposed to contingent remainder interest.
For example, A is trustee of a trust funded by Z with $1 million of assets. The trust is created for the benefit of B, D, and E.
* If A dies, what value of the trust assets will be included in A’s estate?
For example, A is trustee of a trust funded by Z with $1 million of assets. The trust is created for the benefit of B, D, and E.
* If A dies, what value of the trust assets will be included in A’s estate?
* Since A was merely the trustee over the assets of the trust, no portion of the trust assets would be included in A’s estate.
* In other words, A was not owner of the assets in his individual capacity, but in a fiduciary capacity for the benefit of B, D, and E.
For example, If the plan requires A to reach age 65 before he becomes vested, the plan __ ____?? will / will not____ __ be included in his gross estate if he dies at age 60.
* However, if A was already vested in the plan (say it vested at age 55), then the plan __ ____?? would / would not____ __ be included in his gross estate if he dies at age 60.
For example, If the plan requires A to reach age 65 before he becomes vested, the plan will not be included in his gross estate if he dies at age 60. This is because A’s interest in the retirement plan is contingent upon his attaining age 65.
* However, if A was already vested in the plan (say it vested at age 55), then the plan would be included in his gross estate if he dies at age 60.
Describe the Types of Property Included
All types of property owned by a decedent outright at death are includable in the gross estate. This includes real and personal property, both tangible and intangible. Intangible personal property such as stocks, bonds, mortgages, notes and other amounts payable to the decedent are includable in the gross estate, as well as tangible personal property such as a decedent’s jewelry and other personal effects.
* However, the decedent must possess more than the bare legal title to property before it can be includable in the estate.
Under state law, if the decedent was the trustee of property or was a strawman owner and had no beneficial interest in the property, no part of such property would be includable in the estate.
* Furthermore, the decedent’s gross estate will include the value of his or her share of certain property held in concert with others.
* For instance, if an individual holds property as a tenant in common with another person, the decedent’s share will be includable as property owned at death.
* Similarly, the value of the decedent’s share of community property will be included in his or her estate.
It is important to note that, no inclusion is required for property in which the decedent’s interest was obtained from someone else and was limited to lifetime enjoyment. This means that an interest that terminated at the decedent’s death and that the decedent had no right to transmit at death will not be included.
* This is known as having a terminable interest in property.
* A husband who gives his wife a terminable interest in property will not receive a gift tax or estate tax marital deduction, and the terminable interest will not be included in the wife’s estate.
* An exception would be Qualified Terminable Interest Property (QTIP).
Example #1 (Property Inclusion)
Brett gives Eric the right to live in Brett’s home in Miami for as long as Eric lives and nothing more, the value of that home will not be includable in Eric’s estate.
* The value of the home will be included in __ ____??____ __’s estate at death.
- The value of the home will be included in Brett’s estate at death.
Example #2 (Property Inclusion)
Brett gives Eric’s wife, Pat, the house in Miami for her lifetime and the remainder to Eric, and Eric dies before Pat,
* Eric’s gross estate __ ____?? will / will not____ __ include the value of his remainder interest because it does not terminate at his death.
* Interest will be includable even if it is limited, contingent, or extremely remote as long as it does not end when the decedent dies.
* Of course, the contingency or remoteness of the interest will affect its valuation.
Brett gives Eric’s wife, Pat, the house in Miami for her lifetime and the remainder to Eric, and Eric dies before Pat,
* Eric’s gross estate will include the value of his remainder interest because it does not terminate at his death.
* Interest will be includable even if it is limited, contingent, or extremely remote as long as it does not end when the decedent dies.
* Of course, the contingency or remoteness of the interest will affect its valuation.
What is Income in respect of a decedent, or IRD?
Income in respect of a decedent, or IRD, is the right to future income earned but not received prior to a decedent’s death is a property interest that will be includable in the decedent’s estate.
Future income rights include:
* bonuses
* rents
* dividends
* royalties
* unpaid salary
* IRA accounts in excess of basis
* business accounts receivable
* vested amounts in qualified retirement plans
* interest payments
* the decedent’s share of any post-death partnership profits earned but not yet paid at death.
If a property is an IRD asset, not only will the value of the asset be included in the decedent’s estate, but the recipient of the income, whether the estate or a beneficiary, must pay the income tax liability.
