Gross Estate

Question 1

Internal Revenue Code Section 2033

Answer 1

Internal Revenue Code Section 2033 is a catchall provision dealing with assets, which are included in the gross estate. Effectively, IRC Section 2033 states that the value of all property in which the decedent had an interest on the date of death will be included in the decedent’s gross estate, unless a specific exclusion for the property exists. Therefore, only the value of the property interest held by the decedent on the date of death will be included in the gross estate.

Question 2

Income in respect of a decedent, or IRD,

Answer 2

Income in respect of a decedent, or IRD, is the right to future income earned but not received prior to a decedent’s death is a property interest that will be includable in the decedent’s estate.

Question 3

Property owned jointly with non-spouses

Answer 3

Property owned jointly with non-spouses

For property held as a JTWROS with a non-spouse, then the percentage-of-contribution rule would apply. The rule is that 100% of jointly held property is includable in the estate of the first joint owner to die, except to the extent the survivor can prove contribution with funds that were not acquired by gift from the decedent. For example, if a brother paid 25% for a condo and his sister paid 75%, then when the brother dies only 25% of the FMV of the condo is included in the brother’s estate.

When property is owned with others as a tenancy-in-common, then only the deceased tenant’s fractional share of the property is included in the tenant’s estate. For example, four friends owned property together in different amounts. Roger owned 1/5 of the property therefore only 1/5 of the FMV of the property was included in Roger’s gross estate when he died.

Question 4

Dower & Curtsey Interest

Answer 4

Under the common law system, a surviving spouse has dower or curtesy rights. Dower is defined as the widow’s property rights under state law. Curtesy is defined as the widower’s property rights under state law. Community property states do not apply dower or curtesy rules. Most U.S. states have abolished the common law dower and curtesy statutes and have in place other laws that treat both husband and wife identically, that is, the elective share, or statutory share statutes. However, what is important about Section 2034 is the fact that the gross estate is not reduced by the value of any dower or curtesy interest. The value of these assets will be included in the decedent’s gross estate.

Question 5

Revisionary Interest

Answer 5

The right to regain the property is called a reversionary interest. To cause inclusion, the actuarial value of the transferor’s reversionary interest must be significant. Stated more precisely, the right to regain the property, or the right to dispose of it, must be worth actuarially more than 5% of the property’s value.

Question 6

The late Mr. Daniel Sherwood bequeathed his property to his niece as “To Sandra Sherwood for life, remainder to her issue and if no issue then to the American Red Cross.” Sandra died childless in 2020. At the time of Sandra’s death:

A. Sandra’s life estate terminated.

B. The property ownership was transferred to her issue according to her uncle’s will.

C. Sandra did not own the property.

D. The property interest must be included in her gross estate.

Answer 6

Correct Answers: A. and C.

Explanation: Under IRC Section 2033, no inclusion is required for property in which the decedent’s interest was obtained from someone else and was limited to lifetime enjoyment. Estate tax is a tax on the transfer of property at death. This means that if an interest terminated at the decedent’s death and the decedent had no right to transfer at death, its value will not be included. Sandra did not have anything that she could transfer. Her life estate, by its terms, terminated with her death so there was nothing to transfer. Though Sandra had an interest in the property at the time of her death, it was not a property interest that she could pass to someone else.

Question 7

A When Sharon was 68, she was diagnosed as having terminal cancer. Doctors gave her a life expectancy of just eight months, with little hope of a cure. She had four children to whom she gifted the property that she owned outright. She died a year later. Which of her properties that she gifted as follows would be includable in the gross estate?

A. Her villa to Stephanie, retaining life estate

B. Her country house to Martha, for life, at Martha’s death, it returns to Sharon, unless Sharon is dead, then remainder to Martha’s issue

C. Her shares in Oracle Corp., to Winston, retaining power to revoke

D. Her garment factory to Leyland

Answer 7

Correct Answers: A., B. and C.

