Estate Planning Flashcards
1
Q
Gift Splitting
A
Married donor, with the consent of non-donor spouse, elects to treat a gift to a third party as though each spouse has made 1/2 of the gift.
Thus, the maximum gift from the married couple to an unlimited number of recipients is $32,000, twice the annual exclusion of $16,000 for individuals. This way, neither of the spouse’s unified credit will be used.
Present interest only Spouses only ALL gifts Form 709 Tax-free Unlimited recipients
2
Q
Gift splitting with taxable portion
A
Husband and wife gave their daughter $40,000
Taxable gift for husband: $40,000 / 2 = $20,000 - $16,000 = $4000
Taxable gift for wife: $40,000 / 2 = $20,000 - $16,000 = $4000
3
Q
Gift Tax filing form 709
A
Filed separately by each spouse if the split value > annual exclusion ($16,000)
E.g., $34,000 / 2 = $17,000
Donor spouse files if split gifts < annual exclusion. Other spouse shows consent on Form 709
E.g., $20,000 / 2 = $10,000
No gift tax return is filed if the value of the gift < annual exclusion
E.g., $12,000 gift
Exam tip: Gifts can be made between spouses, tax-free, without limit. When spouses elect to gift-split for transfers to others, the gift-split treatment must be applied to all gifts in a calendar year.
4
Q
Qualified Disclaimer - Definition and Requirements
A
A potential donee expressly refuses to accept a valuable gift, i.e., disclaims the right to the gift.
Qualified Disclaimer Requirements:
- Refusal or rejection in writing
- Writing must be received no later than 9 months of the later of:
(a) the date on which the transfer creating the interest is made OR
(b) the date the person disclaiming reaches age 21 - Person disclaiming must not have accepted the property interests or any benefits of the property
- Someone other than the disclaimant receives the disclaimed property interest; disclaimant cannot in any way influence the potential recipient of the property
5
Q
When to use a Qualified Disclaimer
A
Transfers involving large gifts
Tax free gift to a contingent donee
Spouse is donee, but does not need/want the gift
Election to use a qualified disclaimer to transfer property is permanent and cannot be undone!
The gifted property cannot be received first and disclaimed later. A qualified disclaimer must be elected BEFORE reception of the gift.
6
Q
Gifted Property with Gains - What happens to donee’s basis and holding period if FMV of donor’s gift is greater than donor’s basis?
A
Donee will use donor’s basis as their own
Donee will assume donor’s holding period
Example: Robert’s Aunt gave him $63,000 of MSFT stock that she purchased 19 years ago at a cost of $18,000. She did not have any gift tax liability as a result of this transaction. Robert’s basis in the stock is $18,000, and his holding period is 19 years.
7
Q
Gift Tax Adjustment to Donee’s Basis
A
When the donor actually pays gift taxes AND when FMV > than donor’s basis, the gift tax adjustment is added to the donee’s basis:
Appreciation Factor X Gift Taxes Paid = Gift Tax Adjustment
Appreciation Factor = (FMV - Basis) / (FMV - Annual Exclusion)
Robert’s aunt gave him $63,000 of MSFT stock that she purchased 19 years ago at $18,000. She paid gift taxes of $10,000 after utilizing the $16,000 gift tax annual exclusion. How much is Robert’s basis in the stock and what is the holding period?
(63,000 - 18,000) / (63,000 - 16,000) = 0.9574
0.9574 x $10,000 Gift Tax Paid = $9,574 (= GIFT TAX ADJUSTMENT)
Robert’s basis in the stock = $18,000 + $9,574 = $27,574.
Robert’s holding period is 19 years.
8
Q
Gifted Loss Property: Basis and Holding Period
A
When assets are gifted at a loss, a wait-and-see approach must be adopted until the asset is eventually sold.
Possible scenarios:
(1) Gift of loss property - final sale price > original basis of donor:
- donor’s original basis used to calculate gain
- donee inherits donor’s holding period
(2) Gift of loss property - final sale price < FMV on the date of the gift:
- donee will use FMV on the date of gift as basis
- holding period will begin on date of gift
(3) Gift of loss property - final sale price is between donor’s original basis and FMV on date of gift:
- no loss or gain
- holding period is not a factor
9
Q
Illustration of Gifted Loss Property: Donor’s basis = $40,000, FMV at the time of gift = $20,000
A
↑
Gain basis $40,000 Donee sells for $40,000+
$39,999 uses $40,000 as basis
↑ Donee sells for $20,001+
$20,001 but less than $40,000; Loss basis $20,000 basis=selling price, no gain/loss
↓
Donee sells for $20,000 or less
uses $20,000 as basis
10
Q
What is a generation-skipping transfer and what is a skip person?