* However, under IRC 691, to the extent any estate tax is paid on the income portion of an IRD asset, the person receiving this income may use this as an income tax deduction.
Example #1 (Taxation and Deductibility of IRD)
If in 2023, a decedent with a gross estate of $16.5 million bequeathed his IRA valued at $600,000 to his nephew,
* the value of the IRA __ ____?? would / would not____ __ be included in his gross estate.
* The decedent’s tentative tax would be $6,545,800 and the net federal estate tax would be $1,432,000 after using the decedent’s unified credit amount of $5,113,800 (2023) to offset the tentative tax.
However, suppose that the IRA had NOT been included in the decedent’s estate in 2023,
* then the uncle’s gross estate would only be worth $15.9 million, with a tentative tax of $6,305,800 and a net federal estate tax of $1,192,000.
The difference between the estate tax which included the IRA ($1,432,000) and the estate tax which did not include the IRA ($1,192,000) is $240,000.
- If the nephew received a taxable distribution of $300,000 in 2023 from the IRA, he would report income of $__ ____?? would / would not____ __ and receive a deduction of $120,000. ($300,000 divided by $600,000 IRA x $240,000).
If in 2023, a decedent with a gross estate of $16.5 million bequeathed his IRA valued at $600,000 to his nephew,
* the value of the IRA would be included in his gross estate.
* The decedent’s tentative tax would be $6,545,800 and the net federal estate tax would be $1,432,000 after using the decedent’s unified credit amount of $5,113,800 (2023) to offset the tentative tax.
However, suppose that the IRA had NOT been included in the decedent’s estate in 2023,
* then the uncle’s gross estate would only be worth $15.9 million, with a tentative tax of $6,305,800 and a net federal estate tax of $1,192,000.
The difference between the estate tax which included the IRA ($1,432,000) and the estate tax which did not include the IRA ($1,192,000) is $240,000.
- If the nephew received a taxable distribution of $300,000 in 2023 from the IRA, he would report income of $300,000 and receive a deduction of $120,000. ($300,000 divided by $600,000 IRA x $240,000).
IRD deductions are available on the estate income tax return Form _ ___??___ _
IRD deductions are available on the estate income tax return Form 1041 or may flow by way of Form K-1 from 1041.
* Deductions are allowed each year that IRD income is included in the beneficiary’s taxable income.
* The character of the IRD is taxed to the beneficiary as it would have been to the decedent.
* For example, ordinary income and capital gains are taxed at the beneficiary’s tax rate, and tax-exempt income is not taxable to the beneficiary.
Describe Gross Estate for Jointly Owned Property if held jointly w spouse
The decedent’s gross estate will include the value of his share of property held jointly with others.
* The amount included in the decedent’s gross estate will depend on whether the other joint owner is a spouse or not.
Property held jointly with spouses
* It is common for spouses to own property together as a tenancy-by-the-entirety or as a JTWROS.
* With a tenancy-by-the-entirety, property can only be owned between a husband and a wife. When the first spouse dies, 50% of the fair market value of the decedent spouse’s property is included in his gross estate. The surviving spouse inherits one-half of the decedent’s property and will own 100% of the property outright.
* The surviving spouse’s basis in the property will consist of the step-up in basis included in the decedent’s estate (50% FMV) in addition to the spouse’s original basis in the property, which does not receive a step-up when the first spouse dies.
Example (Stepped-Up Basis on Jointly Held Property)
A couple bought a home held as a tenancy-by-the-entirety for $60,000 each spouse has an acquisition basis of $30,000.
* If the home appreciates to $200,000 at the husband’s death, then $__ ____??____ __ will be included in the husband’s estate.
* The wife’s new basis in the home would be $__ ____??____ __.
A couple bought a home held as a tenancy-by-the-entirety for $60,000 each spouse has an acquisition basis of $30,000.
* If the home appreciates to $200,000 at the husband’s death, then $100,000 will be included in the husband’s estate.
* The wife’s new basis in the home would be $130,000.
* The same situation occurs when spouses own property as JTWROS.
Example (Stepped-Up Basis on Community Property)
For example, if a couple in Texas bought a home together for $20,000 and the FMV was $180,000 at the husband’s death, then
* $__ ____??____ __ was included in the husband’s estate
* the wife would inherit his one-half interest.
