Bryant - Course 6. Estate Planning. 5. Estate Tax Calculations

Question 1

Module Introduction

Most people keep themselves well-informed about the latest trends in investing and personal finance because they desire to save and invest their hard-earned money wisely. Over the years they may accumulate a substantial amount of assets. Someday they will want to pass these assets on to their children, charitable organizations, or other beneficiaries.

A properly executed estate plan is essential to ensure that their wishes for the future become a reality. Some may feel they are not wealthy enough to worry about estate planning. Others cringe at the thought of estate planning because it involves death. Nevertheless, there is value in estate planning for practically everyone. Even individuals with only modest wealth should be concerned with preserving as much of their assets as possible by minimizing estate taxes and/or the other expenses associated with death.

Answer 1

Without proper planning, more than 40% of a person’s estate assets could be lost to federal estate taxation, income tax, and other expenses. There are steps that can be initiated prior to death to avoid most or all of these expenses. Although estate planning can be a complicated process, the efforts taken to do planning today can reap great rewards in the future. Knowledge of the estate tax laws and tax reduction strategies is critically important for assessing an estate and implementing strategies to reduce the impact of the costs associated with the probate process, tax burdens, and related administrative expenses.

The Estate Tax Calculations module, which should take approximately four hours to complete, will explain the formula for computing the federal estate tax.

Upon completion of this module, you should be able to:
* Define federal estate tax
* Calculate the federal estate tax
* Understand what assets make up the gross estate
* Calculate adjusted gross estate
* List the tax credits available for estate tax
* Determine net estate tax
* Articulate the methods by which the estate tax may be paid

Question 2

Module Overview

The first step in calculating the federal estate tax is to measure the value of the decedent’s gross estate. The gross estate is the value of all property or interests in property owned or controlled by the decedent. The gross estate, less allowable funeral and administration expenses, as well as certain debts, taxes, and losses, is referred to as the adjusted gross estate.

Next, allowable deductions (e.g., charitable and/or marital deductions), if any, are subtracted from the gross estate, resulting in the taxable estate.

To arrive at the tentative estate tax base, the value of the estate on which the tentative estate tax will be calculated, the aggregate of all post-1976 adjusted taxable gifts is added to the taxable estate. On this tentative tax base, the tentative estate tax is calculated.

From the tentative tax, all gift tax paid on the post-1976 gifts is subtracted.

Answer 2

We then arrive at the estate tax payable before the tax credits. The tax credits are as follows:
* the unified credit
* the state death tax credit
* credit for any foreign tax paid
* credit for prior transfers made within 10 years

After applying all of the applicable credits to the tentative federal estate tax, we arrive at the net federal estate tax due.

To ensure that you have a thorough understanding of how to calculate the estate tax, the following lessons will be covered in this module:
* Computing the Estate Tax
* Adjusted Gross Estate

Question 3

Section 1 - Computing the Estate Tax

Before we can calculate the estate tax, we need to determine the value of the gross estate-the first step in the estate tax calculation process. The gross estate will include the fair market value of any assets over which the decedent held any element of control. Outright ownership of property is not required for its value to be included in the gross estate.

To ensure that you have a thorough understanding of how to calculate the estate tax, the following topics will be covered in this lesson:
* Defining the Estate Tax
* Ascertaining the Gross Estate

Answer 3

Upon completion of this lesson, you should be able to:
* Define the estate tax
* List the five steps in calculating the estate tax
* Explain how the gross estate is ascertained
* Describe the rationale for including post-1976 adjusted taxable gifts into the calculation to determine the tentative tax base
* Identify when the marital and charitable deductions would apply to reduce the value of the adjusted gross estate
* Calculate the estate tax
* Explain the difference between the estate tax exclusion amount and the unified credit

Question 4

Define Estate Tax

Answer 4

The federal estate tax is a tax on the transfer of property when a person dies. It is measured by the value of the property rights that are shifted from the decedent to others. It is a tax on the right to transfer property or an interest in property, rather than a tax on the right to receive property, which is the basic characteristic of an inheritance tax.

It is important to recognize that the estate tax is not limited to property actually transferred by the decedent at death.
* To thwart tax avoidance schemes, the tax is levied on certain lifetime transfers that are essentially testamentary dispositions (i.e., transferred at death), and on transfers over which the decedent retained certain interests or powers.

The estate tax is tax inclusive. This means that the tax is levied upon all property that is included in the estate, including the amount used to pay the estate tax.

Question 5

What are the 5 steps to calculate federal estate tax?

Answer 5

The federal estate tax is calculated in five steps:
* Determining the value of the gross estate.
* Arriving at the adjusted gross estate.
* Determining the taxable estate.
* Calculating the federal estate tax payable before credits.
* Applying the allowable credits to arrive at the net federal estate tax.

The resulting federal estate tax is usually payable by the decedent’s executor on the date the return is due, which is within nine months of the decedent’s death.

Each stage mentioned above is illustrated on the Federal Estate Tax Form, which may be useful in following the flow of dollars from the gross estate to the net federal estate tax payable.

Question 6

How do you Determine the Value of the Gross Estate?

Answer 6

The value of the gross estate, the first step in the process of calculating the estate tax, is the fair market value of:
* Property owned outright by the decedent.
* Certain property transferred gratuitously within three years of death, as well as any gift tax paid within three years of death.
* Certain lifetime transfers where the decedent retained the income or control over the income from the property transferred.
* Certain gratuitous lifetime transfers where the transferee’s possession or enjoyment of the property is conditioned on surviving the decedent.
* Gratuitous lifetime transfers over which the decedent retained the right to alter, amend or revoke the gift.
* Annuities or similar arrangements purchased by the decedent and payable for life to both the annuitant and to a specified survivor.
* Certain jointly held property where another party will obtain the decedent’s interest at death by survivorship.
* General powers of appointment.
* Life insurance in which the decedent possessed incidents of ownership or which was payable to or for the benefit of the decedent’s estate.
* QTIP in the estate of the surviving spouse.

