Lesson 2 of Estate Planning: Gift and Estate Taxes Flashcards
Gift Tax!
The gift tax is an excise tax on the right to transfer assets gratuitously to another person during life.
In 1976, Congress unified the gift and estate tax rate schedules to discourage taxpayers from transferring assets during life to avoid the higher tax on the transfer of property at death. Essentially, the unified gift and estate transfer tax system taxed the transfer of property at the same tax rates regardless of the time of transfer of property, dunng life (gifts) or at death (bequests).
This unitied system ended in 2003, when the effects of the Economic Growth an Tax Relief Reconciliation Act
of 2001 (herein referred to as EGTRRA 2001), which repeals the estate tax over a nine-year period ending 2010 took force.
With the Tax Relief, Unemployment Insurance, Reauthorization and Job Creation Act of 2010 the estate, gift and generation-skipping transfer tax systems are unified.
Gift Tax!
- Table Showing Tax Rate Schedules for Gifts and Estates for 2023
Given on Exam
Gift Tax!
- Table Showing: (Years 2009 - 2023)
- Estate and Gift Tax Rates
- Exclusion Amounts
- Credit Amount
Introduction to Gifts
- 4 Basis Questions for Gift Tax System?
While the gift tax system is replete with rules, exceptions, and exemptions, the overall scheme can be described with four basic questions:
- Disregarding all other factors, is the transfer a taxable gift?
- Is the gift nontaxable because of an available exemption, exclusion, or legislative grace?
- If the gift is taxable, what is the tax due and how is it reported?
- Is the gift an appropriate gift considering both the donor objectives and donee?
Characteristics of Gifts
- Two Parties Involved in Gifts
The donor is the person who makes the gift.
The donee is the person who receives the gift.
Characteristics of Gifts
- Elements of a Gift Are?
- The donor must have the intent to make a voluntary transfer.
- The donor must be competent to make the gift.
- The donor must actually part with dominion and control over the gifted property.
- The donee must be capable of receiving the gift.
- The donee must take delivery.
Dominion means donor must have had had ownership of the gift.
Characteristics of Gifts
- Consideration
Consideration is the value of property transferred in return for other property.
- A gift arises whenever an exchange of property occurs and each of the parties does not receive full and fair consideration for their property or services
Characteristics of Gifts
- Two Types of Gifts
- Direct Gifts
A direct payment of cash or transfer of property to a donee is a direct gift.
Characteristics of Gifts
- Two Types of Gifts
- Indirect Gifts
An indirect gift is a transfer on behalf of a donor for the benefit of the donee. Indirect gifts can take many forms, and generally occur with intrafamily transactions.
- One of the most common ways an indirect gift occurs is through the payment of another’s debt or through an interest-free or below-market loan (also known as a gift loan).
- Interest-free loans and below-market loans have special income tax treatment
- that requires the lender to impute the interest income that they would have earned had they made a bona fide interest-bearing market loan.
- The interest, also known as phantom interest income, is included in income even though the lender did not actually receive any money.
- The lender is also considered to have made a gift to the borrower in the amount of the imputed interest. Whatever the amount the lender (donor) must impute as interest income for income tax purposes is also the amount of the gift from the donor (lender) to the donee (borrower). Note that the amount of the gift may be eligible for the annual gift tax exclusion.
Important: Interest Free Loans or Below Market Loans
Characteristics of Gifts
- Two Types of Gifts
- Chart Outlining Rules for Imputing Interest on Below - Market Loans
Exam Question: Below-Market Rate Loans
Tom loans $11.000 to his daughter Tina. Why would interest not be imputed on this loan?
a) Interest would not be imputed because the loan is less than the amount of the annual exclusion.
b) Interest would not be imputed because loans of $100,000 or less are exempt from both income tax and gift tax consequences.
c) Interest would not be imputed because Tina has unearned income of $500.
d) Interest would not be imputed because lina s earned income is less than $1.000
Answer: C
Answer A is incorrect because, while interest may be imputed, the annual exclusion deals with whether a gift is taxable.
Answer B is incorrect; loans of less than $10,000 are exempt from both income tax and gift tax consequences.
Answer D is incorrect because whether interest is imputed on this loan is based on Tina’s level of unearned income, not earned income.
Characteristics of Gifts
- When is a Gift Complete?
A gift is complete when the donor releases all control over the asset and the donee can be identified at the date of the gift.