* Her original basis of $__ ____??____ __ would also be stepped-up to $__ ____??____ __ for a new basis in the home of $__ ____??____ __.
For example, if a couple in Texas bought a home together for $20,000 and the FMV was $180,000 at the husband’s death, then
* $90,000 was included in the husband’s estate
* the wife would inherit his one-half interest.
* Her original basis of $10,000 would also be stepped-up to $90,000 for a new basis in the home of $180,000.
Spouses who live in a community property state will include 50% of the FMV of the couple’s property in the decedent spouse’s gross estate, and the surviving spouse will inherit one-half of the property if it was left to the spouse in the will.
* The surviving spouse will have a complete step-up in basis at the first spouse’s death, because their one-half of the original basis and the decedent’s one-half of the property included in the gross estate are stepped up to FMV.
Describe Gross Estate for Jointly Owned Property with non-spouses
For property held as a JTWROS with a non-spouse, then the percentage-of-contribution rule would apply.
* The rule is that 100% of jointly-held property is includable in the estate of the first joint owner to die, except to the extent the survivor can prove contribution with funds that were not acquired by gift from the decedent.
* For example, if a brother paid 25% for a condo and his sister paid 75%, then when the brother dies only 25% of the FMV of the condo is included in the brother’s estate.
When property is owned with others as a tenancy-in-common, then only the deceased tenant’s fractional share of the property is included in the tenant’s estate.
* For example, four friends owned property together in different amounts. Roger owned 1/5 of the property therefore only 1/5 of the FMV of the property was included in Roger’s gross estate when he died.
Describe Gross Estate for Dower and Curtesy Interest (IRC 2034)
The value of the gross estate shall include 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 curtesy, or by virtue of a statute creating an estate in lieu of dower or curtesy.
Under the common law system, a surviving spouse has dower or curtesy rights.
* Dower is defined as the widow’s property rights under state law.
* Curtesy is defined as the widower’s property rights under state law.
* Community property states do not apply dower or curtesy rules.
* Most U.S. states have abolished the common-law dower and curtesy statutes and have in place other laws that treat both husband and wife identically, that is, the elective share, or statutory share statutes.
* However, what is important about IRC Section 2034 is the fact that the gross estate is not reduced by the value of any dower or curtesy interest.
* The value of these assets will be included in the decedent’s gross estate.
Describe Gross Estate for Certain Property Transferred (IRC 2035)
In general, a gift of property results in having that property permanently removed from the donor’s gross estate.
* Any future appreciation on that property is transferred to the new owners and will not be included in the donor’s gross estate either.
In some circumstances, gifts made within three years of death are included back into the donor’s gross estate to calculate the estate tax liability.
* However, this only applies for certain types of property transfers.
* In other words, not all property transferred within three years of death will have a value that is included in the decedent’s gross estate.
* It is important to know what types of property is permanently removed, and which types of property are included back in, under the “three year rule.”
Which types of transfers would cause a gift made by the decedent to be included back in his gross estate?
There are certain situations that would cause a gift made by the decedent to be included back in his gross estate.
- The donor created a life estate and gifted the remainder interest. The FMV of the life estate is included in the life tenant’s estate because the decedent had too much control over the property during lifetime and chose the remainder beneficiary of the property.
- The donor kept a reversionary interest in property he gifted away. Because the donor retained the right to take the property back in the future, he retained too much control over the property and the value of the reversionary interest is included back in his estate.
- This assumes that the reversionary interest is greater than 5% since the right to regain or dispose of the property must be worth actuarially more than 5% of the property’s value.
- A grantor creates a revocable trust and transfers property to the trust. Because the grantor could revoke the trust, the value of the trust is included in his gross estate.
The donor or grantor can relinquish these property interests by giving up the life estate or the reversionary interest, or by making the revocable trust irrevocable.
* This will avoid inclusion in the grantor’s gross estate if he outlives that transfer for more than three years.
What types of transfers will the three-year date of death rule apply?
The types of transfers to which the three-year date of death rule will apply include the following:
* An interest in property that would be included in the gross estate under IRC Sections 2036, 2037, and 2038.
For example, the decedent relinquished a life estate in property or a right to lifetime income from a trust, within 3 years of death (Section 2036).
The decedent gave up a reversionary interest in property or trust corpus within 3 years of death (Section 2037).
The decedent relinquished a right to revoke, alter or amend a transfer within 3 years of death (Section 2038).
