Estate and Gift Tax

Question 1

Estate and Gift tax rate

Answer 1

40%

Question 2

Gross estate

Answer 2

Fair market value of decedent’s property AT DEATH.

Includes ALL property transferred by decedent at death, whether real, personal, tangible or intangible, and no matter where situated if a US citizen.

Question 3

GST consequences of an inter-vivos gift

Answer 3

Say Grandmother gives grandson a taxable gift (because exemption has been previously used up) of $1,000,000.

First the mother will have to pay 40% GST on the gift:
$1,000,000 X 40% = $400,000 in GST.

In addition gift tax is owed on the $1,000,000 gift AS WEL AS the $400,000 in GST taxes paid on behalf of the son so: $1,400,000 X 40% = $560,000 in gift tax.

In all $960,000 in taxes is owed on the $1,000,000 gift

Question 4

GST - Non-relatives

Answer 4

If a decedent leaves her estate to a non-spouse or non-relative who is more than 37.5 years younger, GST applies

Question 5

Gross Estate: Alternative valuation date

Answer 5

The estate representative can select a date 6 months after the decedent’s death to value the property of the estate, IF:

it results in a decrease of the gross estate and estate tax liability and estate tax liability.

However, an alternative valuation date cannot be used to get a step-up for income tax purposes if no estate tax is due

Question 6

Gross Estate: Special valuation rule §2032A for family business and farm property

Answer 6

Farm land and any other REAL property used in a trade or a business can be valued at its FARM or BUSINESS use, rather than its “highest and best use” IF:

1) Family: the property must pass to a close family member
2) Major Item: The property must constitute 50% or more of the decedent’s gross estate
3) Use: The land muse continue to be used as it was by the decedent for at least 10 years after his death
4) Cap: $1,000,000 maximum fair market value reduction (adjusted for inflation)

Question 7

Co-Ownership of property: TIC

Answer 7

The amount included in the decedent’s estate is equal to his percentage ownership of the property

Question 8

Co-ownership of property: Joint tenants (non-spouse)

Answer 8

General rule: when joint tenant dies, the entire value of the property is generally included in his estate

Exceptions:

1) If it can be proved that the SURVIVING joint tenant made a monetary contribution to the acquisition or improvement of the property, that PROPORTIONATE share will be deducted from the estate
2) Gift: If both parties to a joint tenancy acquired their interest through gift, only the proportional ownership interest is included in the estate.
3) Spouses

Question 9

Co-Ownership of property: Joint Tenants (spouses)

Answer 9

If spouses hold property in joint tenancy, only half of the value of the property is included in the estate of the decedent. Who actually contributed to the purchase or improvement of the property is irrelevant for spouses.

Step up: only the deceased’s share is stepped up.

Gallenstein exception: if the joint tenancy was created before 1977 property receives a full step-up IF the deceased spouse furnished ALL of the consideration

Question 10

Totten Deeds (trusts)

Answer 10

A Totten trust is a bank account where the owner grants a revocable future interest in the funds inside the account to another. Thus, when the owner dies, the account transfers automatically to the beneficiary, avoiding probate. However, because it is revocable, the funds are includable the the deceased’s gross estate.

A Totten Deed is newly available in CA and acts in the same way as a Totten Trust, but for real property

Question 11

Tainted Code Sections

Answer 11

The only code sections that the 3 year rule applies to are:

2036 - Termination of a retained life interest
2037 - Termination of a transfer taking effect on death
2038 - Termination of a revocable transfer
2042 - TRANSFER OF OWNERSHIP OF LIFE INSURANCE POLICY

Question 12

Transfer with retained life estate

Answer 12

2036- If the life estate was held by the creator of the life estate, the property is included IN FULL in his estate.

2036(a)(2) - Retained rights: if the creator retains the right to the income from the property, or the right to affect the enjoyment of the property, it is included in his estate

Exception: Bona fide sale

Question 13

GRUT, GRAT, and GRIT

Answer 13

Generally, if a grantor has a retained interest, unless it qualifies as a GRAT or GRUT, this grantor retained interest (GRIT) will have a value of $0. Meaning that and the entire value of the property transferred in trust, not just the remainder interest, will be subject to gift tax. Further, no annual exclusion applies because it is a gift of future interest.