Explanation: As per IRC Section 2035, gifts made within three years of death are not includable. The exceptions are properties includable under IRC Sections 2036, 2037, 2038 or 2042. The villa falls under Section 2036 because Sharon retains life estate. The country house as life estate falls under Section 2037 because it is contingent that Martha be alive to enjoy the gift, with Sharon still retaining a right to regain the property personally. Her shares in Oracle Corp., fall under Section 2038 because Sharon retained the power to revoke. Therefore, these three properties-the villa, country house and Oracle shares-are includable in the gross estate. The only property that is not includable is the garment factory, which was a complete gift

Question 8

A dower is the right of:

A. the surviving wife to an interest for life in one-fourth of all real property owned by her husband during their marriage.

B. the surviving wife to an interest for life in all of the real property owned by her husband during their marriage.

C. the surviving husband to an interest for life in one-fourth of all real property owned by his wife during their marriage.

D. the surviving husband to an interest for life in all of the real property owned by his wife during their marriage.

Answer 8

Correct Answer: B. the surviving wife to an interest for life in all of the real property owned by her husband during their marriage.

Explanation: Under the common law system, marriage creates a spousal interest in the real property owned by the decedent. Dower is the right of the surviving wife to an interest, for life, in all of her husband’s real property. The right of the husband to an interest for life in all of the real property owned by his wife during their marriage is called curtesy

Question 9

Revocable Transfer

Answer 9

A Revocable Transfer is a transfer of property in which the decedent retained the right to alter, amend, revoke or terminate the gift.

Question 10

Types of Annuities

Answer 10

Annuities are broadly classified into two types:

Commercial annuities

Private annuities

Question 11

The general rule regarding annuities, as defined in IRC 2039, is subject to three qualifications:

Answer 11

The general rule regarding annuities, as defined in IRC 2039, is subject to three qualifications:

Contracts such as a life annuity that provide payments to the decedent and end at death are not subject to this provision because they are not capable of death time transmission, that is, there is no transferable interest.

If the survivor or anyone other than the decedent furnished part of the original purchase price, then that portion of the survivor’s annuity will not be included in the decedent’s gross estate. So if the survivor paid one-third of the initial premium, only two-thirds of the value of survivor’s income interest would be includable. If the decedent’s employer furnished all or part of the purchase price, that contribution is treated as if it were made by the decedent.

Where the death proceeds of a life insurance policy are taken under a settlement option, they are considered life insurance proceeds rather than an annuity and are not taxed according to annuity rules.

Question 12

There are two rules that affect the estate taxation of property held jointly with the right of survivorship:

Answer 12

There are two rules that affect the estate taxation of property held jointly with the right of survivorship:

When the joint tenants are spouses

When the joint tenants are not spouses

Question 13

Spouses as Joint Tenants

Answer 13

Spouses as Joint Tenants

If an asset is owned jointly with rights of survivorship by a husband and wife, or as a tenancy by the entirety, upon the death of the first spouse only 50% of the value of the jointly-owned property will be included in the first spouse’s gross estate. This is regardless of the size of his or her contribution. In fact, even if contribution of more than half can be proven by the survivor, this rule must be used.

This rule applies to both real and personal property regardless of how it was acquired or when it was purchased.

Question 14

Percentage-of-Contribution Rule

Answer 14

Percentage-of-Contribution Rule

The percentage-of-contribution rule, also known as the consideration-furnished rule, affects the estate taxation of property held jointly with the right of survivorship and is used where the joint owners are not spouses, or if one of the spouses is not a U.S. citizen. Essentially, this provision measures the estate tax includability of jointly-held property with survivorship rights by referring to the portion of the purchase price attributable to the decedent’s contribution.

Actually, the rule is that 100% of jointly-held property is includable in the estate of the first owner to die, unless the survivor can prove contribution out of funds other than those acquired by gift from the decedent. So, if the survivor can prove contribution of one-third of the original purchase price, only two-thirds of the value of the jointly-held property will be includable in the decedent’s estate. If the survivor can prove contribution of two-thirds of the original purchase price, only one-third would be includable in the decedent’s estate.