Question 7

Practitioner Advice:

Practitioner Advice: As you may recall, we discussed each of these sections in the Gross Estate section of this course. Each of the assets listed above is specifically included in the gross estate under IRC Sections 2033 - 2042. Additionally, in determining the value of the gross estate, the general rule is the fair market value of the asset on the date of death, or the alternate valuation date if so elected by the personal representative (the executor or the administrator) of the estate.

Question 8

What types of property owned by a decedent outright at death are includable?

Answer 8

• All types of property owned by a decedent outright at death are includable.
• 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.

Question 9

Describe The 50-50 rule

Answer 9

The 50-50 rule provides that only 50% of certain property titled and held jointly by the decedent and spouse with rights of survivorship, or as tenants by the entirety, will be includable in the decedent’s estate. This is regardless of the size of his or her contribution. This rule applies to property interests included in the decedent’s estate.

This 50-50 rule applies to both real and personal property regardless of how it was acquired or when it was purchased. However, it can be used only in the case of a joint tenancy between spouses or a tenancy by the entirety and if the joint interest was created after 1976.

Qualified spousal property applies to probate and non-probate property and includes 50% of property held as JTWROS between spouses and 50% of property held as Tenants by the Entirety.

Question 10

What date are federal estate taxes based on the fair market value of the transferred property?

Answer 10

Generally, federal estate taxes are based on the fair market value of the transferred property as of:
* The date the decedent died, or
* An alternate valuation date, which is six months after the date of the decedent’s death.
The alternate valuation date (AVD) is designed to alleviate hardship where there is a sudden and sharp decline in the value of the estate’s assets six months after death. This provides relief for a decedent who dies when his estate has a temporarily high market value which later declines due to changes in market conditions. The executor will elect the alternate valuation date on the estate tax return Form 706 when a significant portion of the estate assets have decreased in value.

The election can be made if both the value of the decedent’s gross estate and the estate tax liability is lower than the amounts calculated at the decedent’s date of death. Therefore, if the decedent’s entire estate passes to the surviving spouse through the marital deduction, then the alternate valuation date could not be used since there would be no estate tax liability. Use of the alternate valuation date results in a lower stepped-up basis for the assets transferred to the decedent’s heirs, which could result in higher capital gains taxes if the heirs sell the assets in the future.

If the AVD election is made by the executor on Form 706 and certain assets are sold within the 6-month window following the decedent’s death, they will be valued as of the date of sale.

Question 11

Describe valuation of property disposed of within 6 months of decendent’s date of death

And how to calulation valuation on property that diminishes over time

Answer 11

If the alternate valuation date is elected for a decedent and the property is distributed, sold, exchanged, or otherwise disposed of within six months after the decedent’s death, the asset disposed of will be valued as of the disposition date, not the six-month date.

Certain types of property diminish in value as time goes on.
* For instance, the present value of an annuity reduces each time a payment is made.
* Therefore, the alternate valuation date is not available for any asset whose value is affected by the mere passing of time.
* For these assets, the general fair market value on the date of death rule is applied.

Question 12

Section 1 - Computing the Estate Tax Summary

The federal estate tax is a tax on the transfer of property at death that was reinstated in 2011. The calculation of the estate tax involves five steps: (1) determining the value of the gross estate, (2) computing the adjusted gross estate, (3) arriving at the taxable estate, (4) calculation of the federal estate tax payable before credits, and (5) application of the allowable credits to finally arrive at the net federal estate tax.

In this lesson, we have covered the following:

Answer 12

• The estate tax is defined as a tax on the right to transfer property or an interest in property. It is calculated on the value of property included in the gross estate. The net federal tax owed is calculated by valuing the gross estate and then deducting from this value the administration and funeral expenses, claims against the estate such as taxes owed by the decedent prior to death, outstanding obligations, marital deductions, charitable contributions, and casualty and theft losses. To this amount, the appropriate tax rates and allowable tax credits are applied.
• Ascertaining the gross estate must be done before estate tax can be calculated. The value of the gross estate is the fair market value of all property in which the decedent had an ownership interest at the time of his or her death. The value of the gross estate is determined as of the date of death or, if an alternative valuation method is elected, up to six months after the date of death.

Question 13

Arnold picked up a booklet at his attorney’s office that had a section on computing federal estate tax. Some of the steps in the computation were in the wrong order. Select the correct order.
I. gross estate value
II. adjusted gross estate
III. estate tax payable before credits
IV. taxable estate
V. net federal estate tax.
* I, II, IV, III, V.
* II, I, V, III, IV.
* IV, I, V, III, II.
* V, I, III, II, IV.
* III, I, II, IV, V.

Answer 13

I, II, IV, III, V.

The correct sequence for computation of federal estate tax is as follows:
* gross estate value
* adjusted gross estate
* taxable estate
* estate tax payable before credits
* application of allowable credits to equal the net federal estate tax.

Question 14

Which of the following properties are NOT includable in the gross estate? (Select all that apply)
* Property owned outright by decedent at the time of his or her death.
* Property gifted within three years of death of decedentYou correctly checked this.
* Annuities payable for life to both annuitant and a specified survivor
* Life insurance in which the decedent possessed incidents of ownership
* Property to which decedent holds the legal title but has no beneficial interest

Answer 14

Property to which decedent holds the legal title but has no beneficial interest
* Property gifted within three years of the death of the donor is generally not included in the gross estate. The exceptions are found in IRC Section 2035 and pertain to relinquishing life estates, reversionary interests, revocable trusts, and life insurance policies owned by the insured.