- Transfers that include a revocable beneficiary designation, or a transfer to a revocable trust are
incomplete transfers which are not gifts for gift tax purposes. - The creation of joint bank accounts and the purchase of US Savings Bonds are treated differently from other apparent joint gifts, because a completed gift does not occur until the noncontributing party withdraws money for their own benefit.
Characteristics of Gifts
- When is a Gift Complete?
- Example 1 & 2
One example is a Joint Banking and one is a Trust
Characteristics of Gifts
- Reversionary Interests
- What is the Value of a Gift is the PV…
- A Net Gift Occurs When?
- Value of a Gift for Tax Purposes is Equal
Reversionary interests are interests that have been transferred by a transferor and subsequently revert back to the transferor.
- A reversionary interest has both** gift and estate tax consequences.**
The value of the gift is the present value of the use that the donee will have as a result of the gift. The present value is determined using statutory tables related to the term of use.
A net gift occurs when a gift is made on the condition that the donee pay any gift tax due.
- The donor will have taxable income (for income tax purposes) to the extent that any gift tax paid by the donee exceeds the donor’s adjusted basis in the gifted property.
Generally, the value of a gift for gift tax purposes is equal to the FMV of the gifted property on the date of the gift.
Characterisitcs of Gift
- A Net Gift Occurs When?
- Example
Exclusions and Exemptions
- As a Result of the Annual Exclusions…
As a result of the annual exclusion, all individuals may gift, transfer-tax free, up to $17,000 per donee per year. Any person may be a donee; one need not be a related party.
- To qualify for this annual exclusion, the gift must be of a present interest (discussed in the next section).
- If the gift is of a future interest, then the gift does not qualify for the annual exclusion and will be reported as a taxable gift.
- There is a special annual exclusion for non-citizen spouses equal to $175,000 (as indexed) for 2023.
- For citizen spouses there is an unlimited deduction for gifts.
Exclusions and Exemptions
- Split Gift
When one donor makes the gift, and the donor’s spouse consents and agrees to use their annual exclusion for that donee, then the gift is called a split gift.
- A gift tax return (Form 709) is required for all split gifts, and both spouses must consent and are required to sign the gift tax return.
Exclusions and Exemptions
- Gifts of Community Property
Gifts of community property do not require gift splitting, since each spouse is deemed to own one-halfof any community properly.
- Therefore, any gift of community property is a joint gift not subject to gift splitting.
Exclusions and Exemptions
- Examples:
- Gifts Were From Community Property
- Gifts Were From Seperate Property and Without Gift Splitting:
- Gifts Were From Seperate Property and Gift Splitting Were Elected
Exclusions and Exemptions
- Lifetime Gift Tax Applicable Amount of $5,113,800
This applicable credit amount shelters up to $5,113,800 of cumulative taxable transfers in excess of the annual exclusion amount, from transfer taxes.
The applicable credit is calculated based on the $12,920,000 applicable exclusion. The first $1,000,000 would have tax due of $345,800 (using the gift and estate tax table on page xin1 of this book), the next $11,920,000 is taxed at 40%, which equals $4,768,000 for a total tax of $5,113,800 ($345,800 plus $4,768,000). The calculated applicable credit covers taxes due on the applicable exclusion.
The applicable exclusion amount of $5,113,800 (also known as the applicable credit equivalency amount) is defined as the FMV of taxable property that can transfer without creating a gift tax greater than the applicable credit against transfer taxes.
For gifts in excess of the annual exclusion, there is a mandatory reduction in the applicable credit amount
Gifts of a Present and Future Interest
- Present Interest is a Unrestricted Right
A present interest is an unrestricted right to the immediate use of property.
- Gifts of cash, property, etc., where title passes immediately are common examples of gifts of a present interest.
- Only a present interest gift will qualify for the $17,000 annual exclusion,
Example:
- Ginny transfers $17,000 to Chelsea’s individual bank account. Chelsea has full and complete control over the current use of the money so it is a gift of a present interest. The gift is eligible for the $17,000 annual exclusion.
Gifts of a Present and Future Interest
- Future Interest is an Interest Which is Limited
A future interest is an interest which is limited in some way by a future date or time.
Example 1:
- Jessie gives Beau a house in Destin, Florida, but reserves for herself the right to use the property for a term. Because Beau cannot benefit trom the property at the time of the transfer, the interest transterred to Beau is a gift of a future interest.
Example 2:
- Ashauna assigns (transfers) a life insurance policy on her life to an irrevocable life insurance trust and names Mark as the beneticiary of the trust. While it may not be obvious, Mark cannot benefit from the transfer until Ashauna dies (some time in the ruture), so this is a gift of a future interest.