A
Transfer of property by gift or death to any person who is 2 or more generations below that of the transferor
skip person = person who is 2 or more generations below that of the transferor
11
Q
Generation-Skipping Transfer Tax (GSTT) - features
A
in addition to gift tax and estate tax
GSTT annual exclusions of $16,000 and a separate lifetime GSTT exemption of $12.06MM offsets this tax
flat rate of 40%
GSTT Payor = Transferor (Grandparent)
Tax-Exclusive
12
Q
Types of GSTT - Direct Skip
A
Direct transfer to a skip person
Tax Exclusive: Transferor pays Tax
Related persons:
Skip persons determined by family tree: grandchildren, great-grandchildren, grand-nieces, grand-nephews
Non-related persons:
Skip person was born between 37 1/2 and 62 1/2 years after the donor
13
Q
Types of GSTT - Taxable Distribution
A
Taxable distributions:
Any distribution of income or corpus from a trust to a skip person that is NOT otherwise subject to estate or gift tax
Scenario: Grandparent has a trust from which a taxable distribution is made, GSTT payor is the Transferee (Skip person)
Tax inclusive: Transferee pays tax
14
Q
Types of GSTT - Taxable Termination
A
termination by death, lapse of time, release of power, or otherwise of an interest in property held in a trust resulting in skip persons holding all interests in the trust
Sample scenario: Grandparent has a trust, life income is paid to his/her child (parent of grandchild) who dies, Skip person (grandchild) now holds all interest in the trust
Tax inclusive: GSTT payor = trustee
15
Q
Federal Estate Tax - definition
A
tax on transfer of property when a person dies
tax on right to TRANSFER property (rather than on right to receive property)
16
Q
Steps in calculating the federal estate tax
A
- Determine value of gross estate
- Arrive at Adjusted Gross Estate
- Determine Taxable Estate
- Calculate federal estate tax payable before credits
- Apply allowable credits to arrive at NET FEDERAL ESTATE TAX
Payable by decedent’s executor on the date the return is due: within 9 months from the date of decedent’s death
17
Q
Federal Estate Tax
A
Taxable Gifts
\+
Taxable Estate
↓
Tentative Tax Base
↓
Calculating tax with unified transfer tax rates
↓
Federal estate tax on tentative tax base
LESS
Credit for Gift Taxes Paid
Unified Credit Amount
Credit on Prior Transfers
↓
Federal Estate Tax Payable
18
Q
Marital Deduction
A
Unlimited marital deduction is available for most gifts made to a donee spouse
Can NOT be used for gifts made to a non-citizen spouse (annual exclusion: $164,000)
NOT available for TERMINABLE INTEREST PROPERTY (TIP)
Gross Estate
minus: expenses, debt, taxes, losses
Adjusted Gross Estate
minus Marital Deduction
minus Charitable Deduction
= Taxable Estate
19
Q
Charitable Deduction
A
Charitable estate tax deduction is available for property passing to a QUALIFIED charity
20
Q
IRS Form for Estate Tax Return
A
Form 709
21
Q
Charitable Lead Trust
A
Grantor receives charitable income tax deduction for PV of charity’s income interest
22
Q
Charitable Remainder Trust
A
Grantor receives charitable income tax deduction for PV of charity’s remainder interest
23
Q
Charitable Gift Annuity
A
donor transfers cash or property to a charity, and charity pays donor or other donees an annuity payment each year for life
Gift charitable deduction = PV of charity’s remainder interest
Gift annuity payments to a spouse: marital deduction is available if spouse receives all annuity payments and has general POA over payments after donor’s death
Gift annuity payments to others: gift tax = PV of the annuity payments
24
Q
Pooled Income Funds
A
Donor gifts property to a charity and receives annual pro-rata share of income from charity’s commingled funds for life
Additional gifts can be made to the fund to increase donor’s income stream
Charity manages the fund which CANNOT INVEST IN TAX-EXEMPT SECURITIES and receives remainder when donor’s income interest ends
Donor takes income tax deduction for PV of charity’s remainder interest
Donor pays income taxes on income received from fund
25
Private Foundation
Separate legal entity, either non-profit or tax-exempt trust
Most are funded and controlled by family members. High set-up and maintenance fees.
Family members who make gifts to the foundation may take an income tax deduction limited to 30% for cash and 20% for LTCG property.
Foundation must distribute a minimum of 5% of the assets to public charities every year.
26
Ownership Titling - Separate Ownership
- one owner
- owner fully controls transfer
- transfers by will or laws of intestacy
- 100% Probate inclusion
- 100% Gross Estate inclusion
27
Ownership Titling - JTWROS
- 2 or more owners
- transferable without JT approval
- automatic survivorship at JT's death
- not included in probate
- Inclusion in Gross Estate: 50% spouses, FMV x % ownership non-spouses
Appropriate to:
- ensure the property automatically passes to a specific individual upon owner’s death
- avoid probate
- reduce administrative costs and attorney’s fees
- minimize income tax liability
28
Ownership Titling - TBE
- only spouses
- transferable with approval of JT
- automatic survivorship at death of spouse
- no inclusion in probate
- 50% of FMV included in Gross Estate
29
Ownership Titling - TIC
- several owners
- transferable each owner separately, based on interest
- transfers by will or laws of intestacy
- FMV of interest included in probate
- FMV of ownership % included in Gross Estate
Appropriate to:
- reduce potential estate tax liability
- reduce any income tax liability
- ensure that the property is transferred to a designated beneficiary
30
Ownership Titling - Community Property
- 2 spouses
- transferable with spouse approval
- automatic survivorship if titled "S1 and S2 community property with rights of survivorship or titled in joint trust"; otherwise, not automatically transferred
- only assets that do not transfer to someone else are included in probate
- 50% of value of decedent's interest is included in Gross Estate
31
Power of Attorney
Written agreement that allows an AGENT to act on behalf of a PRINCIPAL
32
Durable Power of Attorney
Immediate authority to act on behalf of principal
Agent's power does not lapse even when principal becomes incapacitated or disabled
33
Non-Durable Power of Attorney
Remains active until incapacitation
Also used when principal needs agent to act on his/her behalf (e.g., sign a document while on vacation)
34
Springing Power of Attorney
Not operative until principal becomes incapacitated (must be confirmed, may delay decisions)
35
General Power of Attorney
Allows for a broad array of decisions (financial, legal, business matters)
Lapses at incapacitation
36
Special Power of Attorney
Used only for specific matter or until task is completed or time period has passed, then authority expires
37
Step up in Basis - Spousal vs. Non-Spousal JTWROS
Spousal: Regardless of contribution (basis), each spouse owns 50% of FMV at death of one spouse.
Add 50% of FMV to original basis (contribution %) to get Step-up Basis for surviving spouse
Non-Spousal: % ownership x FMV at death is added to other owner's original basis
38
Legal requirements for will and intestacy
anyone over 18 can create a will, to execute a will you need testamentary capacity
Without a will, state laws of intestacy determine the distribution of property:
Minor children receive equal shares of parents' property and take ownership at majority.