GRAT - Grantor Retained Annuity Trust - where grantor maintains the right to receive fixed amounts payable not less than annually

GRUT - Grantor Retained Uni-Trust - Where the grantor retains the right to receive payments not paid less than annually, that are a fixed percentage of the fair market value of the trust.

With a Qualified GRAT or GRUT, the transfer is not subject to gift tax and will also be out of the deceased’s estate.

Question 14

3 types of estate tax deductions - 2053

Answer 14

A. Funeral Expenses

B. Administration Expenses

C. Claims against the Estate

Question 15

Administrative Deductions

Answer 15

Those that are incurred after the decedent dies for services rendered as a consequence of his death.

Investment management fees - Not deductible because they are not only incurred but for the death.

However, if there were instructions for such things as to liquidate all investments at death, the management fees this action incurs would be deductible

Question 16

Deductibility of claims - Old Rule

Answer 16

the value of a bona fide claim against the state is deductible against the estate.
- Bona Fide Claim - must be supported by “adequate and full consideration in money or money’s worth.” Intended to prevent what in reality is a gift for tax purposes from being considered a debt.

Contractual Consideration - consideration here is not the same to make a valid contract. No “if you graduate law school”

Question 17

Deductibility of Claims - New Rule

Answer 17

New treasury regulations provide that any DISPUTED claim against the estate valued at over $500,000 cannot be deducted until actually paid. Disputed AGGREGATE claims not over $500,000 may be deducted prior to actual payment.

• Standard Reg rule for deductibility of claims: No deduction until a claim is reduced to a specific amount
• De minimus claims: Aggregate claims of under $500k can be deducted if value is determined by a PROFESSIONAL APPRAISER
• Reasonable Certainty - If a claim is known with reasonable certainty (reduced to an amount) it can be deducted

Question 18

Deductibility of Claims - Protective refund claim

Answer 18

• Filed with the IRS if an outstanding claim exists against the estate
• tolls the statute of limitations in regards to the ability to take deductions resulting from the claim
• However it DOES NOT toll the statute of limitations for other actions against the estate.

Question 19

Charitable bequest

Answer 19

If decedent leaves all or some portion of his estate to a qualified charitable organization (501(c)(3)), the portion of the bequest is fully deductible

Question 20

Charitable split-intrest Gifts - General Rule

Answer 20

No deduction for a remainder left to charity unless it qualifies as a CRAT/CRUT or a pooled income fund

Question 21

CRAT, CRUT, Pooled income fund

Answer 21

CRAT - (Fixed)Trust must state that between 5% - 50% of the initial fair market value is paid out to the initial beneficiary at least ANNUALLY, and the value of the remainder to the charity must be at least 10%. The trust MUST pay the stated percentage, even if the corpus has to be invaded

CRUT - )Variable) Same as CRAT, but based on the FMV of the trust assets in that year, not off the initial FMV. CRUT Pays lesser of:

• The stated percentage of trust assets, OR
• The Trust’s actual net income. NO INVASION OF CORPUS IS PERMITTED.
  However, the trust can make up shortfalls in subsequent years with a NIMCRUT

Pooled Income Fund - a qualified entity that pools contributions from many different donors

Question 22

Perpetual Land Grants/ Conservation Easements

Answer 22

2031(c)(1) - When a conservation easement is granted:

• The value of the property in the estate is reduced by the value of the easement; AND
• The value of the remaining portion of the property retained by the estate gets an exclusion of 40%
• further, because it is just a conservation easement, the original owners can continue to use the land, they simply cannot build on it

Example:

$1,000,000 property and $300,000 easement

• • $1,000,000 - $300,000 = $700,000
• • $700,000 X 40% = $280,000
• • $700,000 - $280,000 = $420,000

Thus by making a conservation easement a property worth $1,000,000 is only valued at $420,000 in the estate

Question 23

Spousal “Terminable interest rule”

Answer 23

If the surviving spouse has only a terminable interest, marital deduction does not apply. Example: “To wife for life, then to children”

Rationale: If allowed, estate tax might be avoided at the death of both spouses

Question 24

Spousal Terminable interest rule - 3 exception

Answer 24

1) Simultaneous death Rule - Decedent can require that the surviving spouse MUST survive for 6 months (or less) after the decedent’s death to take the property left to her. If the period exceeds 6 months, terminable interest rule applies
2) Life estate with a general power of appointment: Surviving spouse is given a life estate of all the income with a general power of appointment
3) QTIP

Question 25

QTIP

Answer 25

Qualified terminable interest property rule:

If a QTIP election is made, the surviving spouse can receive a marital deduction on a terminable interest (life estate), HOWEVER, the value of the trust must be included in the estate of the second spouse to die.