Gifts of a Present and Future Interest
- Example of a Present Interest and Future Interest Combined
Ben’s Car and Life Estate are Combined to get $30,000.
Gifts of a Present and Future Interest
- Crumney Provision
- The 5/5 Lapse Rule
- What Constitutes “Taxable Gift’ Under the 5/5 Lapse Rule
A Crummey provision is the explicit right of a trust beneficiary to withdraw some, or all, of any contribution to a trust for a limited period of time, generally 30 days, after the contribution. This power of withdrawal is essentially a general power of appointment, or the ability of the power holder to appoint assets to himself.
- A Crummey provision (called a power to lapse) may limit the withdrawal right to an amount equal to
the annual exclusion or less, thus, converting what might have been a gift of a future interest in trust to a gift of a present interest, which will then qualify for the annual exclusion.
If a trust has more than one beneficiary, the 5/5 Lapse Rule must be applied to determine if the lapse causes a taxable gift from the beneficiary holding the Crummey power to the other beneficiaries of the trust. Such a taxable gift is a gift of a future interest and is not qualified for the annual exclusion.
Under the 5/5 Lapse Rule, a taxable gift is deemed to have been made when a power to withdraw an amount in excess of the greater of $5,000 or 5% of the trust assets has lapsed, or not been used by a beneficiary.
Gifts of a Present and Future Interest
- Chart Explaining 5/5 Rule
Transfers Resulting in No Gift Tax
- Gifts Made to Political Organizations
- Payments of Legal Support of Obligations
- Payment One Spouse to Another Pursuant to a Divorce
- Transfer Within a Business Setting Between People
- Unlimited Marital Deduction
- Unlimited Gift Tax Charitable Deduction
Gifts made to political organizations are exempt from gift tax. The term “political organization” means a party, committee, association, fund, or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.
Payments of legal support obligations are exempt from the gift tax rules
Payments made from one spouse to another pursuant to a divorce decree are not gifts. Rather, they are either nontaxable property settlements with a carryover basis or alimony payments deductible for income tax by the payor and included for income tax by the payee on contracts on or prior to 12/31/18.
- A property transfer is considered to be pursuant to a divorce decree if it occurs within one year of the
termination of the manage or is related to the cessation or the marriage.
Any transfer within a business setting between business people is presumed to be compensation for services rendered and is not a gift.
An unlimited marital deduction allows for unlimited tax-free transfers between spouses during life. To be eligible for this unlimited marital deduction, however, the donee spouse must be a citizen of the United States.
- Non-citizen spouses do not receive an unlimited marital deduction; however, a citizen spouse may
transfer $175,000 annually to their non-citizen spouse with no transfer tax consequences. This annual exclusion is sometimes referred to as the “spousal super annual exclusion.”
There is an unlimited gift tax charitable deduction for transfers to the following:
- Federal, state, or local government for public use; 501(c)3) corporations operated exclusively for religions, charitable, scientific, literary, or education purposes.
Transfers Resulting in No Gift Tax
- A Qualified Transfer is a Payment Made Directly To:
A qualified transfer is a payment made directly to:
- a qualified educational institution (a qualified educational institution is an educational organization which maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance) for tuition (this does not include room and board, books, supplies, and other similar expenses which do not constitute direct tuition costs) or
- a payment made directly to a medical care provider for qualifying medical expenses of someone else.
- Qualified transfers are not allocated against the annual exclusion and do not reduce the applicable lifetime credit.
Exam Question - Qualified Transfers
Which of the following transfers would not be considered a qualified transfer?
a) Piper pays $50,000 to her friend Paige, who uses the money to pay for her medical expenses.
b) Piper pays $35,000 to Harvard University for her niece’s tuition.
c) Piper pays 510,000 to Children’s Hospital for her granddaughter’s medical expenses.
d) Piper pays $25,000 to Prestigious Preparatory School for her nephew’s tuition.
Answer: A
Answers B, C, and D described qualified transfers.
Answer A is not a qualified transfer because the payment was not made directly to the healthcare provider.
Exam Question - Transfers Not Resulting in Gift Tax
Which of the following transfers would result in gift tax?
a) Bob gifts $10,000 to his daughter Barbie.
b) Elroy gifts $50,000 to his wife, Elizabeth, who is a US citizen.