- A transfer of a life insurance policy to which IRC Section 2042 would apply.
For example, let’s assume A is the owner and the insured of a life insurance policy with a death benefit of $1 million.
For estate planning purposes, it is recommended that the policy be gifted into an irrevocable life insurance trust, an ILIT. A dies a year after the policy has been gifted into the trust. What is included in A’s gross estate? Since A made a gift of the life insurance policy within 3 years of A’s death, the full $1 million death benefit of the policy would be included in A’s gross estate.
Note that an owner of a life insurance policy who is not the insured can transfer this policy and not be subject to the 3-year rule. - Any gift tax liability paid within three years of the decedent’s death. For example, B makes a taxable gift of $1 million after using his $12,920,800 (2023) lifetime exemption, pays a gift tax of $400,000 ($1,00,000 x 0.40), and dies 2 years later. Although the $1 million gift is excluded from B’s gross estate, the $400,000 gift tax liability, which was paid, would be included in the gross estate.
Describe Gross Estate for Retained Life Estate (IRC 2036)
The gross estate includes the value of property the decedent has gifted away over which the decedent retained or reserved:
* The right to use, possess, or enjoy the property, or receive income during lifetime. (e.g., a mother creates a life estate in her home to live there until her death and gifts the remainder interest in her home to her son. The FMV of the property will be included in her gross estate at death.)
* The right to designate who would use, possess or enjoy the property. (e.g., the decedent, as trustee of an irrevocable trust, had discretion to decide which beneficiary could receive income or corpus from the trust.)
If either of the above rights had been retained by the decedent, in order for an asset to be included in the gross estate under 2036, the right must have been retained by the decedent for:
* Life
* Period not ascertainable without reference to death
* Period that does not end before the decedent’s death
Example (Full Rights Retained by Decedent)
Mom transfers 1,000 shares of stock to her daughter and reserves the right to receive the income from all 1,000 shares.
* When Mom dies, since she retained the right to the income from all 1,000 shares during her lifetime, __ ____??____ __% of the value of the shares will be included in Mom’s gross estate.
Mom transfers 1,000 shares of stock to her daughter and reserves the right to receive the income from all 1,000 shares.
* When Mom dies, since she retained the right to the income from all 1,000 shares during her lifetime, 100% of the value of the shares will be included in Mom’s gross estate.
Example (Partial Rights Retained by Decedent)
Mom transfers 1,000 shares of stock to her daughter and reserves the right to receive income from only 500 shares of stock.
* When Mom dies, since she only retained the right to receive income from 500 shares of stock, __ ____??____ __ will be included in her gross estate.
Mom transfers 1,000 shares of stock to her daughter and reserves the right to receive income from only 500 shares of stock.
* When Mom dies, since she only retained the right to receive income from 500 shares of stock, only the value of the 500 shares will be included in her gross estate.
What is the The Rationale for IRC 2036?
The rationale for including this type of lifetime transfer is that the right to enjoy or control property or designate who will receive the property or its income is characteristic of ownership.
Describe Gross Estate for Transfer at Death (IRC 2037)
The value of property, which has been transferred, must be included in the gross estate if the donee’s possession and enjoyment of the property is contingent upon surviving the decedent.
A Section 2037 transfer includes in the decedent’s gross estate the value of the property transferred if:
* The donee must survive the decedent.
* The decedent retained a reversionary interest in the property worth more than 5% of the value of the transferred property immediately before death.
Example #1 Application of Section 2037
Albert makes an irrevocable transfer into trust for his spouse. His spouse is to receive income from the trust for life. Upon the spouse’s death, the remainder of the trust will pass to Albert, if living, otherwise to Albert’s children. Albert dies in the current year.
What is included in Albert’s estate?
* The interest to Albert’s children __ ____?? would / would not____ __ be included in Albert’s estate because it is contingent upon the children surviving Albert.
* In other words, if his spouse dies, Albert has a reversionary interest in the property.
* Assuming the value of this reversionary interest satisfies the 5% requirement, the value of the reversionary interest __ ____?? would / would not____ __ be included in Albert’s estate.
* Since the spouse had a life estate in the income from the trust, the value of the spouse’s lifetime interest in the property __ ____?? would / would not____ __ be included in Albert’s gross estate.