Community states: all property in intestacy passes to surviving spouse
Decedent's estate gets marital deduction for percentage of property surviving spouse receives
39
Testamentary capacity
Testator must know they are executing a will
Testator must be aware of what assets they own
Testator must know and remember their relationship to the beneficiaries
40
Provisions in a will can be invalidated due to:
Fraud
Testator being subject to undue influence
Mistakes in will clauses
Will is not properly executed/signed/witnessed according to state law
41
Types of wills
Mutual will: made in agreement with another person to dispose of property interests
Reciprocal will: each person's will designates property to be assigned to the other person
Holographic will: handwritten will
Nuncupative will: oral will
42
Probate
Process of proving will in court
Personal property: probated in decedent's state of domicile
Real property: probated in state where it's located (situs)
Ancillary property: property in another state, probated in the other state
43
Advantages of probate
court-supervised distribution of property
protects creditors by ensuring that debts are paid
bars future creditor claims against estate
documents title and transfer of property
44
Disadvantages of probate
public process
expensive
time consuming (9-12 mo)
45
Property transferred via a will that is subject to probate
solely owned personal or real property
TIC
Community property
property passing from will into a testamentary trust
property transferred by a pour-over will into a trust
life insurance policy owned by decedent who was not the insured
46
Property not transferred by will that is subject to probate
Intestate property
Life insurance policy proceeds or annuities payable to decedent's estate
Homestead and exempt property allowances
47
Avoiding probate
Will substitutes: TLC
Trusts (funded revocable, irrevocable, and property in trust)
Operation of law (JTWROS, TBE, joint bank accounts, POD/TOD, life estate)
Contract (named beneficiaries on retirement accounts/plans, life insurance, annuities)
48
Asset Transfer at Death - Per Capita
By the head, to be split equally among ALL survivors
Distribution is based on surviving family members
Example 4 survivors (children and grandchildren): each gets 1/4
```
Capita by Generation:
3 siblings, 2 have passed
A passed, has 1 child
B survivor
C passed, has 2 children
```
A's child gets 2/9
B gets 1/3
C's 2 children each get 2/9
49
Asset Transfer at Death - Per Stirpes
by the trunk/root or right of representation
distributions follow the family tree
Example 3 siblings, each get 1/3, but 2 have passed; sibling A has one child, sibling C has 2 children
B gets 1/3
child of A gets 1/3
2 children of C each get 1/6
50
Estate Tax Process
5 steps to calculate the federal estate tax:
1. Determine value of Gross Estate
2. Arrive at Adjusted Gross Estate
3. Determine Taxable Estate
4. Calculate federal estate tax payable before credits
5. Apply allowable credits to arrive at net federal estate tax due
Due within 9 months of decedent's death
51
Simple Trust
Required to distribute all income to beneficiaries in year earned
May not have charitable beneficiary
Can't distribute principal during tax year
Personal exemption of $300
52
Complex Trust
not required to make distributions (can accumulate income)
may have charitable beneficiary
may distribute principal during tax year
personal exemption of $100
53
Revocable Trust
grantor has right to terminate the trust
transfer of assets does NOT constitute a completed gift
assets in trust are subject to estate tax at grantor's death
becomes irrevocable when grantor gives up right to amend/revoke, reclaim property, or dies
!!! If you make a revocable trust irrevocable and die within 3 years, trust property is brought back into the gross estate!!!
```
Used for:
Estate planning
Avoiding probate fees
Flexibility
Grantor retains right to amend or take back trust property
Can be funded or unfunded
```
54
Irrevocable Trust
May NOT be revoked once created
Transfer of assets = completed gift, subject to gift taxes
Assets in trust are not subject to estate tax at grantor's death
Must be funded to legally exist
Trust property is transferred into trust, and trust becomes owner of property
Grantor gives up control, ability to amend, dominion of property
Property in trust is excluded from Gross Estate
```
Used for:
Estate Planning
Asset Protection
Avoiding probate fees
Medical planning
Tax deductions
Amendment option only with beneficiary/OK
```
55
Grantor Trust
Revocable trust in which all income is taxed to the grantor
Any trust that allows grantor, grantor's spouse, or third party without a beneficial interest in the trust, any rights or powers as specified in the grantor trust rules, will be taxed as a grantor trust.
Grantor Trust rules:
grantor may revoke/amend trust, retains beneficial enjoyment, administrative powers or control of beneficial enjoyment; income distributed to grantor for support of grantor's children
56
Living (Inter-Vivos) Trust
established and funded during grantor's lifetime and effective immediately
funds pass outside will and probate process, saving cost and time
title to property inside is held in the name of the trust
57
Testamentary Trust
Created through a will, funded with assets after death
Possible purposes:
reduce estate taxes
provide professional investment management
make sure estate ends up in the right hands
58
Trustee
receives legal title to the property placed in trust by grantor
manages, distributes, accumulates income & principal
must follow formal written agreement (terms of trust) to benefit beneficiaries
serves as fiduciary
59
Standby Trust
used to manage a person's assets if they become incapacitated
Grantor creates trust by transferring legal title of the property to the Trustee
Trustee manages trust property for the benefit of the beneficiaries
Beneficiary has equitable title to trust property
60
5 Elements of a trust
```
Grantor
Trustee
Corpus (res)
Terms of the trust
Beneficiary
```
61
Grantor
person who transfers property to and dictates terms of a trust
62
Corpus (res)
Amount of principal in a trust
63
Terms of the trust
Document outlining the provisions of a trust
64
Beneficiaries (Remainderman)
party that will receive benefit of use of the trust property and/or income
65
Fiduciary on a trust must file which form for a taxable trust and when?