C) Adam gives his favorite employee, Aaron, a new car at Aaron’s retirement.
d) Pete transfers $22, 000 to his ex-wife, Patricia. Pete and Patricia were divorced five
years ago,
Answer: D
Answer A would not result in gift tax because the gift does not exceed the annual exclusion.
Answer B is incorrect because a person can gift an unlimited amount to his or her spouse without incurring gift tax,
Answer C is incorrect because transfers in a business setting are presumed to be compensation. If Pete had transferred $22 000 to Patricia pursuant to a divorce decree, there would be no taxable gift, but transfers to an ex-spouse five years after the divorce was final are not considered “transfers pursuant to a divorce decree.”
The Gift Tax Return
- File a Gift tax Return (Form 709)
Any donor who makes a gift during a calendar year must file a gift tax return (Form 709), unless all of the gifts are less than or equal to the annual exclusion, or are not subject to gift tax, such as qualified transfers, transfers to spouses, or transfers to charities.
- If a split gift election is made, a gift tax return must be filed by the spouse who makes the gift, or both spouses if both make a gift, even if after the split, the gift is under the annual exclusion.
- The gift tax return (Form 709) must be filed by the donor by April 15 following the year of the gift. The
filing date can be extended simply by extending the donor’s income tax return, but similar to income tax, the time to pay is not extended and penalties will apply. - In the event the donor dies in the year of the gift, the gift tax return must be filed no later than the due date, including extensions, of the estate tax return. The donor is primarily liable for the payment of gift tax, but the donee may be liable in the event that the donor does not pay.
The Gift Tax Return
- Statue of Limitations for the IRS to Assess Additional Gift Tax is 3 Years
- Steps to Determine Gift tax Liability for a Particular Donor
The statute of limitations for the IRS to assess any additional gift tax is 3 years, unless the gift is not adequately disclosed on a filed gift tax return. In this case, the statute of limitations will never expire.
The following steps are used to determine the gift tax liability for a particular donor:
- Sum the “total gifts” for the calendar year;
- Subtract the total exclusions and deductions (annual exclusions, marital deduction, charitable deductions);
- Add the donor’s taxable gifts for the calendar year (the sum of #1 and #2) to the donor’s previous
taxable gifts for all prior calendar years; - Calculate the gift tax from the unified estate and gift tax rate schedule;
- Reduce the gift tax by the gift tax deemed paid and the lesser of the applicable gift tax credit (85,113,800 for 2023) or the calculated gift tax. (The gift tax deemed paid is the amount of tax that would have been paid if the donor had made the gift today. The deemed-paid amount and the actual amount paid will vary in years when there has been a change in the marginal transfer tax rates.)
Example of Gift Tax Return Calculations
Exam Question - Calculation of Gift Tax
Jordan, a single woman, is very generous. She enjoys giving gifts to others and has given taxable
gifts of 56.000,000 in prior years and paid gift tax of $350,000. This year she gave the following gifts:
- $34,000 cash to her friend Judy so that Judy could pay her medical bills.
- A new car worth $48,000 to her friend Mark.
- A painting to her friend Kristen worth $7,000.
- A check for $19,000 to LSU for her niece Haley’s tuition for the year.
Calculate Jordan’s total taxable gifts for the current year.
a) $34,000
b) $48,000
c) $67,000
d) $84,000
e) $108,000
Calculate Jordan’s gift tax liability due for the current year.
a) $0
b) $15,170
c) $16,120
d) $22,140
e) $22,960
Gift Strategies
- Gifts of Appreciating Property
If the overall objective of the client is federal gross estate reduction:
- the client should** gift property that has the greatest potential for future appreciation**, rather than transferring cash or fully appreciated
property.
Gift Strategies
- Gifts to Spouses
Gifts to citizen spouses are not subject to gift tax and may be in any amount.
Frequently, large gifts are made to a spouse so that the spouse will have an amount equal to the estate exemption equivalency (512,920,000 for 2023). Such gifts can be outright or in a qualified trust.
If the wealthy spouse simply wants to use the lifetime exemption of the nonwealthy spouse they can make use of the split-gift election to gift assets to a junior generation and thus use the spouse’s credit equivalency.
Gift Strategies
- Single Party Gift Strategies
One of the most common donor objectives in a gifting program is to reduce the overall gross estate of the donor.
To achieve this goal, it is generally never wise to gift cash. Rather, the donor should prepare a current balance sheet with a forecast of which property (assets) is likely to experience the greatest appreciation.