Albert makes an irrevocable transfer into trust for his spouse. His spouse is to receive income from the trust for life. Upon the spouse’s death, the remainder of the trust will pass to Albert, if living, otherwise to Albert’s children. Albert dies in the current year.
What is included in Albert’s estate?
* The interest to Albert’s children would be included in Albert’s estate because it is contingent upon the children surviving Albert.
* In other words, if his spouse dies, Albert has a reversionary interest in the property. A
* ssuming the value of this reversionary interest satisfies the 5% requirement, the value of the reversionary interest would be included in Albert’s estate.
* Since the spouse had a life estate in the income from the trust, the value of the spouse’s lifetime interest in the property would not be included in Albert’s gross estate.
Example #2 Application of Section 2037
Brandi transfers property into a trust for her child’s benefit. The child is to receive income from the trust for a lifetime. Upon the child’s death, assets then remaining in the trust will transfer to the grandchildren, if alive, if not then to Brandi or Brandi’s estate. Brandi dies in the current year.
* What portion of this trust will be included in Brandi’s estate under Section 2037?
- Since either the child or the grandchildren could take from the trust without surviving Brandi, the requirements of Section 2037 have not been satisfied.
- Therefore, regardless of the reversionary interest to Brandi, there is no inclusion of assets in Brandi’s gross estate.
This is often called the “But if…back to…” section because it will not be operative unless the transferring document provides wording to the effect of: “But if the donee does not survive the donor, the property comes back to the donor.”
Define Reversionary Interest
The right to regain the property is called a reversionary interest.
* To cause inclusion, the actuarial value of the transferor’s reversionary interest must be significant.
* Stated more precisely, the right to regain the property, or the right to dispose of it, must be worth actuarially more than 5% of the property’s value.
Example (Reversionary Interest Application)
During his lifetime, Stuart transferred property to his wife, Mona, for her lifetime. Upon Mona’s death, the property was to return to Stuart if he was living. If he was not living, the property was to go to Stuart’s daughter, Ellen. What is the outcome if Stuart dies before Mona?
* Stuart’s daughter can obtain possession or enjoyment of the property only if she survives Stuart.
* Stuart retained a reversionary interest under the original transfer. If Stuart’s reversion is worth more than 5% of the value of the property he placed in a trust, the value of the remainder interest will be includable in Stuart’s estate. Such a transfer is includable because it is considered to be, in substance, a substitute for disposing of the property by will.
During his lifetime, Stuart transferred property to his wife, Mona, for her lifetime. Upon Mona’s death, the property was to return to Stuart if he was living. If he was not living, the property was to go to Stuart’s daughter, Ellen. What is the outcome if Stuart dies before Mona?
* Stuart’s daughter can obtain possession or enjoyment of the property only if she survives Stuart.
* Stuart retained a reversionary interest under the original transfer. If Stuart’s reversion is worth more than 5% of the value of the property he placed in a trust, the value of the remainder interest will be includable in Stuart’s estate. Such a transfer is includable because it is considered to be, in substance, a substitute for disposing of the property by will.
Section 1 - Gross Estate Assets Summary
The gross estate, the starting point for the computation of the estate tax, is composed of the value of the decedent’s interest in all property. The types of property whose value is included in the gross estate include tangible and intangible, and real as well as personal. Additionally, outright ownership of property is not required for its value, or a portion thereof, to be included in the gross estate.
In this lesson, we have covered the following:
* Property owned outright: Defined in IRC Section 2033 as includable in the decedent’s gross estate if it was beneficially owned by the decedent and transferred at death by his or her will or state intestacy laws. It is only the value of the property owned by the decedent and transferred at the decedent’s death which will be included in the gross estate. This includes the value of all real and personal property. It does not include property in which the decedent possessed just the bare legal title but had no beneficial interest.
* Jointly owned property: If owned by spouses, then 50% of the FMV of the property is included in the deceased spouse’s estate. If owned by non-spouses, the percentage-of-the-contribution rule applies.
* Dower and Curtesy interest: The interest of the surviving spouse in the real property owned by the decedent under common law in certain states of the U.S. where it is applicable. IRC Section 2034 defines that this interest is includable in the decedent’s gross estate.