Form 1041 if the trust has:
- any taxable income for the tax year
- gross income of $600 or more (regardless of taxable
income) , OR
- a beneficiary who is a non-resident alien
66
Trust accounting income
items of income and expense used to determine amount of income beneficiaries are entitled to receive from trust each year
does not determine trust's taxable income or who will pay the tax (beneficiary or trust)
trust document specifies what accounting income is (how capital gains and expenses are allocated to income and principal) - in cases where accounting income is not specified, allocation is made according to state law
67
Trust taxable income
Determined by subtracting from income deductions (distributions, charitable contributions, investment interest, investment advisor fees)
trust is entitled to appropriate personal exemption
68
Distributable Net Income
allocates trust income between beneficiaries and trust
represents maximum income that can be taxed to beneficiaries in a year
beneficiary is responsible for lesser of DNI allocation or amount required to be distributed according to trust document
Example: trust earns $10,000 and distributes $12,000 to beneficiary; first $10,000 = income, remaining $2,000 = tax free distribution of corpus; trust will deduct $10,000 distributed to beneficiary, beneficiary is taxed on $10,000, not the full $12,000 distributed from the trust
69
Grantor Retained Annuity Trust (GRAT)
irrevocable trust into which grantor places assets and a right to a fixed payment of income (at least annually) for a chosen period
future appreciation of assets pass to non-charitable beneficiary (usu. family member), free of estate and gift taxes, if the grantor survives the trust term
if grantor dies before end of trust term, GRAT continues payment to grantor's estate & property is subject to estate tax
Purpose:
- transfer property in the trust at reduced (or zero) gift tax value
- pass appreciation in GRAT to beneficiary without incurring additional gift tax
- reduce value of grantor's gross estate
70
Advantages and Disadvantages of a GRAT
Advantages:
- Estate tax reduction: if grantor outlives trust term, property in GRAT receives no estate tax
- Income to grantor
- Support for grantor & beneficiaries
Disadvantages:
- initial gift = taxable (FMV - annuity payments); income payments are taxable to grantor
- no additional assets
- beneficiaries receive carryover basis
- grantor loses control over property
- income subject to creditor claims
- fixed annuity must be paid to grantor even if trustee has to use trust corpus to borrow funds
Gift tax exposure is reduced in a GRAT if:
1. Value of Retained Annuity is INCREASED, and
2. Value of Remainder Interest is DECREASED
Ways to reduce the remainder interest in a GRAT:
Increase the value of the retained annuity
Extend the trust term
Use a lower interest rate for the PV calculation of the retained annuity
71
Grantor Retained Unitrust (GRUT)
irrevocable trust into which grantor places assets and a right to payment of income (at least annually) for a chosen period; grantor retains right to payment of a FIXED PERCENTAGE of the value of the trust property (determined annually) for a number of years
Purpose:
- transfer property in the trust at reduced (or zero gift tax value)
- pass appreciation in the GRUT to beneficiaries without occurring additional gift tax
- reduce value of grantor's gross estate
72
Advantages and Disadvantages of a GRUT
Advantages:
- estate tax reduction; if grantor outlives the trust term, property in GRUT receives no estate tax
- income to grantor
- additional assets are okay
- support for grantor & beneficiaries
Disadvantages:
- Initial gift is taxable (FMV - annuity payments); income payments are taxable to grantor
- beneficiaries receive carryover basis
- grantor loses control over property
- income subject to creditor claims
- payment must be made to grantor even if trustee has to use trust corpus or borrow funds
A GRUT is especially useful as an INFLATION HEDGE!!!
73
Grantor Trusts (GRAT & GRUT)
grantor retained trust = irrevocable trust into which grantor places assets and retains interest for a fixed number of years
at the end, principal will go to non-charitable beneficiary
Benefit: have high value which can be transferred using a low valuation method that limits the amount of gift or estate tax payable on these gifts
74
GRAT vs. GRUT compared
GRAT
- grantor contributes appreciated property
- grantor receives income stream based on % INITIAL valuation
- taxable gift = FMV - PV of annuity stream
- valued AT TRUST CREATION
- NO additional assets permitted
- NO inflation hedge
- Client suitability: conservative tolerance, desires fixed income for trust term
GRUT:
- grantor contributes appreciated property
- grantor receives income stream based on % ANNUAL valuation
- taxable gift = FMV - PV of annuity stream
- valued ANNUALLY
- additional assets permitted
- inflation hedge
- Client suitability: moderate to aggressive tolerance, income to outpace inflation
75
Qualified Personal Residence Trust (QPRT)
irrevocable trust that holds a person's home residence, allowing couples or individuals to live in the house rent-free for a specified period; at end of term, home will pass gift-tax free to trust beneficiaries
Advantages:
- tax reduction: potentially removes a higher valued asset out of estate
- property use: permits grantor's continued use of property during trust term
- support for beneficiaries
Disadvantages:
- possible estate inclusion (FMV on date of death if grantor does NOT outlive term)
- taxes (income)
- if beneficiaries intend to sell the home, original basis is transferred, increased by a portion of any gift taxes paid
- maintenance expense on property
- when grantor survives term, they must either move or rent
When deciding whether to use this strategy, identify beneficiaries' intended use of the home following the trust term. If they plan to sell the property, it may be best to keep the home in the grantor's estate and pass to the beneficiaries upon death because of the STEP-UP-IN-BASIS at the death of the grantor!
76
Charitable Lead Trust (CLT) - Charitable Lead Annuity Trust (CLAT)
pays income stream to qualified charity for a period of years, usually not more than 20 years
at expiration, remainder interest passes to one or more noncharitable beneficiaries
CLAT = type of CLT that provides annual payment of fixed amount to a qualified charity with the remainder going to a noncharitable beneficiary
Advantages:
- qualify for income tax, gift tax, and estate tax deductions
- if using grantor CLT, there is a large, front-loaded tax deduction that can offset taxation
- flexibility: can either be inter-vivos or testamentary
- means to support philanthropic goals and support beneficiaries
Disadavantages:
- trust principal is invaded if income is insufficient to make payments to charity (leaves less for beneficiaries)
- income tax deduction is only available for grantor CLTs (non-grantor CLTs do not qualify)
- lead trusts are non tax-exempt entities. Income earned by trust is taxed to grantor
CLAT = BEST CLT choice when interest rates are lower because smaller annuity payments to charity result in GREATER VALUE of trust corpus for remaindermen!!!!
77
Charitable Lead Unitrust (CLUT)
type of CLT that provides payment of a periodic sum, usually percentage of trust assets (revalued ANNUALLY) to a qualified charity, with remainder going to noncharitable beneficiary - annual payments fluctuate based on annual valuation
Advantages:
- qualify for income tax, gift tax, and estate tax deductions
- if using grantor-CLT, there is a large, front-loaded tax deduction that can offset taxation
- flexibility: can be inter-vivos or testamentary
- means to support philanthropical goals and support beneficiaries
- additional assets permitted
- income stream serves as inflation-hedge
Disadvantages:
- trust principal is invaded if income is insufficient to make payments to charity (leaves less for trust beneficiaries)
- income tax deduction is only available for grantor-CLTs, non-grantor CLTs do not qualify
- Lead trusts are non-exempt entities; income earned by trust is taxed to grantor
When the GSTT is a concern, CLUTs are a better alternative because the unlimited charitable deduction is available for the full value of the interest going to the qualified charity!!!!