Question 15

Section 2 - Adjusted Gross Estate

Before we can determine the net amount of the federal estate tax due, we need to calculate the value of the adjusted gross estate. The adjusted gross estate equals the value of the gross estate less funeral expenses, administration expenses, debts, and any casualty losses.

However, the calculation of the adjusted gross estate does not allow us to calculate the tax-it is the beginning of arriving at the taxable estate, which equals the adjusted gross estate less any marital or charitable deductions. Finally, the appropriate tax rates and relevant tax credits are applied to arrive at the net estate tax.

To ensure that you have an understanding of the adjusted gross estate, the following topics will be covered in this lesson:
* Determining the Gross Estate
* Determining the Taxable Estate
* Determining the Net Estate Tax
* Payment of the Estate Tax

Answer 15

Upon completion of this lesson, you should be able to:
* Determine adjusted gross estate,
* Specify the method for determining taxable estate,
* List the deductions available from the adjusted gross estate to arrive at the taxable estate,
* List the tax credits applicable against the estate tax,
* Calculate net estate tax, and
* State the procedure for payment of estate tax.

Question 16

What are the three categories deductions fall into?

Describe administrative expenses

Answer 16

Once the gross estate is calculated, certain deductions are allowed in arriving at the adjusted gross estate. These deductions fall into three categories:
* Funeral and administrative expenses,
* Debts including certain taxes, and
* Casualty and theft losses.

Administrative expenses refer to the costs of administering property that is includable in the decedent’s gross estate. Essentially this means the expenses incurred in:
* The collection and preservation of probate assets,
* The payment of estate debts, and
* The distributing of probate assets to estate beneficiaries.
Such expenses include:
* Court costs,
* Accounting fees,
* Appraisers’ fees,
* Brokerage costs,
* Executors’ commissions, and
* Attorneys’ fees.

Administrative expenses vary widely from location to location and depend on the size of the estate and the complexity of the administrative problems involved. Deductions cannot exceed the amount allowed by the laws of the jurisdiction under which the estate is being administered. Certain administration costs may be deducted from either the federal estate tax return (Form 706) or from the estate’s income tax return (Form 1041). The estate executor has the option of electing either one or a combination of both.

Generally, the executor will elect to deduct attorneys’ fees and executors’ commissions from the return in which the tax rates are higher. This will result in an overall tax saving. However, a deduction on the income tax return, as opposed to the estate tax return, or vice versa, may result in favoring one beneficiary or group of beneficiaries over another.

Question 17

Describe Debts including certain taxes deduction

Answer 17

Bonafide debts are deductible, including mortgages and other liens that were:
* Personal obligations of the decedent at the time of death, including any interest accrued to the date of death, and
* Founded on adequate and full consideration in money or money’s worth.
Mortgages are deductible if the decedent was personally liable and the full value of the property was includable in the estate. On the other hand, if the decedent had no personal liability for the payment of the underlying debt and the creditor would look only to the encumbered property for payment, the mortgage would result in a reduction in the value of the property subject to the mortgage.

In the case of community property, only those claims and expenses that were the decedent’s personal obligations are deductible in full. This means an allocation of claims and expenses must be made. As only one-half of the total community property is includable, only half of any obligation attributable to community property is deductible.

Certain taxes unpaid at the time of the decedent’s death are considered debts. Three common deductible taxes are:
* Income taxes unpaid but reportable for some tax period prior to the decedent’s death,
* Gift taxes that were not paid on gifts the decedent made sometime prior to death, and
* Property taxes that accrued but remained unpaid at the time of the decedent’s death.

Question 18

Describe deduduction of casualty and theft losses incurred by the estate.

Answer 18

Casualty and theft losses incurred by the estate are deductible if the loss arose from:
* Fire,
* Storm,
* Casualty losses, or
* Theft.

To be deductible, the loss must have occurred during the time the estate was in the process of settlement and before it was closed.
* Such deductions are limited in two respects.
The deduction is reduced to the extent that:
* Insurance or any other compensation is available to offset the loss, and
* A loss is reflected in the alternate valuation because an executor can elect to value assets in the estate either on the date of death or at the alternate date.

At the executor’s option, losses may be deducted from either the estate tax return or the estate’s income tax return. Typically, they are taken on the return where the deduction will result in the greatest benefit to the taxpayer.

Question 19

Funeral expenses, subject to certain limitations, are deductible. Deductions are generally limited to a reasonable amount. Identify all expenses that would be eligible for a deduction. (Select all that apply)
* Grave marker
* Transportation
* Interment
* Burial lot or vault
* Perpetual care of the grave site

Answer 19

Grave marker
Transportation
Interment
Burial lot or vault
Perpetual care of the grave site
* All of these items are eligible for a deduction.

Question 20

What 3 conditions reduce the adjusted gross estate?

Answer 20

Determining the Taxable Estate
The Internal Revenue Code (IRC) allows several deductions for properties that meet certain conditions. The taxable estate is determined by deducting these amounts from the adjusted gross estate.
The adjusted gross estate may be reduced by:
* A marital deduction,
* A charitable deduction, and
* A deduction for state death taxes

Question 21

Describe the Marital Deduction

Answer 21

The marital deduction reduces estate taxes when the first spouse dies, but this merely postpones estate taxation of the couple’s estate since the property will be taxed in the surviving spouse’s estate.

A marital deduction is allowed for property that fulfills the following conditions:
* The property must be included in the decedent’s gross estate.
* The property must pass at the decedent’s death to a surviving spouse.
* The property must be transferred in a qualifying manner. This means that it must be passed in a manner that gives the surviving spouse control and enjoyment essentially tantamount to outright ownership or that meets the requirements of QTIP.