3 qualifications for a QTIP:

1) Surviving spouse is entitled to ALL the income from the property for her life, payable at least annually.
2) There can be no power of appointment that can deflect income from the surviving spouse during her lifetime
3) QTIP election is made on the estate tax return of the decedent spouse

Question 26

Marital Deduction - Non-US Citizen Spouse

Answer 26

General rule - no marital deduction if surviving spouse is not a US citizen.

Exception: Qualified domestic trust: Must meet 3 requirements

a) At least one trustee of the trust must be a US citizen (or domestic corporation)
b) No distribution of trust principal unless the US citizen trustee is required to withhold US estate tax
c) The Trustee MUST agree to satisfy the above requirements

Question 27

Tax Consequences of a no or low interest loan

Answer 27

a) if the borrower is expected to pay back the loan principle, the principle is not considered a gift
b) However, the amount of foregone interest is considered an annual gift
c) The foregone interest income is imputed to the lender and subject to income tax

Exemptions:

1) no GIFT OR INCOME TAX on Loans in the aggregate to any borrower of $10,000 or less
2) no IMPUTED INTEREST INCOME to the lender If the net investment income of the borrower is $1000 or less, and the total loan is $100,000 or less. however gift taxes still apply

Example: Mother lends son $300,000 at no interest, but expects son to repay the loan on demand. Assume IRS posted rate of interest is simple 6%. Exclusion amount is $14,000

Annual amount of mother’s gift subject to gift tax:
$300,000 X 6% = $18,000 - $14,000 = $4000

Annual amount of imputed interest income to mother = $ the full $18,000.

Son can only deduct imputed interest if the mother holds an enforceable security interest

Question 28

Annual Gift Tax Exclusion

Answer 28

General rule: only applies to gifts of a PRESENT INTEREST

Exception: Minor’s trust

Question 29

Annual Gift Tax Exclusion: Trustee Income Accumulation

Answer 29

General Rule: If trustee has the power to accumulate income, rather than pay it out in full to current beneficiaries, it is a FUTURE INTEREST

Crummy Withdrawal rights: A trust can allow for income accumulation and qualify for the gift tax exclusion IF:

• the beneficiary is given a right to withdraw the property from the trust for a short period of time.
• The code doesn’t define “short-term” but the courts are liberal and a 30 day withdraw window should suffice

a) sufficient notice and a reasonable amount of time must be given to beneficiary to qualify
b) the annual exclusion will be denied if there is a prearranged understanding that the power will not be exercised, or if exercising the power would result in adverse consequences to the donee

Question 30

Benefits of Estate planning - Not subject to Estate Tax

Answer 30

1) Avoid Probate
- Revocable living trust
2) Lock in feature
- Revocable living Trust
- Ensure your assets go where you want and surviving spouse can’t change

3) Ensure no gifts of appreciating property during lifetime
- Ensure Step-up
- Portability plus Q-tip

4) Full step-up, Transmutation agreement
5) Hold Back - determine when kids get access to trust assets
6) Avoid changes in ownership for prop 13 reassessment purposes

Question 31

Benefits of Estate Planning - Subject to Estate Tax

Answer 31

For all-

1) Avoids probate
2) Lock in feature
3) Full step up, transmutation agreement
4) Hold back feature
5) Avoid changes in ownership for prop 13

When subject to estate tax, all above plus:

6) Make gifts
- Get assets and any future appreciation out of estate
- Take advantage of discounting if gifting less than a corporation or LLC
- Consider adjustment clause

7) Buy life insurance, don’t be owner
- ILIT
- Possibly make kid owner

8) Charitable gifts
- GRIT GRAT
- CRAT CRUT
- Conservation easement

9) GST bypass trust
- In South Dakota and other states with no RAP
- $5.45 million: income to so for life, then to grandchildren for life, then to great grandchildren, etc.
- for as long as you want in a state without RAP