Question 15

Corporate Owned Life Insurance (COLI)

Answer 15

Corporate Owned Life Insurance (COLI)

Corporate owned life insurance (COLI) is includable in a decedent’s estate if he or she owned more than 50% of the corporation’s stock at death and is the insured on the policy, but only to the extent that it is payable to a party other than the corporation or its creditors.

Question 16

David transferred his estate to his daughter, Jennifer, in 2015 with the condition that she would receive income until age 35, at which age she would receive the principal, if she were not married. He retained the power to distribute the income to his son, Stephan, if Jennifer should get married. David dies in 2020 when Jennifer is 32 years old and not married. Which of the following is includable in David’s gross estate?

A. The value of all interest paid to Jennifer from 2015 to David’s date of death.

B. The value of the remaining income term interest for three years from David’s date of death to when Jennifer reaches age 35

C. The value of the principal

D. The value of both the principal and all interest paid to Jennifer from 2015 to David’s date of death.

E. The value of both the principal and the remaining income term interest for three years from David’s date of death to when Jennifer reaches age 35.

Answer 16

Correct Answer: B. The value of the remaining income term interest for three years from David’s date of death to when Jennifer reaches age 35

Explanation: According to IRC Section 2038, in David’s case only the transfer of income is a revocable transfer. Only the value of property subject to this power will be included in the gross estate and not the entire value of the transfer of property. The property for which David retained this power at the time of his death was the remaining income that would be paid to Jennifer until she reaches age 35. David did not retain the right to the transfer of principal because Jennifer would receive it in any case at age 35, and therefore the principal is not includable.

Question 17

Tom purchased an annuity contract for his son, with payments to be commenced at his death, which was irrevocable. When Tom dies, which of the following apply to the value of the annuity interest?

A. Includable in Tom’s gross estate because he purchased the annuity.
B. Includable in Tom’s gross estate because a transfer of property takes place at death.
C. Not includable in Tom’s gross estate because he has no beneficial interest in the payments.
D. Not includable in Tom’s gross estate because he has no right to payments.

Answer 17

Correct Answer: C. and D.

Explanation: Both IRC Sections 2039 and 2033 are applicable here. Tom does not have any beneficial interest in the payments because they will commence at his death and go to his son. The annuity is not being transferred at death. Therefore, it is not includable in Tom’s gross estate. According to IRC Section 2039, it will be includable only if it provided the decedent with a payment or a right to payment for life

Question 18

Benjamin and his son Jerome jointly purchase 2,500 shares of Petra Inc. at the rate of four dollars per share. Benjamin paid $7,500, while Jerome paid the remaining $2,500 required for this purchase. At the time of Benjamin’s death in 2020, the stock is worth $20 per share. How much will be includable in his gross estate?

A. $37,500

B. $7,500

C. $10,000

D. $5,000

Answer 18

Correct Answer: A. $37,500.

Explanation: The percentage-of-contribution rule will be applied here because the property is held jointly with the right of survivorship. This provision measures the estate tax by referring to the portion of the purchase price attributable to Benjamin’s contribution, which was 75%. Therefore, the value includable in his gross estate is 75% of market value of the shares when he dies, that is, 75% of $20 x 2500, which is $37,500.

Question 19

General Valuation Rules

Answer 19

General Valuation Rules

According to the general rules, assets included in the gross estate are valued on the decedent’s date of death.

IRC Section 2031 deals with the factors which must be recognized in order to value items includable in the gross estate for federal estate tax purposes. Not only must all the factors affecting value be considered, but there must be sound reasoning for the relative weight given to each one.

Question 20

The alternate valuation date (AVD)

Answer 20

The alternate valuation date (AVD) is six months after death. The executor can elect the alternate valuation date only if the value of the decedent’s gross estate has diminished in value in six months and the estate tax liability is also less. If all of the decedent’s property is transferred to the surviving spouse by will, then the estate tax liability is zero and cannot decline, so the alternate valuation date could not be used. Once the date of death or alternate valuation is selected for valuation purposes, such date applies to all assets in the estate.