The maximum amount allowable as a marital deduction for federal estate tax purposes is the net value of the property passing to the surviving spouse in a qualifying manner. Otherwise, there is no limit to the marital deduction.
An individual could conceivably transfer his or her entire estate to the surviving spouse estate tax-free.

In the past, this approach often created a scenario referred to as over-qualifying the decedent’s estate for excessive use of the marital deduction.
* If all of the decedent’s property passes to the surviving spouse through the marital deduction the decedent would not be able to use their unified credit amount to offset any estate taxes.
* Furthermore, all of the assets passing to the surviving spouse under the marital deduction will be included in the surviving spouse’s estate if not consumed prior to death.
* The surviving spouse will be unable to use a marital deduction to offset taxes in their estate unless he or she eventually remarries.

Under current estate law, however, over-qualifying is not as pervasive of an issue because at the death of the first spouse an election can be made to transfer any unused lifetime exclusion amount to the surviving spouse.
* This is known as a Deceased Spouse Unused Exclusion (DSUE) election.
* Unlike in the past, the unused portion of the lifetime exclusion is not forfeited if an unlimited marital deduction is used to the deceased’s entire estate tax-free to a surviving spouse.

Question 22

List Qualifying Property for the Marital Deduction

Answer 22

A marital deduction can be taken in the decedent’s estate equal to the value of the property that passes to the surviving spouse by:
* Will, intestacy, a will contest, or an election against the will.
* Property transferred to a surviving spouse via dower, curtesy, or nuptial agreements.
* Operation of law such as joint tenancy with right of survivorship (JTWROS) or by tenancy by the entirety. The value of the marital deduction is the 50% share of the decedent’s property included in their gross estate.
* General power of appointment over property interests given to the surviving spouse.
* Contracts such as life insurance proceeds payable to the surviving spouse when the decedent was the owner and insured or when the surviving spouse is named the new owner of a life insurance policy owned by the decedent who is not the insured.
* Pension benefits payable to the spouse as a joint and survivor annuity that was included in the decedent’s estate.
* IRAs that name the spouse as beneficiary.
* Property transferred into marital trusts such as Power of Appointment trusts, Q-Tip trusts, Estate trusts, or QDOTs.
* Life income interest from a charitable remainder trust.
* Lifetime income interest from a Pooled Income Fund when the executor elects Q-TIP treatment.
* Remainder interest given to a spouse from a charitable lead trust.
* Life estates given to the spouse when the executor makes a Q-TIP election or when the spouse is given a general power of appointment over the life estate property. Also, when the life estate is directed to pass to the surviving spouse’s estate at death.
* When both spouses die simultaneously and there is a presumption-of-survivorship clause in the will.
* When a bequest to a spouse is conditional upon the spouse surviving longer than 6 months after the decedent’s death, and the spouse outlives the 6-month period. If the spouse dies before the 6 month period ends, no marital deduction can be taken for that property interest.

Question 23

Describe what Qualified domestic trust (QDOT)

Answer 23

Although an unlimited federal marital deduction allows a decedent spouse to transfer assets to a surviving spouse without estate tax liability, the marital deduction only applies if the surviving spouse is a U.S. citizen.
* The unlimited marital deduction will not apply to an outright transfer of assets at death to a non-U.S. citizen spouse.
* In the event that the surviving spouse is not a U.S. citizen, the value of the decedent’s assets in excess of the estate tax exclusion amount will be subject to estate tax.
* However, under IRC Section 2056, the decedent’s estate will qualify for the federal marital deduction if assets transfer into a marital trust, referred to as a qualified domestic trust, or QDOT.
* A QDOT ensures that the assets will not ultimately leave the US without being taxed.

The citizen spouse can establish the QDOT as a living trust or through their will.
* At the spouse’s death, the executor would designate the trust as a QDOT on the federal estate tax return (Form 706).
* If the citizen spouse does not establish this trust the non-citizen spouse can establish their own QDOT before the decedent’s estate tax return is due.

Question 24

What are the requirements for establishing a QDOT?

Answer 24

The requirements for establishing a QDOT are:
* The trustee must be a US citizen or a domestic corporation, or a US bank if trust assets exceed 2 million,
* The trust must retain sufficient assets to cover the non-citizen’s spouse’s estate taxes,
* The trust must be set up as a QTIP trust or an Estate Trust, and
* The trustee must approve all distributions of principal, and withhold estate taxes from principal distributions that are not subject to an ascertainable standard (HEMS).
* A disadvantage to transferring assets into a QDOT is that the assets remaining in the trust at the non-citizen spouse’s death are calculated and taxed as if they had been included in the citizen spouse’s estate. However, non-citizen spouses can use their applicable credit amounts to offset their own estate tax liability. Non-citizen spouses can also become US citizens which makes them eligible for the unlimited marital deduction.

Question 25

Describe Terminable Interest Property

Answer 25

There are some property interests that are transferred to a spouse which do not qualify for a marital deduction.
* Examples are property interests disclaimed by the spouse and terminable interest property (TIP).

Property bequeathed to a surviving spouse by will, which is disclaimed by the spouse, does not qualify for a marital deduction in the decedent’s estate.
* The property reverts back to the decedent’s estate and will be transferred to other beneficiaries named in the will or the residuary clause.
* However, if the decedent bequeathed the property to a child who disclaims that property in favor of the surviving spouse, then that property will qualify for a marital deduction in the decedent’s estate.

Terminable interests are those where the surviving spouse’s interest would cease upon the occurrence or nonoccurrence of a particular event, and the children or some other party would receive the marital property instead.
* Examples are a life estate given to the surviving spouse, or a provision in a trust document that states the surviving spouse is entitled to trust income until remarriage.
* Most terminable interests would not qualify for the marital deduction.