10) spendthrift

Question 32

Problems with Probate

Answer 32

1) expensive (attorneys fees mandated by CA statute)
2) Time consuming
3) Public Record
4) Will contests
5) Incapacity problems

Question 33

Probate applies when

Answer 33

1) Value of estate is $150,000 or less

2) property not passing to surviving spouse

Question 34

Portability + QTIP

Answer 34

• QTIP deceased spouse’s half of estate
• Surviving spouse’s assets go into survivor’s trust
• Surviving spouse elects portability on QTIP
• Therefore marital deduction applies, and all assets are included in the estate of the surviving spouse, and will be stepped up at her death. Plus, the combined exclusion amount of $10.9 million will apply
• ONLY WHEN ASSETS AT DEATH OF FIRST SPOUSE ARE BELOW EXCLUSION AMOUNT

Question 35

ABC Trusts (community property state)

Answer 35

A Trust: SURVIVORS TRUST - the surviving spouses’ half of the estate goes into this trust, where the surviving spouse generally has full power of appointment of the remainder at her death, and has entire freedom and control over A Trust assets. She can use the corpus and income from trust assets as she wishes.

B Trust: BYPASS TRUST - Consists of an amount of property up to the exclusion amount, so that there is no estate tax due. Normally provides income for life to wife, remainder to children. NO QTIP, so the trust assets are excluded from the survivor’s estate. (no step up in basis when wife dies)

C Trust: MARITAL DEDUCTION TRUST or QTIP ELECTION TRUST - If total community property estate exceeds the combined exemption amount, A Trust will get 1/2 of the estate (survivor’s half), B Trust will get up to the unused exemption limit, and then any remainder will go to C Trust

Question 36

ILIT

Answer 36

Irrevocable Trust

Trust is owner and beneficiary of the policy

Neither insured nor the spouse of the insured should be Trustee, to avoid holding incidents of ownership

Neither insured nor spouse should be beneficiary of trust

Benefits versus making child owner and beneficiary:

• Child may take actions, or use insurance proceeds in ways against the wishes of the insured
• The insurance proceeds would be included in the beneficiary’s taxable estate

Question 37

Prop 13 - changes in ownership

Answer 37

In CA, real property is reassessed for tax purposes when there is a “change in ownership”

Not a “Change in Ownership”

• Change in entity that holds ownership but the same proportion
  - EX: transfer in ownership to an LLC owned entirely by the original owner
• Transfer to a revocable trust
• Transfer of PRIMARY RESIDENCE of a parent to children
  
  • Must go directly to children
• Transfer of up to $1 million in other real property (not primary residence) per parent
  - IN ADDITION to primary residence exclusion
  - Cumulative for all real estate, not per property
• Transfer from grandparent to child, provided that parent of child has died

CHANGES IN OWNERSHIP

• More than 50% change in ownership
  
  • I.e. if held in an LLC, no change if 49% ownership in the LLC is given to another, but as soon as more than 50% is transferred there is a “change in ownership” and a complete reassessment
• transfer to an irrevocable trust with different beneficiaries
• Transfer to a new life tenant

Question 38

Prop 13 and life estates

Answer 38

• A single transfer to a life estate is a change in ownership
  
  • From mother to daughter for life, then to grandchildren – transfer was made out of mother’s ownership
• Multiple transfers
  
  • From mother to daughter for life, then to grandchildren to life, then to great grandchildren for life
  • Law is unclear

Question 39

6 Areas to be careful

Answer 39

1) Not to make gifts of 50% or more in property
- Prop 13 reassessment
- No discounting
- No control

2) Making a taxable gift to a grandchild or other skipped generation
- GST and Gift Tax

3) Non-perpetual land grant / conservation easement
- there can not even be a possibility for the easement to be revoked, no matter how remote

4) Gifting with GRIT GRAT
- If retain right to income and doesn’t qualify as GRAT or GRUT, the entire amount is subject to gift tax, not just the remainder interest. AND no annual exclusion applies because a gift in future interest.

5) Charitable bequests/ CRAT/CRUT
- Not stating that between 5% and 50% must be paid out to beneficiary
- If create a life estate in another, and not qualify for CRAT CRUT, value of remainder is not deductible

6) Electing portability and QTIPins when estate is over exemption limits