78
grantor CLT vs. non-grantor CLT
grantor CLT: allows large up-front income tax deduction
non-grantor CLT: no deduction at time of funding
79
CLAT vs CLUT
Same for both:
- Grantor contributes income producing, appreciating property
- Non-charitable beneficiary receives remaining trust corpus
- PV of charity's lead interest is tax deductible in grantor trust, no tax deduction non-grantor CLTs
Differences:
CLAT - income stream based on % initial valuation (valued once at trust creation)
CLUT - income stream based on % annual valuation (valued annually)
CLAT - No additional assets
CLUT - additional assets permitted
CLAT - no inflation hedge
CLUT - inflation hedge
Client suitability:
CLAT - risk averse, seeks tax deduction on fixed payments to charity, desire for lump sum later
CLUT: moderate to aggressive risk tolerance, seeks tax deduction and income stream that keeps pace with inflation, desire for lump sum later
80
Charitable Remainder Annuity Trust (CRAT)
pays fixed amount annually to noncharitable beneficiary with remainder going to charity
- fixed payment based on a % of trust's initial valuation to noncharitable beneficiary at least annually
- income payments: between 5%-50% of trust value
(if income insufficient to meet required annual payment, difference is paid from capital gains or principal; if income > than required amount in a given year, excess is reinvested in trust)
- trust term: not to exceed 20 years
- No additional assets
- charity receives all trust assets upon death of income beneficiary or at end of trust term
- tax deduction can be carried forward a maximum of 5 years following initial contribution
Advantages:
- Current income tax deduction: PV of remainder interest
- income to grantor or non-charity beneficiaries
- support for grantor or beneficiaries
- giving to charity
- assets within trust accumulate tax free
Disadvantages:
- contributions are irrevocable, grantor loses control over property
- purchasing power of income stream may be reduced with inflation
- income received may be subject to ordinary income or capital gains taxes
CRAT retains any income above the guaranteed payments which can lead to larger transfer to qualifying charity and greater reduction to estate upon grantor's death!!!
81
Charitable Remainder Unitrust (CRUT)
payment of periodic sum, usually percentage of assets of trust to noncharitable beneficiary with remainder going to charity
- fixed percentage of net FMV of trust, revalued annually, distributed to noncharitable beneficiary at least annually
- income payments: 5%-50% of trust value
- Additional assets allowed
- reduces value of grantor's gross estate
- charity receives all trust assets upon death of income beneficiary or end of trust term
- tax deduction can be carried forward a maximum of 5 years following initial contribution (PV of remainder interest can be deducted if electing FMV for donation, 30% of AGI is deductible in current year)
Advantages:
- current income tax deduction, PV of remainder interest
- income to grantor or noncharitable beneficiaries
- support for grantor or beneficiaries
- giving to charity
- assets within trust accumulate tax free
Disadvantages:
- contributions to trust are irrevocable, grantor loses control over property
- annual revaluation of trust assets may result in lower payments if investments underperform
- income received may be subject to ordinary income or capital gains tax
CRUT is particularly useful for a grantor who has a highly appreciable asset and is seeking diversification without triggering capital gains tax!!!!
82
CRAT and CRUT
Same:
- grantor contributes appreciated property
- charity receives remaining trust property
- tax deduction: Charity's remainder interest FMV - PV of income stream
Differences:
CRAT: - income stream based on % of initial valuation (valued at trust creation)
CRUT: - income stream based on % of annual valuation (valued annually)
CRAT: - no additional assets
CRUT: additional assets allowed
CRAT: no inflation hedge
CRUT: inflation hedge
Client Suitability:
CRAT: risk-averse, desires tax deduction and predictable fixed payments
CRUT: Moderate to aggressive risk tolerance, seeks tax deduction and income stream that keeps in pace with inflation
For charitable remainder trusts remember the current year tax deduction in addition to charitable deduction from gross estate at grantor's death!!!
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Terminable Interest Property (TIP)
interest in a property that may terminate on the happening or failure of some event or contingency; marital deduction is NOT available for TIP, but exceptions available to the rule
Examples:
- spouse receives income interest in trust for life
- spouse receives trust income for a term of years
- spouse receives a life estate in real property
Gift Tax consequences:
Donor spouse can NOT take marital deduction for gifting TIP to donee spouse
Donor can take annual exclusion for present interest of the gift
Estate Tax consequences:
Spouse who receives TIP will NOT include property in their gross estate at death
Spouse who gifts TIP will remove property from their estate
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Exceptions:
#1: Spouse is given a life estate in a trust and is given a general power of appointment over trust corpus (this allows spouse to appoint property to themselves, their estate, their creditors, and creditors of the estate)
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→ donor spouse can take marital deduction for TIP
→ property will be included in donee spouse's estate
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#2: Donor spouse "qualifies" TIP given to spouse for the marital deduction, i.e., QTIP property
→ election can be made by donor spouse or decedent spouse's executor to obtain a marital deduction for gifts or bequests
→ QTIP property is included in recipient spouse's estate, resulting in higher estate tax
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84
Spousal Transfers: Bypass Trusts
Aka: credit shelter trust, family trust, B-Trust
- Designed to receive property that is not allocated to the A-Trust, the estate trust, or the QTIP trust
- Amount equal to $12.06MM is placed in trust
- Trustee may distribute net income of trust to surviving spouse during lifetime, or income may be accumulated or directed to other persons to reduce overall income tax effect on family
Purpose:
- Avoids over-qualifying decedent spouse’s estate for marital deduction by utilizing decedent’s maximum unified credit
- Allows surviving spouse to obtain income as needed
- Trust assets are NOT included in surviving spouse’s estate at death
Creation:
- Decedent spouse determines trust beneficiaries when trust is created (surviving spouse, children)
- Trust is funded with property solely owned by decedent
Funding:
- Established during life: Inter-Vivos recovable trust
- Established at death: Testamentary Bypass trust
Spousal income from a B-Trust:
- Surviving spouse can obtain income as needed from trustee
- Income interest = terminable interest
- Decedent spouse cannot receive marital deduction on their estate tax return
Surviving Spouse’s Estate:
- Property bypasses inclusion in surviving spouse’s estate
- Spouse can be given limited power of appointment with an ascertainable standard (HEMS) to receive distributions from trust income and corpus
- Spouse can exercise limited power of appointment to distribute assets to beneficiaries
- Spouse can be given a 5 x 5 power of appointment over the trust corpus (lets the beneficiary make withdrawals from the trust on a yearly basis. The beneficiary can cash out $5,000 or 5% of the trust's fair market value each year, whichever is a higher amount.)