Question 26

What are the 2 exceptions where Terminable interests can qualify for the marital deduction?

Answer 26

Terminable interests can qualify for the marital deduction using one of the following two exceptions:
* Exception # 1 (General Power of Appointment):
* The spouse is given a life estate in trust and is given a general power of appointment over the trust corpus.
* A General Power of Appointment (POA) permits the spouse to appoint the property to themselves, their estate, to their creditors, and the creditors of their estate.
* Result
Donor spouse can take a marital deduction for the TIP
The property will be included in the donee spouse’s estate

• Exception # 2 (QTIP election):
• The donor spouse “qualifies” the terminable interest property given to the spouse for the marital deduction.
• if the executor makes the appropriate QTIP election in a timely manner.

A qualifying terminable interest is one which:
* Passes from the decedent,
* Gives the surviving spouse a lifetime income payable at least annually, and
* The decedent’s executor makes an irrevocable election on his or her estate tax return.

The election is really the price of qualifying what under prior law would not have qualified for the marital deduction. For instance, an individual can now provide, “Income to my wife for life. At her death, the principal goes to my children.”
This terminable interest will receive the marital deduction in the husband’s estate if a QTIP election is made.
However, the election would obligate the wife’s estate to pay the appropriate estate tax on the trust’s interest as if she were the ultimate recipient instead of the children.
In other words, the value of the principal is included in the wife’s estate, the estate of the life tenant. Her executor is entitled to recover the share of estate taxes generated in her estate by the inclusion of that property, from the person who receives the principal, unless in her will she chooses to exonerate that individual.

Question 27

Describe the Other Deductions that may be taken

Answer 27

A charitable deduction is allowed for the fair market value of any type of gift to a qualified charity at a decedent’s death.
* The deduction is limited to the net value of the property includable in the gross estate that is transferred to the charity.
* In other words, a decedent could conceivably leave his or her entire estate to charity and receive a deduction for the entire amount.

A deduction for state death taxes can be taken for any death taxes paid to a state because of property includable in the decedent’s gross estate.
* This includes estate, inheritance, legacy, or succession taxes.

Answer 28

Estate Tax Payable Before Credits
Once the taxable estate is determined, adjusted taxable gifts are added to arrive at the tentative tax base.
* Adjusted taxable gifts are defined as the taxable portion of all post-1976 gifts.

A gift is taxable to the extent that it exceeds any allowable:
* Annual gift tax exclusion,
* Gift tax marital deduction, which is similar to the estate tax marital deduction, but for lifetime gifts to a spouse, or
* Gift tax charitable deduction.

Gifts that for any reason have already been includable in a decedent’s gross estate, such as a gift with a retained life estate, are not considered adjusted taxable gifts.
* Adding adjusted taxable gifts to the taxable estate makes the estate tax computation part of a unified transfer tax calculation.
* The process uses a cumulative approach, with death time dispositions merely being the last in a series of gratuitous transfers.
* The net effect of adding in adjusted taxable gifts is to subject the taxable estate at death to rates that are higher than if the computation did not consider lifetime gifts.
* When adjusted taxable gifts are combined with the taxable estate, the result is the tentative tax base—the amount upon which the tax rates are based.

The tentative tax is computed by applying the appropriate rates specified in the IRS Gift and Estate Tax Rate Schedules to the tentative tax base.
Different tax rate schedules apply, depending on the year of death. These rates are progressive.

Question 29

What are the 4 tax credits that are allowed as a dollar-for-dollar reduction of estate tax?

Answer 29

Four tax credits are allowed as a dollar-for-dollar reduction of the estate tax. These credits are:
* The unified credit amount,
* The credit for foreign death taxes,
* The credit for gift tax on pre-1977 gifts, and
* The credit for taxes on prior transfers.

The applicable or unified credit amount is allowed against the gift tax or the estate tax payable as shown in the table below.

Question 30

For example, assume Patricia Anderson, a widow, died in 2023 with an $18 million taxable estate. In 2010 she made only one taxable gift of $10,000 after utilizing the annual exclusion. Patricia paid no gift tax on the $10,000 gift because $1,800 of her unified credit was applied to offset the $1,800 gift tax liability. These facts resulted in the following estate tax liability in 2023, ignoring other tax credits:
2023 Taxable Estate $18 million
Plus: Adjusted taxable gifts $10,000
Total $18,010,000
Tax on $18,010,000 $7,149,800
Minus: Gift taxes paid on lifetime transfers $0
Minus: Unified Credit $5,113,800
Tax Due $2,036,000

Answer 30

In the example, $1,800 would be the tax on a $10,000 gift that was not paid only because the decedent used $1,800 of credit.
* The required computation process has the effect of reducing the credit by adding back the adjusted taxable gifts.
* In other words, although the applicable credit in the example does not appear to be reduced by $1,800, the effect is the same because of the adding back of the $10,000 worth of adjusted taxable gifts.
* Stated another way, adding back $10,000 of adjusted taxable gifts restores the $1,800 of applicable credit.

Question 31

Describe the credit for foreign death taxes

Answer 31

A credit for foreign death taxes, the second credit available, is intended to prevent double taxation. It is allowed for death taxes paid to a foreign country or a United States possession on property that is:
* Included in the decedent’s gross estate, and
* Situated in that country or possession and subject to tax.

This credit is available only to United States citizens or resident aliens.

Question 32

Describe the credit available for federal gift taxes paid by a decedent on gifts made prior to 1977

Answer 32

Credit is available for federal gift taxes paid by a decedent on gifts made prior to 1977 if the property is included back into the decedent’s estate at death.
* Examples would be gift taxes paid on remainder interests when the grantor retained a life estate or a reversionary interest.