Once determined, the donor should select from those assets which are expected to appreciate the most. Such a strategy will remove highly appreciating assets from the donor’s gross estate and the appreciation will occur in the hands of the donee.
Gift Strategies
- Multi-party Gift Strategies
Exam Tip: Be Familar with the Various Gifting Strategies
If one of the purposes of gifting is to minimize future taxes for the donor, and if there are multiple donees, it is wise to consider which assets to give to which donee. Here is a general set of guidelines:
- Never gift property when the FMV is less than the adjusted basis.
- Rather, sell the property and let the donor recognize a capital loss for income tax. The donor can then gift the cash proceeds to the donee who can then purchase the property with the proceeds.
- Consider gifting property with the greatest appreciation potential to the youngest donee available
who has the most time for the asset to appreciate. - When making gifts to charities, always gift appreciated property to avoid the capital gain taxes on the difference between the FMV and the donor’s adjustable taxable basis.
- For such property, the donor may be able to deduct the fair market value as a the income tax limitations charitable deduction, subject to the income tax limiations.
- Gift income-producing property to the done in the lowest marginal income tax bracket so that the income is subject to the lowest possible income tax
Gift Strategies
- Chart Outlning the Basis Strategies for Transferring Welath Through Gifts
Exam Tip: Know This Chart
Estate Tax!
When a citizen or resident of the United States dies:
- an estate tax is imposed on all property owned directly or indirectly by the decedent at the time of death.
The following chart is an abbreviated version of the estate tax formula:
The Gross Estate
- Chart of What Must be Included in Gross Estate Under IRC Section 2033
The Gross Estate
- Gift Tax Paid Within 3 Years of Death
Any **gift tax paid **on gifts made within 3 years of a decedent’s date of death must be added to the gross estate.
Note that the actual value of the gifts made within 3 years of the decedent’s date of death are NOT included in the gross estate.
The Gross Estate
- Transfer of a Life Insurance Policy Within 3 Years of Death
Under Section 2035, the proceeds of a life insurance policy on the life of the decedent will be included in the decedent’s gross estate if, within 3 years of the decedent’s death, the decedent made a gratuitous completed transfer of the policy.
If the decedent continued to pay premiums on a policy gifted within three years of death the premium payments would be a gift eligible for the annual exclusion (if a present interest), and any gift tax paid on the gift may be included in the decedent’s gross estate under Section 2035.
The Gross Estate
- Interest Retained for Life
A decedent who retains or reserves an interest in transferred property for his life
must include the value of that property in his gross state under IRC Section 2036.
An example of this situation is when the decedent transfers property but retains the use or enjoyment of such property for his life.
The Gross Estate
- Interest Retained for a Period Only Ascertainable by Death
A decedent who retains an interest in property for any period not ascertainable without reference to the decedent’s death must include the fair market value, determined at the decedent’s date of death, of the property in his gross estate under IRC Section 2036.
The Gross Estate
- Retained Interest Held at Death
When a decedent transfers property and retains or reserves an interest for any period of time, and that
interest does not in fact end before the decedent’s death, the fair market value of the property at the decedent’s date of death must be included in his gross estate.
The inclusion also applies when: the decedent
- retains the use,
- possession,
- right to the income,
- other enjoyment of the transferred property, or
- the right, either alone or with another person, to designate the person, or persons, who shall possess or enjoy the transferred property or its income.
The Gross Estate
- Transfers Taking Effect at Death (IRC Section 2037)
A decedent’s gross estate includes the FMV at the decedent’s date of death of any interest in property transferred by the decedent if the transfer was conditioned on all of the following:
- possession or enjoyment of the property can be obtained only by surviving the decedent, and
- the decedent has retained a reversionary interest in the property, and
- the value of such reversionary interest immediately before the death of the decedent exceeds 5% of the value of such property
The Gross Estate
- Reversionary Interest
A reversionary interest is any interest which includes a possibility that the property transferred by the decedent may return to him or his estate or the possibility that property transferred by the decedent may become subject to a power of disposition by him.
The FMV of a decedent’s reversionary interest is calculated as of the moment immediately before his death, and use of the alternate valuation date does not apply.
To determine whether or not the decedent retained a reversionary interest in transferred property of a value in excess of 5%, the FMV of the reversionary interest in the property is compared with the FMV of the transferred property, including interests in the property which are not dependent upon survivorship of the decedent.