85
Spousal Transfers: A-Trust
Aka: Power of Appointment Trust, marital trust
= testamentary trust, only takes effect upon death of grantor
- Consists of property that qualifies for federal marital deduction, thus surviving spouse must be the only beneficiary of this trust
Purpose:
- Surviving spouse has access to income and corpus for life
Features:
- Surviving spouse has a general power of appointment over trust corpus, exercisable during life and/or at death
- Surviving spouse must receive all income, paid at least annually, NO accumulation of trust income
- Surviving spouse determines beneficiaries of trust assets at death via general power of appointment in the will
- Trust property included in surviving spouse’s estate
86
A-B Trust
Designed to give surviving spouse full use of family’s economic wealth, while minimizing total federal estate tax payable at deaths of both spouses
- Avoids overqualification of the estate for the marital deduction because of underutilization of the applicable credit in the estate of the first spouse to die
Surviving spouse
- has right to all income and corpus from A-Trust and income if needed from B-Trust
- only property from A-Trust is included in surviving spouse’s estate
Decedent spouse:
- marital deduction available for A-Trust
- unified credit is used for B-Trust
- estate tax liability is zero
A-B Trust
Estate
B-Trust A-Trust
Funded with amount Funded with amount of
equal to Estate Tax Credit assets in excess of Estate
Tax Credit
At death of surviving spouse At death of surviving
spouse assets pass to beneficiaries trust assets are taxed
tax free
87
Spousal Transfers: QTIP Trust
Purpose:
- provide beneficiary spouse with income for life
- qualifies trust property for marital deduction
- give trust corpus to children from previous marriage
Provisions:
- surviving spouse must receive all trust income annually, may receive distributions of trust corpus at the trustee’s discretion
- corpus passes to remainder beneficiaries designated by decedent, at beneficiary spouse’s death (terminable interest!)
- qualifies decedent’s estate for marital deduction, executor elects QTIP treatment on Form 706
- assets are included in surviving spouse’s estate for estate tax purposes
Executor of the estate makes the QTIP election!
Appropriate for grantor who is in a second marriage and would like to provide support for current spouse and children from previous marriage – QTIP is best option!
88
Estate Equalization
Estate planning technique under which an estate is divided into two parts and taxed at a lower rate rather than remaining as a whole and taxed at a higher rate. Division may be necessary because of progressive nature of federal estate tax.
OBJECTIVE: minimize total estate tax liability for combined estates
89
Disclaimer Trust
estate planning technique in which married couple incorporates irrevocable trust in their planning, which is funded only if surviving spouse chooses to disclaim the outright distribution of certain assets following deceased spouse's death
Allows surviving spouse to determine what portion of decedent’s estate to transfer into a trust to use decedent’s unified credit
90
Ascertainable Standard
added to trust to give trustee guidance as fas as when and how they need to make distributions to the beneficiaries
a trustee can make distributions to a beneficiary for health, education, maintenance, and support (HEMS standard)
91
Estate Trust
qualifies property for a marital deduction in the decedent's estate
used if beneficiary spouse has substantial wealth and does not need trust income or corpus
92
Which trust(s) is/are appropriate if the spouse is to receive all income annuallly?
A
| QTIP
93
Which trust(s) is/are appropriate if the surviving spouse should be able to receive income if needed?
B Trust
| Estate Trust
94
Which trust(s) allow(s) decedent spouse to receive a marital deduction?
A Trust
QTIP
Estate Trust
outright gift to the spouse
95
Which trust(s) allow the surviving spouse to choose the trust beneficiaries?
A Trust
| Estate Trust
96
Which trust allows the surviving spouse to determine what portion of the decedent's estate is to be transferred to use the decedent's unified credit?
Disclaimer Trust
97
What allows the surviving spouse to access trust income for health, education, maintenance, and support without including the assets in their estate?
Ascertainable Standard
98
Spousal Transfer Trusts Compared
Marital Deduction Surviving Spouse Included in Included in
Power of Appointment Decedent's Estate Surviving
Spouse's
Estate
A Y Y N Y
QTIP Y N N Y
B Y N Y N
99
Qualified Domestic Trust (QDOT)
Unlimited marital deduction does not apply to gifts made to non-citizen spouses nor to transfers made to them at death
IRC Section 2056: decedent's estate will qualify for the federal marital deduction if assets transfer into a marital trust (QDOT). A QDOT assures that the assets will not ultimately leave the US without being taxed.
Surviving Spouse
US Citizen US Resident Nonresident
Noncitizen Noncitizen
Decedent
US Citizen 12.06M exclusion 12.06M exclusion 12.06M exclusion
Unlimited MD No MD No MD
QDOT deferral QDOT deferral
Potential treaty Potential treaty
benefits benefits
US Resident 12.06M exclusion 12.06M exclusion 12.06M exclusion Noncitizen Unlimited MD No MD No MD
QDOT deferral QDOT deferral
Potential treaty Potential treaty
benefits benefits
Nonresident $167k exclusion $167k exclusion $167k exclusion Noncitizen Unlimited MD No MD No MD
QDOT deferral QDOT deferral
Potential treaty Potential treaty
benefits benefits
100
What happens when the executor of an estate does not make a QDOT election on form 706 for a decedent who leaves his assets to his resident noncitizen spouse?
The lifetime and estate tax exemption apply: $12.06MM, but the rest is taxable to the surviving spouse.