Question 33

Describe the credit for taxes on prior transfers

Answer 33

Finally, there is a credit for taxes on prior transfers.
* If a prior decedent, the transferor, transferred property that was taxed at death to the current decedent, and the property is includable in the current decedent’s estate, a credit will be allowed for all or part of the estate tax paid by the transferor’s estate on the transferred property.
* The present decedent must have received the property prior to death.
* The transferor must have died within ten years before or two years after the present decedent.
* A formula is utilized to determine the value of this credit.

As long as the property was includable in the transferor’s estate and passed from the transferor to the present decedent, the method of transfer is irrelevant. It can be transferred by will, by intestacy, by election against the will, by lifetime gift, as life insurance proceeds, or as joint property with the right of survivorship.

Interestingly enough, the law arbitrarily assumes that property that was in the transferor’s estate and that was transferred to the present decedent is subject to double taxation and is therefore entitled to the credit.
* There is no requirement that the property actually is in existence at the present decedent’s death or, if in existence, subject to federal estate tax at that time.

The credit is the lower of:
* The federal estate tax attributable to the transferred property in the transferor’s estate, or
* The federal estate tax attributable to the transferred property in the estate of the present decedent.

The credit is reduced by 20% increments every two years, and at the end of ten years after the transferor’s death, no credit is allowable.
* For instance, between years two and four, only 80% of the credit is allowable.

Question 34

Practitioner Advice:

Practitioner Advice: Prior to the passage of EGTRRA 2001, the unified credit available for taxable transfers made either during lifetime or after death were identical.
* After EGTRRA 2001, the unified credit for gift and estate tax purposes remained the same only in the years 2002 and 2003.
* In the year 2004, the gift and estate tax separated.
* The applicable credit began to increase for estate tax purposes, but for gift tax purposes it stayed at a constant $345,800 (tax on an asset with an equivalent value of $1 million).
* For 2023, the gift tax and estate tax rate schedule is a unified credit of $5,113,800 to offset gift and/or estate taxes up to $12,920,000.

Question 35

When is payment of the estate tax is due?

Answer 35

The estate tax is due at the time the return is to be filed nine months after the decedent’s death.

The federal estate tax is filed on Form 706.

Estate returns and gift tax returns for the donor’s year of death are due with the decedent’s income tax return.

Late estate returns will incur a 5% a month penalty.

This threshold amount is lowered by the total of any adjusted taxable gifts not included in the gross estate. Therefore, in some estates, filing will be required even if the taxable estate is far less than the exemption equivalent.

Question 36

Describe Reasonable Cause for Extension

Answer 36

The reasonable cause extension can supersede the requirement that the tax is due nine months from the date of the decedent’s death.
* It provides that an executor or administrator can request that the IRS grant an extension of time for paying the tax, up to 12 months from the date fixed for the payment, if there is reasonable cause.
* Furthermore, at its discretion, the IRS could grant a series of extensions upon the executor’s showing of reasonable cause.
* This series of extensions could, in total, run as long as 10 years from the due date of the original return.

There is no definition of reasonable cause in the IRC. However, the regulations give illustrative examples of situations where reasonable cause will be found:
* A substantial portion of the estate consists of rights to receive future payments such as annuities, accounts receivable, or renewal commissions, and the estate cannot borrow against these assets without incurring a substantial loss.
* The gross estate is unascertainable at the time the tax is normally due because the estate has a claim to substantial assets that cannot be collected without litigation.
* An estate does not have sufficient funds to pay claims against the estate, including estate taxes when due, and at the same time provide a reasonable allowance during the period of administration for the decedent’s surviving spouse and dependent children, because the executor, despite reasonable efforts, cannot convert assets in his or her possession into cash.

Question 37

Describe the Installment Payment of Estate Tax

Answer 37

IRC Section 6166 is a method by which a closely held business owner’s estate taxes can be paid on an installment basis to improve the estate’s liquidity position.
* Estate taxes in 2023 can be paid from future business earnings or future payment rights.
* The sale of the business can also be deferred to sell later at its FMV, rather than liquidating the business to pay estate taxes due 9 months after the business owner’s death.
* Section 6166 applies to a decedent’s interest in a sole proprietorship, partnership, or corporation.

According to this provision, an executor may elect to pay on Form 706, the estate tax attributable to a closely held business in 14 annual installments.
* In the first four years, there is no need to pay the tax, just the interest only.
* Installment payments of principal and interest are paid over the next 10 years.
* There is a 2% rate of interest on the first $1,750,000 of closely held business or farm property that is included in the owner’s estate in 2023.

To qualify for Section 6166, the value of the closely held business interest in the decedent’s estate must exceed 35% of the value of the decedent’s adjusted gross estate.
Gifts made within 3 years of the business owner’s death are added to the gross estate for purposes of this calculation since the 35% test must be met both with and without consideration of transfers within 3 years of death.

Question 38

Section Two Summary

The taxable estate for federal tax purposes is calculated based on the value of the gross estate. Certain expenses, debts, and applicable deductions are subtracted from the value of the gross estate. Appropriate tax rates and allowable tax credits are applied to arrive at the net estate tax that is owed to the IRS.