- Three-year rule and exceptions: Certain property transferred as gifts within three years of the death of the decedent are not generally includable in gross estate according to IRC Section 2035. The exceptions to this rule are transfers in which the decedent had retained certain interest or power over the gifted property such as IRC Section 2036 retention of life estate, IRC 2037 transfers taking effect at death, IRC Section 2038 revocable gifts, and IRC Section 2042 life insurance policies.
- Property with a retained life estate: Property identified under IRC Section 2036 is includable in the decedent’s gross estate. When a decedent gives away property during his or her lifetime but retains some control over or interest in the property, the property is generally included in the gross estate. The rationale behind the IRC is that the decedent retained the right to enjoy or control property or designate who will receive the property or its income. This right is characteristic of ownership.
- Transfer at death: Property specified in IRC Section 2037 is includable in the decedent’s gross estate. The value of the property transferred and not the value of the interest retained will be includable. Property to which this section applies is that which the donee can begin to enjoy only by surviving the decedent. Since the decedent may have the right to regain the property during their lifetime, this right to regain is known as a reversionary interest.
The late Mr. Daniel Sherwood bequeathed his property to his niece as “To Sandra Sherwood for life, remainder to her issue and if no issue then to the American Red Cross.” Sandra died childless this year. At the time of Sandra’s death: (Select all that apply)
* Sandra’s life estate terminated.
* The property ownership was transferred to her issue according to her uncle’s will.
* Sandra did not own the property.
* The property interest must be included in her gross estate.
Sandra’s life estate terminated.
Sandra did not own the property.
* Under IRC Section 2033, no inclusion is required for property in which the decedent’s interest was obtained from someone else and was limited to lifetime enjoyment.
* Estate tax is a tax on the transfer of property at death. This means that if an interest terminated at the decedent’s death and the decedent had no right to transfer at death, its value will not be included.
* Sandra did not have anything that she could transfer.
* Her life estate, by its terms, terminated with her death so there was nothing to transfer.
* Though Sandra had an interest in the property at the time of her death, it was not a property interest that she could pass to someone else.
A When Sharon was 68, she was diagnosed as having terminal cancer. Doctors gave her a life expectancy of just eight months, with little hope of a cure. She had four children to whom she gifted the property that she owned outright. She died a year later. Which of her properties that she gifted as follows would be includable in the gross estate? (Select all that apply)
* Her villa to Stephanie, retaining life estate
* Her country house to Martha, for life, at Martha’s death, it returns to Sharon, unless Sharon is dead, then remainder to Martha’s issue
* Her shares in Oracle Corp., to Winston, retaining power to revoke
* Her garment factory to Leyland
Her villa to Stephanie, retaining life estate
Her country house to Martha, for life, at Martha’s death, it returns to Sharon, unless Sharon is dead, then remainder to Martha’s issue
Her shares in Oracle Corp., to Winston, retaining power to revoke
- As per IRC Section 2035, gifts made within three years of death are not includable.
- The exceptions are properties includable under IRC Sections 2036, 2037, 2038 or 2042.
- The villa falls under Section 2036 because Sharon retains life estate.
- The country house as life estate falls under Section 2037 because it is contingent that Martha be alive to enjoy the gift, with Sharon still retaining a right to regain the property personally.
- Her shares in Oracle Corp., fall under Section 2038 because Sharon retained the power to revoke.
- Therefore, these three properties-the villa, country house and Oracle shares-are includable in the gross estate.
- The only property that is not includable is the garment factory, which was a complete gift.
A dower is the right of:
* The surviving wife to an interest for life in one-fourth of all real property owned by her husband during their marriage.
* The surviving wife to an interest for life in all of the real property owned by her husband during their marriage.
* The surviving husband to an interest for life in one-fourth of all real property owned by his wife during their marriage.
* The surviving husband to an interest for life in all of the real property owned by his wife during their marriage.
The surviving wife to an interest for life in all of the real property owned by her husband during their marriage.
* Under the common law system, marriage creates a spousal interest in the real property owned by the decedent.
* Dower is the right of the surviving wife to an interest, for life, in all of her husband’s real property.
* The right of the husband to an interest for life in all of the real property owned by his wife during their marriage is called curtesy.
Section 2 - Determining the Value of Gross Estate
Let us continue with the remaining Sections of the IRC dealing with the assets to be included in the gross estate. Remember, unless the IRC specifically excludes property, the total value of all assets or interests in assets over which the decedent held an element of control will be included in the decedent’s gross estate. Additionally, these assets include the treatment of property that has been transferred over that the decedent retained the right to revoke and assets over which the decedent held a general power of appointment. We will also cover how annuities, life insurance, and jointly-owned assets are treated for gross estate inclusion purposes.