If the alternate valuation date is selected and if the property is distributed, sold, exchanged, or otherwise disposed of within six months of the decedent’s death, it will be valued as of that 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. Any such property interest or estate whose value is affected by the mere passing of time is valued as of the date the decedent died.

Question 21

Special Use Valuation (Section 2032A)

Answer 21

Special Use Valuation (Section 2032A)

An executor may elect to value qualifying real property on the basis of its actual special use rather than its highest and best use. This rule is especially useful where the price of farmland is artificially increased by, or has not kept up with, the price per acre of encroaching housing developments or more lucrative commercial businesses. Electing a valuation based on special use enables the executor to value the farmland for farming purposes by applyting the inflation-adjusted reduction amount.

The maximum reduction of the decedent’s gross estate under this provision in 2020 is $1,180,000.

Question 22

Qualification Requirements for Special Valuation Rule

Answer 22

Qualification Requirements

The following are the requirements for a property to qualify for the special valuation rule:

On the date of the decedent’s death, the property must be involved in a qualified use. The term qualified use is defined by IRC Section 2032A(b)(2) as use of a farm for farming purposes or in a trade or business other than farming.

The value of the qualified property in the decedent’s estate must equal at least 50% of the decedent’s gross estate. This is after debts or unpaid mortgages are deducted from both the qualified property as well as the gross estate.

At least 25% of the gross estate, less debts and unpaid mortgages on all property in the gross estate, must be qualified farm or closely held business real property.
All gifts made within three years of the donor’s death are added back into the gross estate solely for the purpose of calculating the 50% and 25% tests.

Question 23

For federal estate tax purposes, an unmatured life insurance policy owned by the decedent on the life of another is valued as follows:

A. An unmatured policy owned by the decedent on the life of another is not includable in the decedent’s estate

B. If the policy is paid up, the policy is valued at its replacement cost

C. If the policy is a new policy, the policy is valued at its interpolated terminal reserve plus any unearned premium

D. If the policy is a term policy, the policy is valued at the lower of cost or standard valuation tables

Answer 23

Correct Answer: B. If the policy is paid up, the policy is valued at its replacement cost

Explanation: The value of an unmatured policy owned by a decedent on the life of another is includable in the gross estate where he or she predeceases the insured. If the policy is paid up, its value is its replacement cost. If the policy is new, the value is the gross premium paid. If the policy is a term policy, the value is the unused premium.

Question 24

Cedric left a huge estate to his daughter, Lucy, when he died. The executor of his estate approaches you to advise him about the valuation of Cedric’s estate. What do you think could be the various factors that will affect the valuation of Cedric’s real property?

A. The value of net income received from the property
B. The size, shape and location of the property
C. The nature and condition of the property
D. An active market for the land
E. The actual and potential use of the property

Answer 24

Correct Answers: A., B., C. and E.

Explanation: Some of the basic factors that affect valuation of real property are the size, shape and location, the nature and condition, the actual and potential use of the property, the value of net income received, and zoning restriction. However, land does not have to have an active market to attain substantial value.

Question 25

A blockage discount occurs when:

A. The block of stock to be sold is too large to be marketed in an orderly manner
B. Selling prices and bid and asked prices may not reflect the fair market value
C. The block of stock valued represents a controlling interest in the going business
D. The block of stock has the effect of increasing value because of its element of control

Answer 25

Correct Answers: A & B.

Explanation: A blockage discount occurs when a large block of stock that cannot be marketed in an orderly manner results in depressing the market. If this is the case, selling prices and bid and asked prices may not reflect their fair market value. The converse of the blockage situation is where the block of stock to be valued represents a controlling interest either actual or effective in a going business. Here, the large block could have the effect of increasing value because of its element of control.