In this lesson, we have covered the following:
* Determining the Adjusted Gross Estate involves subtracting certain amounts such as funeral and administrative costs, debts, taxes, and losses. Funeral expenses include interment, burial lot or vault, grave marker, perpetual care of the gravesite, and transportation expenses. Administrative expenses include the collection and preservation of assets, the payment of estate debts, the cost of distributing probate assets to beneficiaries, expenses for household maintenance such as rent, utility bills, etc., court costs, accounting fees, appraisers’ fees, brokerage costs, executors’ commissions, and attorneys’ fees. As long as these expenses are reasonable, they may be used to reduce the value of the gross estate. Debts that were personal obligations of the decedent at the time of death are deductible. Unpaid taxes such as income taxes, gift taxes, and property taxes are also deducted from the gross estate. The deductible casualty and theft losses include those arising from fire, storm, shipwreck, or theft that occurred during the time the estate was in the process of settlement.
* Determination of Taxable Estate is arrived at only after determining whether the estate qualifies for certain deductions. Bequests to the surviving spouse qualify for the marital deduction if the property is included in the decedent’s gross estate and is transferred to the surviving spouse at the decedent’s death in a qualifying manner that meets the requirements of QTIP. Marital deductions are not available for transfers of terminable interest property to spouses. Be careful with assets transferring to a non-U.S. citizen spouse. The marital deduction will apply only if these assets transfer into a qualified domestic trust (QDOT). The fair market value of property bequeathed to a qualified charity at the decedent’s death is eligible for a charitable deduction. A deduction for state death taxes is also available.

Answer 38

• Determining the Net Estate Tax begins with the addition of adjusted taxable gifts to the taxable estate. Taxable gifts do not include the annual gift tax exclusion, gift tax marital deduction, and gift tax charitable deduction. This results in the tentative tax base to which appropriate tax rates must be applied as specified in the IRS Gift and Estate Tax Rate Schedules. The top estate tax rate is 40%. Next, the unified credit, credit for foreign death taxes, and credit for taxes on prior transfers are allowed as dollar-for-dollar reductions of the estate tax. This gives us the net estate tax that is the actual amount payable to the IRS.
• Payment of the Estate Tax must be done by filing the estate tax return, Form 706 within nine months of the decedent’s death. Generally, the decedent’s representative must file an estate tax return if the value of the gross estate exceeds the exemption limit provided by the estate tax unified credit. The executor or administrator of the estate can request the IRS to grant an extension of up to 12 months for payment if there is a reasonable clause. The IRS can also grant a series of extensions that could continue up to 10 years from the original due date of the return. There is also a provision for closely held business interests, known as Section 6166, which may allow an executor to elect to pay estate tax in 14 annual installments if the interest exceeds 35% of the adjusted gross estate.

Question 39

Herbert is in the process of drafting his will and is interested in minimizing estate tax. You mention that the unlimited marital deduction would allow:
* An entire estate to be transferred to his heirs without estate tax.
* A portion of the estate to be transferred to heirs without estate tax.
* An entire estate to be transferred to the surviving spouse without estate tax.
* A portion of the estate to be transferred to the surviving spouse without estate tax.

Answer 39

An entire estate to be transferred to the surviving spouse without estate tax.
* The maximum amount allowable as a marital deduction for federal estate tax purposes is the net value of the property passing to the surviving spouse in a qualifying manner.
* Otherwise, there is no limit to the marital deduction.
* An individual could conceivably transfer his or her entire estate to the surviving spouse estate tax-free.

Question 40

Adjusted taxable gifts must NOT be added to the taxable estate if:
* The gift was made before 1976.
* The gift exceeded the annual gift tax exclusion.
* The gift exceeded the gift tax marital deduction.
* The gift exceeded the gift tax charitable deduction.

Answer 40

The gift was made before 1976.

• Adjusted taxable gifts are defined as the taxable portion of all post-1976 gifts. A gift is taxable to the extent it exceeds any allowable annual gift tax exclusion, gift tax marital deduction, or gift tax charitable deduction.

Question 41

The unified credit or applicable credit is used as an offset against: (Select all that apply)
* Gift tax
* Estate tax
* Income tax
* Inheritance tax

Answer 41

Gift tax
Estate tax

• The term unified credit is used because under the unified transfer tax system the same credit amount is used to offset gift taxes and estate taxes.
• This credit does not offset the income tax or the inheritance tax.

Question 42

The unified tax credit is used as an offset against: (Select all that apply)
* Gift tax
* Estate tax
* Income tax
* Inheritance tax

Answer 42

Gift tax
Estate tax

• The term unified credit was adopted because that credit is used as an offset against gift as well as estate taxes.
• It does not offset income tax and inheritance tax.

Question 43

Module Summary

The federal estate tax is calculated on the value of property included in the gross estate. For this reason, the estate tax is tax inclusive. It is a tax on the right to transfer property or an interest in property. The taxable estate is the gross estate less allowable expenses, deductions, and credits. The federal estate tax return is due within nine months after the date of the decedent’s death.

Computing the Estate Tax: Calculation of estate tax involves five steps:
1. determining the fair market value of the gross estate,
2. determining the adjusted gross estate,
3. calculating the taxable estate,
4. calculating the federal estate tax payable before credits, and
5. applying the allowable credits to arrive at the amount of net federal estate tax owed.

The most complex part of this process is the first stage, involving the valuation of the gross estate. The gross estate basically comprises all of the property that the decedent owned outright at the time of death, in which the decedent had a beneficial interest. It may also include certain property gifted to others within the three years immediately preceding the death, property in which the decedent retained a life estate, and property over which the decedent held a general power of appointment.

Answer 43

Estate Tax: The estate tax is computed using the following formula:
1. Determine the value of the gross estate.
2. Subtract relevant expenses and debts.
3. Subtract the allowable deductions,
4. Add the value of taxable gifts and apply the estate and gift tax rates.
5. Subtract the unified credit amount and other allowable credits.