To ensure that you have a thorough understanding of other IRC Sections, the following topics will be covered in this lesson:
* Revocable Transfer (IRC 2038)
* Annuities (IRC 2039)
* Jointly-Owned Property (IRC 2040)
* Power of Appointment (IRC 2041)
* Life Insurance (IRC 2042)
* Estate of Surviving Spouse where Marital Deduction previously allowed (IRC 2044)
Upon completion of this lesson, you should be able to:
* Identify a revocable transfer
* Define an annuity
* Identify types of annuities
* List the qualifications that govern the inclusion of annuities in the gross estate.
* Describe the 50-50 rule applied to jointly-owned property
* Explain the percentage-of-contribution rule and its use
* Define power of appointment and its treatment in valuing the gross estate
* Specify the conditions under which life insurance is includable in the gross estate
* Discuss how a previously utilized marital deduction impacts the gross estate of the surviving spouse
Describe Gross Estate for Revocable Transfer (IRC 2038)
A revocable transfer is a transfer of property in which the decedent retained the right to alter, amend, revoke or terminate the gift.
* When a grantor creates an irrevocable trust but can decide whether to accumulate trust income or distribute it to trust beneficiaries, the grantor retains a right to alter or amend a transfer.
* When a grantor establishes a revocable trust, the grantor retains a right to revoke or terminate a transfer.
The gross estate of the decedent will include the value of the property subject to this power.
IRC Section 2038 would apply regardless of whether the decedent retained the said power alone or together with others. Only the value of property subject to this power will be included in the gross estate, not the entire value of the transferred property.
What’s Included in Gross Estate for Revocable Transfer (IRC 2038)
The courts have broadly interpreted revocable transfers. For example, the mere power retained by the donor to vary the timing of when a beneficiary will receive an interest will cause inclusion, even if the beneficiary cannot forfeit the interest.
There are, however, exceptions for inclusion in the gross estate for transfers that would otherwise qualify as revocable transfers. These exceptions include the following:
* If the decedent’s power can only be exercised with the consent of all of the parties having an interest in the transferred property, and
* If the power retained by the decedent adds nothing to the rights of the parties under local law, or
* If the prohibited power is retained, it is subject to an ascertainable standard.
An ascertainable standard is an external standard that limits the decedent’s exercise of a power for the health, education, maintenance, or support (HEMS) of a beneficiary.
* Therefore, even if the decedent held a prohibited power, if this power was limited by an ascertainable standard, the value of the assets over which this power was held would not be included in the decedent’s gross estate.
Example #1 (Estate Inclusion Scenario)
Larry creates a trust with Larry as the trustee. Larry has retained the power to revoke the trust. Larry has transferred $1 million of property into the trust. Larry dies. Since Larry has the right to revoke the trust,
* __ ____??____ __ of property will be included in Larry’s estate.
- the full $1 million of property will be included in Larry’s estate.
Example #2 (Estate Inclusion Scenario)
Larry creates a trust with Erica as the trustee. Larry retains the power to name a successor trustee or to remove a current trustee and appoint a new trustee including himself. Larry has transferred $1 million into the trust. Larry dies.
* Since Larry had the right to remove and appoint a new trustee, including Larry, how much will be included in Larry’s estate?
- Since Larry had the right to remove and appoint a new trustee, including Larry, which may have impacted the beneficiaries’ right to enjoy the timing of the trust benefits, the full $1 million will be included in Larry’s estate.
Example (Ascertainable Standard Application)
Alice transfers property into trust with income to Bradley, remainder to Coretta. Alice retains the power to invade the trust principal for Bradley’s health, support, maintenance, and education (the ascertainable standard).
* Even though Alice has retained the right to affect the timing of Bradley’s enjoyment of the property, the value of the property over which Alice retains the power to revoke __ ____?? will / will not____ __ be included in Alice’s gross estate.
- Even though Alice has retained the right to affect the timing of Bradley’s enjoyment of the property, since it is limited by an ascertainable standard, the value of the property over which Alice retains the power to revoke will not be included in Alice’s gross estate.