E.g.: decedent leaves $17MM, $12.06MM lifetime and estate exemption apply, $4,940,000 = taxable to surviving spouse
101
Trust for Minors
2503(b) trust (aka Qualifying Minor's Trust or Mandatory Income Trust) = irrevocable trust, requires distribution of income annually; most often, distributed funds are placed in a custodial bank account until child reaches legal age
2503(c) trust = gift tax tool that enables grantor to make a gift to a minor in trust and still obtain annual gift tax exclusion
102
2503(b) Trust
- must distribute income to minor annually or more frequently
- all portions of gifts qualify as gifts of present interest for income beneficiaries, thus are eligible for annual gift tax exclusion (actuarial value of income interest)
- can last for lifetime of the beneficiary or for any lesser period of time
- corpus may be withheld from beneficiary until his/her death
- corpus will be excluded from donor's gross estate
- corpus will be excluded from gross estate of income beneficiary if income interest terminates at beneficiary's death
- the actuarial value of the income interest is eligible for the annual exclusion (not the value of the income and principal)
103
2503(c) Trust
- gift to minor will be considered a gift of present interest, thus qualify for annual gift tax exclusion
- no requirement for current income distributions
- income and principal must be available for distribution to or on behalf of beneficiary at any time prior to the time of the beneficiary reaches age 21 (regardless of state laws on maturity)
- Income accumulated in the trust is taxed to trust (not beneficiary!)
- unexpected income and principal must be distributable to beneficiary at age 21
- if beneficiary dies before age 21, accumulated trust income and corpus must go to minor's estate or appointee pursuant to a general power of appointment
- entire gift to the trust is eligible for exclusion
104
Special Needs Trust
preserve eligibility for government benefits (SSDI, SSI, Medicaid for food, shelter, and clothing) and pay for extra services that are not covered by public assistance programs
Cover extra services:
- medical expenses not covered by Medicaid
- supplemental attendant and custodial care
- additional therapies
- respite care for family caregivers
Pay for:
- telephones
- computers and internet access
- cable TV
- basic household furnishings
- travel and a companion
parents and/or relatives fund with cash or assets or life insurance
A person who gets SSI can earn up to $1,767 a month ($2,607 for a couple) and still get SSI; unearned income must be less than $861 to receive SSI
105
Irrevocable Life Insurance Trust (ILIT)
can provide decedent's estate with liquidity for payment of all death taxes with existing life insurance, or with insurance the trust intends to purchase, without subjecting the proceeds themselves to depletion by estate taxes
grantor transfers existing life insurance into an ILIT; if owner survives transfer of policy by at least 3 years, no portion of the death benefit proceeds will be included in the owner's estate
3-year rule: certain property interests that were previously transferred within 3 years of owner's death are included in their gross estate;
Transfer of a life insurance policy or any incidents of ownership in the policy in which the decedent was the owner and the insured
An owner who is NOT the insured: a policy gifted within 3 years of owner's death will NOT be brought back into the owner's estate
106
Unfunded ILIT
includes only grantor's life insurance policy
- grantor must transfer money into trust each year so the trustee can pay the life insurance premiums
- beneficiaries are given Crummey Powers: right to withdraw some, or all, of a grantor's contribution to an irrevocable trust each year turn a future interest gift into a present interest gift, thus eligible for annual exclusion
→ withdrawal amount must be the lesser of:
- annual exclusion
- annual contribution made to the trust
- greater of $5000 or 5% of the amount transferred into the trust
LI Policy:
Owner = trust
Beneficiary = trust
Insured = grantor
107
Funded ILIT
Transfer a life insurance policy and income-producing property into the ILIT
- trust income pays for life insurance premiums
- beneficiaries are not given Crummey Powers
- grantor is taxed on trust income due to grantor trust rules
LI Policy:
Owner = trust
Beneficiary = trust
Insured = grantor
108
Family Limited Partnership
Pass-through entity established under state law; works as a partnership consisting entirely of family members
Allows senior family members to transfer property to junior family members at significantly reduced transfer costs to lower the value of their estates and keep the property in the family
Advantages:
- control: general partners (senior family members) retain control of property through the FLP
- Income tax reduction: shares are shifted to junior family members at lower tax brackets, reducing current taxation; earnings from assets in the FLP are taxed at recipient's tax bracket
- protection from creditors
- valuation discounts: range from 30%-70% for lack of marketability and minority ownership; leads to more efficient transfer of wealth
- gifting: ease of gifting assets that are difficult to distribute; transfers qualify for the annual exclusion
Disadvantages:
- income shifting to younger family members may be limited to Kiddie Tax
- additional filing, fees, informational tax returns are due when setting up and accounting for an FLP
- gifts do not receive a step-up in basis
- retained partnership interests continue to appreciate in senior family member's estate
109
Intra-Family Transfers: Sale-Leaseback & Gift-Leaseback
used to structure a sale or gift of business property to family members to provide them with
(1) income stream from lease payments
(2) remove business property from owner's estate
Sale or gift of property must be irrevocable and based on FMV; a legally enforceable lease agreement should be in place that provides for reasonable lease payments.
110
Sale Leaseback
- business owner sells business property to adult child, then leases it back
- owner receives lump sum payment or installment payments from child and continues to use the property in the business
- owner deducts monthly lease payments to child as a business expense
- Lease payments are taxed in the child's lower tax bracket
- business property is removed from business owner's estate
111
Gift Leaseback
- owner gifts property into irrevocable trust, then leases property back
- owner receives business deductions for lease payments made to the trust
- trustee distributes lease payments to family beneficiaries in lower tax brackets
- business property is removed from owner's estate
112
Intra-Family Transfers
Installment Sale
Self-Cancelling Installment Note (SCIN)
Private Annuity
- available to business owners to transfer their business interests to family members according to their objectives
- remove business interests and future appreciation from estate by selling or gifting to family members, while minimizing taxes in the process
Type Duration Secured Impact on Seller's Gross Estate
Installment Fixed Term Y PV of unpaid installments
Notes may be includable
SCINs Fixed Term Y Transferred property removed
from gross estate
Private Life of Seller N If payment over joint lives, PV
Annuities of remaining payments
included in decedent's gross
estate
113
Installment Sale
used to sell a business to a family member or 3rd party and provide secured income for seller
- promissory installment note is secured and does not require a set sale price
- buyer does not need down payment and payment amounts can vary
- at least one payment must be made to owner after taxable year in which the sale occurs
- PV of any outstanding installment payments is included in seller's estate
114
Self-Cancelling Installment Note (SCIN)
partially or fully cancels installment note before note matures
- seller can cancel installment note in the will, unpaid balance of the note is NOT included in seller's gross estate
- seller can cancel entire note at once, which is subject to capital gains and gift taxes (example: basis of business $100,000 sold for $800,000. Capital gain is reported on $700,000 and $684,000 is subject to gift taxes.)