The resulting amount is the net federal estate tax owed by the estate. Funeral and administrative costs, debts, taxes, and losses are subtracted from the value of the gross estate to get the adjusted gross estate amount. The allowable marital deductions, charitable deductions, and state death tax deductions are then made to get the taxable estate. To this amount adjusted taxable gifts are added to arrive at the tentative tax base. Tax rates specified in the IRS Schedules are applied to the tentative tax base. Next, allowable credits such as the unified credit are applied. The resulting amount is the net estate tax payable to the IRS. The executor or administrator of the estate must file the estate tax return within nine months after the date of death, though extensions may be granted according to the discretion of the IRS.

Question 44

The alternate valuation date election is made by the __ ____??____ __.
* trustee
* beneficiary
* executor
* grantor

Answer 44

executor
* The executor will elect the alternate valuation date on the estate tax return Form 706 when a significant portion of the estate assets have decreased in value.

Question 45

In the event that the surviving spouse is not a U.S. citizen, the value of the decedent’s assets in excess of the estate tax exclusion amount will be subject to estate tax unless the assets are transferred into a(n) __ ____??____ __.
* A-trust
* QTIP
* QDRO
* QDOT

Answer 45

QDOT
* Under IRC Section 2056, the decedent’s estate will qualify for the federal marital deduction if assets transfer into a marital trust, referred to as a qualified domestic trust, or QDOT.
* A QDOT ensures that the assets will not ultimately leave the US without being taxed.

Question 46

Each of the following will be included in the gross estate of a decedent EXCEPT:
* Gratuitous lifetime transfers over which the decedent retained the right to alter, amend or revoke the gift
* Life insurance in which the decedent possessed no incidents of ownership
* Property owned outright by the decedent
* General powers of appointment

Answer 46

Life insurance in which the decedent possessed no incidents of ownership

• Life insurance in which the decedent possessed incidents of ownership or which was payable to or for the benefit of the decedent’s estate will be included in the gross estate.

Question 47

If the alternate valuation date is elected for a decedent and the property is distributed, sold, exchanged or disposed of within six months after the decedent’s death, the asset disposed of will be valued as of __ ____??____ __.
* the date of death
* the appraisal date
* the disposition date
* the six-month date

Answer 47

the disposition date

• If the alternate valuation date is elected for a decedent and the property is distributed, sold, exchanged or otherwise disposed of within six months after the decedent’s death, the asset disposed of will be valued as of the disposition date.

Question 48

Which of the following steps in the estate tax calculation occurs after arriving at the adjusted gross estate?
* Finding the net federal estate tax
* Applying allowable credits
* Calculating the federal estate tax payable before credits
* Determining the taxable estate

Answer 48

Determining the taxable estate

The federal estate tax is calculated in five steps:
1. Determining the value of the gross estate.
2. Arriving at the adjusted gross estate.
3. Determining the taxable estate.
4. Calculating the federal estate tax payable before credits.
5. Applying the allowable credits to arrive at the net federal estate tax.

Question 49

Terminable interests may qualify for the marital deduction by using which of these exceptions:
I. General Power of Appointment
II. QTIP election
* I only
* Both I and II
* II only
* Neither I nor II

Answer 49

Both I and II

• Exception # 1: General Power of Appointment
  The spouse is given a life estate in trust and is given a general power of appointment over the trust corpus. A General Power of Appointment (POA) permits the spouse to appoint the property to themselves, their estate, to their creditors, and the creditors of their estate.
• Exception # 2: QTIP election
  The donor spouse “qualifies” the terminable interest property given to the spouse for the marital deduction.

Question 50

At the death of the first spouse, the __ ____??____ __ election can be made to transfer any unused lifetime exclusion amount to the surviving spouse.
* QTIP
* HEMS
* QDOT
* DSUE

Answer 50

DSUE
* At the death of the first spouse, an election can be made to transfer any unused lifetime exclusion amount to the surviving spouse.
* This is known as a** Deceased Spouse Unused Exclusion (DSUE) election**.
* Unlike in the past, the unused portion of the lifetime exclusion is not forfeited if an unlimited marital deduction is used to the deceased’s entire estate tax-free to a surviving spouse.

Question 51

Identify the type(s) of property titling to which the 50-50 rule applies: (Select all that apply)
* Tenancy by the Entirety
* Joint Tenants with Rights of Survivorship (Non-Spousal)
* Community Property
* Joint Tenants with Rights of Survivorship (Spousal)

Answer 51

Tenancy by the Entirety
Joint Tenants with Rights of Survivorship (Spousal)
* The 50-50 rule provides that only 50% of certain property titled and held jointly by the decedent and spouse with rights of survivorship, or as tenants by the entirety, will be includable in the decedent’s estate.
* This is regardless of the size of his or her contribution. This rule applies to property interests included in the decedent’s estate.

Question 52

The federal estate tax is a tax on __ ____??____ __.
* inherited items
* all property included in the estate, except for the amount used to pay the tax
* the right to receive property
* the right to transfer property

Answer 52

the right to transfer property

• The federal estate tax is a tax on the transfer of property when a person dies.
• It is measured by the value of the property rights that are shifted from the decedent to others.
• It is a tax on the right to transfer property or an interest in property, rather than a tax on the right to receive property, which is the basic characteristic of an inheritance tax.

Question 53

Each of the following is an allowable deduction from the gross estate to arrive at the adjusted gross estate EXCEPT:
* A charitable deduction
* Funeral and administrative expenses
* Casualty and theft losses
* Debts including certain taxes

Answer 53

A charitable deduction

• Once the gross estate is calculated, certain deductions are allowed in arriving at the adjusted gross estate.
• These deductions fall into three categories:
• Funeral and administrative expenses,
• Debts including certain taxes, and
• Casualty and theft losses.
• A charitable deduction is a potential deduction from the adjusted gross estate to arrive at the taxable estate.