There are, however, exceptions for inclusion in the gross estate for transfers that would otherwise qualify as revocable transfers. These exceptions include the following:
* If the decedent’s power can only be exercised with the consent of all of the parties having an interest in the transferred property, and
* If the power retained by the decedent adds nothing to the rights of the parties under local law, or
* If the prohibited power is retained, it is subject to an ascertainable standard.
An ascertainable standard is an external standard that limits the decedent’s exercise of a power for the health, education, maintenance, or support (HEMS) of a beneficiary.
* Therefore, even if the decedent held a prohibited power, if this power was limited by an ascertainable standard, the value of the assets over which this power was held would not be included in the decedent’s gross estate.
Describe Gross Estate Calculation for Annuities (IRC 2039)
The general rule is that the gross estate includes the present value of an annuity or other payment receivable by a beneficiary as a result of surviving the decedent.
An annuity is defined as payments, or the decedent’s right to receive payments, that do not terminate upon the decedent’s death.
* In other words, they include periodic payments over a specified period of time under an enforceable contract where the decedent had the right to the payment.
* An annuity under IRC Section 2039 also includes the decedent’s right to receive future benefits.
What is an Annuity?
An annuity is a contract entered into whereby one party agrees to pay another, the annuitant, a series of payments over a period of time.
* An annuity is defined as a systematic liquidation of principal and interest.
* It might be a life annuity where payments are made for the life of the annuitant, or it might be a term certain annuity where payments are made over a period of years.
* A very common example of an annuity is pension income.
Go to http://www.sec.gov/answers/annuity.htm and read the page.
After reviewing the above link, you should be able to answer the following questions:
What are the savings advantages of an annuity?
What are the advantages and disadvantages of an annuity?
An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.
Annuities typically offer tax-deferred growth of earnings and may include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments.
* While tax is deferred on earnings growth, when** withdrawals are taken from the annuity, gains are taxed at ordinary income rates, and not capital gains rates**.
* If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties.
There are generally three types of annuities — fixed, indexed, and variable. In a fixed annuity, the insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. The insurance company also agrees that the periodic payments will be a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index.
In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically mutual funds. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.
Variable annuities are securities regulated by the SEC. An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the SEC. Fixed annuities are not securities and are not regulated by the SEC. You can learn more about variable annuities by reading our Updated Investor Bulletin: Variable Annuities.
Describe Gross Estate Calculation for Annuities (IRC 2039)
Annuities are broadly classified into two types:
* Commercial annuities
* Private annuities
The person or entity who assumes the obligation for a private annuity is not in the business of selling annuities, in contrast to commercial annuities.
* Further, commercial annuities are usually funded with cash, while private annuities are often funded with various types of property, such as real estate or corporate stock.
* Commercial annuity companies use standard actuarial tables to determine their payout terms, whereas a private annuity may determine its payout terms according to many other factors.
If the decedent owned a commercial annuity on the date of death, the gross estate would include the cost of a comparable contract sold by the issuing insurance company on the decedent’s date of death.
* (In other words, the replacement value of the annuity.)
* The value of the survivorship interest in a commercial annuity is the amount that the same insurance company would charge for a single annuity on the survivor at the time of the first annuitant’s death.
* The value of survivorship in a private annuity is determined using government valuation tables.
Example (Present Value of an Annuity)
Steve purchased a private annuity that would pay him $20,000 a year for life and, upon his death, would pay his wife, Jayne, $10,000 a year for as long as she lives.
* If Steve died before Jayne this year, the present value of future annuity payments to Jayne __ ____?? would / would not____ __ be includable in his gross estate.
* Using the government valuation table called Table S, if Jayne were aged 55 when Steve died, and a 6% rate (as specified in Section 7520) was applicable, the annuity would have a present value at that time of $118,459.
Steve purchased a private annuity that would pay him $20,000 a year for life and, upon his death, would pay his wife, Jayne, $10,000 a year for as long as she lives.
* If Steve died before Jayne this year, the present value of future annuity payments to Jayne would be includable in his gross estate.
* Using the government valuation table called Table S, if Jayne were aged 55 when Steve died, and a 6% rate (as specified in Section 7520) was applicable, the annuity would have a present value at that time of $118,459.
This inclusion provision applies not only to commercial, joint and survivor annuities but also to certain other types of payments made under a contract or agreement to the survivor(s) of the decedent.