- seller can cancel note in increments of $16,000 per year per buyer to avoid or reduce taxable gifts
115
Private Annuity
seller receives fixed annuity income stream for life and removes business/property from their gross estate
- payments from sale are structured as an annuity and are unsecured
- single life annuity: remaining payments are NOT included in seller's estate
- joint and survivor annuity: payments continue for 2 lives; PV of survivor's future annuity payments is included in seller's estate, but a marital deduction is available to offset the tax
if the buyer dies before the seller, the buyer's estate must make payments to the seller for life. If the seller outlives their calculated life expectancy, buyer must continue to pay the seller.
116
Alternate Valuation Date (AVD)
Executor (personal representative) elects to value estate on either:
- Date of Death, or
- AVD (i.e., 6 months after date of death).
AVD election is irrevocable, made on Form 706
If made, ALL assets must be valued as of the AVD, even if they’ve increased in value.
If the alternate valuation date (AVD) 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.
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EXCEPTION: Depreciating assets whose value declines over time do NOT qualify for this treatment and must be valued using FMV on date of death.
Examples:
cars
patents
life estates
remainder interests
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Election can be made if valuation on the AVD results in:
Reduced gross estate value, AND
Reduced estate tax + GSTT.
117
Which is an estate planning document on which a testator can name guardians, appoint an executor, and direct assets into a revocable living trust (RLT) that were incorrectly titled?
Pour-over Will
The pour-over will has similar basic functions to the last will, however, it is often used with a revocable living trust in estate planning. Specifically, the pour-over will serves to direct assets into a revocable living trust (RLT) that were:
Acquired after RLT established
Incorrectly titled
Excluded from the trust
118
Trust with a sprinkle or spray provision
No application of the annual exclusion allowed
A gift into a trust with a sprinkle or spray provision permits the trustee to make discretionary distributions from the trust to the beneficiaries.
119
When an ILIT has Crummey powers attached, the beneficiary is given the right to withdraw the lesser of:
- The annual exclusion
- The annual contribution made to the trust
- The greater of $5,000 or 5% of the amount transferred into the trust
120
In what way is the tax deduction different for donor-advised funds than other charitable giving options?
When contributing to donor-advised funds, donors are entitled to a charitable income tax deduction based on the type of property contributed, subject to AGI limitations.
With charitable remainder trusts, pooled income funds, and charitable gift annuities, the available tax deduction is equal to the PV of the charity’s remainder interest.
121
When is a grantor retained income trust (GRIT) a useful technique?
when a client wants to purchase certain tangible assets such as a work of art, retain the right to display it in his or her own home and have it pass to a specified person immediately and without probate at death.
If the grantor is unable to establish the value of the retained interest through comparable rentals, the gift of the transferred remainder will equal 100% of the value of the transferred property.
122
The fixed annuity amount paid to a grantor from a grantor trust must not exceed ____ of the amount paid the prior year.
120%
123
How does a reverse gift transfer work?
If the decedent lives for more than one year after receiving the gift, or
if the gifted property is bequeathed to anyone other than the original donor or the donor's spouse, the transferred property would receive a stepped-up basis in the decedent spouse's estate for the property's fair market value.
124
What are the community property states?
There are nine community property states including: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
A Cat In Louisiana kNew Nothing More Than Wishy Washy
125
A father gives $18,600,000 to his son in an irrevocable trust. Assume this is a gift of present interest gift.
The father makes no additional taxable gifts in the current tax year and has made no taxable gifts in the past. The unified credit amount in the current year is $4,769,800.
Calculate the total gift tax payable.
$5,608,400
$3,990,880
$2,690,000
$2,609,600
Gift to son $18,600,000 minus the annual exclusion of $16,000 equals a taxable gift of $18,584,000.
Total taxable gifts equal $18,584,000.
Step 1. Compute gift tax on all taxable gifts regardless of when made. The tax on $18,584,000 is $7,379,400
Step 2. Compute gift tax on all taxable gifts made prior to the present gifts: $0
Step 3. Subtract Step 2 result from Step 1 result: $7,379,400
Step 4. Enter gift tax unified credit remaining: $4,769,800
Step 5. Subtract Step 4 result from Step 3 result to obtain gift tax payable: $2,609,600
The father must file a gift tax return, an IRS Form 709.
126
A mother's basis in stock is $40,000 and she gifts the stock to her daughter when it is worth $36,000.
Eight months later, the daughter sells the stock for $38,000.
Identify the correct tax treatment of the daughter’s sale.
$2,000 long-term capital gain
$2,000 short-term capital gain
$2,000 long-term capital loss
No capital gain or loss
Because daughter sells the stock for $38,000, she will use the FMV on the date of the gift as her basis ($36,000).
Since the sale price falls between the mother's original basis ($40,000) and the FMV on the date of the gift ($36,000), she recognizes no capital gain or loss on the sale.
127
What is the maximum reduction of the decedent's gross estate under Section 2032(A) (special use valuation)?
The maximum reduction of the decedent's gross estate under Section 2032(A) (special use valuation) in 2022 is $1,230,000.
This rule is especially useful where the price of farmland falls behind local prices for new homes or commercial property.
128
What are the steps to calculate the federal estate tax?
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.
129
To maximize the use of one's GST tax exemption, it is preferable to allocate it to which of the following?
Taxable distributions
Taxable terminations
Direct skips
Taxable distributions and taxable terminations are tax inclusive whereas direct skips are tax exclusive. Since the net amount for the recipient of direct skips is exclusive of the tax, then, an allocation to direct skips tends to be wasteful. Therefore, in order to maximize the use of one's GST tax exemption, it is preferable to allocate it whenever possible to what otherwise would be taxable distributions and taxable terminations.
130
What is a taxable distribution from a GST?
A taxable distribution is any distribution of income or corpus from a trust to a skip person that is not otherwise subject to estate or gift tax.
Since the trust was established by Milo, Seth’s grandfather, and Seth received a distribution of trust corpus, this transaction would be categorized as a taxable distribution.