The Gross Estate
- Revocable Transfers (IRC Section 2038)
Do not Understand this One
A decedent’s gross estate includes the FMV at the decedent’s date of death of any interest in property transferred by the decedent if the enjoyment of the interest was subject, at the date of the decedent’s death to any change through the exercise of a power by the decedent to alter, amend, revoke, or terminate, or if the decedent relinquished such a power in contemplation of death.
Section 2038 does not apply:
- To the extent that the transfer was for full and adequate consideration, or
- If the decedent’s power could be exercised only with the consent of all parties having an interest (vested or contingent) in the transferred property, and if the power adds nothing to the rights of the parties under local law, or
- To a power held solely by a person other than the decedent.
The Gross Estate
- Annuities (IRC Section 2039)
A straight single life annuity is an annuity paid to the annuitant until his death. A decedent who owned a straight life annuity before his death will not include any amount related to the annuity in his gross estate since the annuitant’s interest in the contract terminated at his death.
A survivorship annuity is an annuity that provides payments to one person, and then provides payments to a second person upon the death of the first.
- When the first annuitant dies, the value of a comparable policy on the second annuitant is included in the first annuitant’s gross estate.
- If the second to die has contributed to the purchase of the policy, then only the proportionate value of the annuity is included in the gross estate of the first to die.
Under Section 2039, the value of the survivorship annuity included in a decedent’s gross estate is based
on the ratio of the decedent’s contributions to the survivorship annuity’s total cost to the total cost of the
survivorship annuity.
The Gross Estate
- Joint Interests (IRC Section 2040)
A decedent’s gross estate includes the FMV at a decedent’s date of death of any property jointly held by the decedent and another person with a right of survivorship.
To prove that the entire value of jointly held property does not have to be included in a decedent’s gross
estate,:
- the executor must submit facts sufficient to show that property was not acquired entirely with consideration furnished by the decedent,
- or was acquired by the decedent and the other joint owner or owners by gift, bequest, devise, or inheritance
The Gross Estate
- Powers of Appointment (IRC Sections 2041 and 2514)
A Power of Appointment is the power to name who will enjoy or own property.
The gross estate of a decedent includes any assets over which the decedent held a general power of
appointment at the time of his death.
If the right to exercise is held to an ascertainable standard (health, education, maintenance, or support), then the power is not a general power of appointment and the property is** not included in the decedent’s gross estate.**
If the right to exercise requires approval of the holder and someone else (who is termed an adverse party - someone who has an interest in the property), then the power of appointment is not included in the decedent’s gross estate.
If the right to exercise is limited to the greater of $5,000 or 5% of the aggregate value of the property each year, referred to as a “5-and-5” power and the power lapses before the decedent’s death, then the power of appointment is not included in the decedent’s gross estate. The “5-and-5” power is designed to limit the withdrawal right to a de minimis amount and penalize those withdrawals that exceed the de minimis amount.
The Gross Estate
- Proceeds of Life Insurance (IRC Section 2042)
- Inclusion Under Sections of the IRC
IRC Section 2042 includes the death benefit proceeds of a life insurance policy on the life of the decedent in the decedent’s gross estate if, at the decedent’s death, either the proceeds were receivable by the decedent’s estate or the decedent possessed any incident of ownership in the policy.
Inclusion Under Other Sections of the IRC:
- Generally, the amount to be included in a decedent’s gross estate under Section 2042 is the full death benefit payable from the life insurance policy. If the proceeds of the life insurance policy are made payable to a beneficiary in the form of an annuity for life, or for a term of years, the amount to be included in the decedent’s gross estate is the value of the available lump-sum payment at the decedent’s death
- If the proceeds of a life insurance policy made payable to the decedent’s estate are community property under the local community property law and, as a result, one-half of the proceeds belongs to the decedent’s spouse, then only one-half of the proceeds is included in the decedent’s gross estate.
The Gross Estate
- Proceeds of Life Insurance (IRC Section 2042)
- Incident of Ownership
An incident of ownership is the right of the insured, or his estate, to enjoy the economic benefits of the policy and includes the power to:
- change the beneficiary,
- surrender or cancel the life insurance policy,
- assign the life insurance policy,
- revoke an assignment,
- pledge the life insurance policy for a loan, or
- obtain from the insurer a loan against the surrender value of the policy, etc.
A decedent is considered to have an incident of ownership in a life insurance policy on his life held in trust if the decedent has the power to:
- change the beneficial ownership in the policy or its proceeds, or
- the time or manner of enjoyment even though the decedent may not have a beneficial interest in the trust.
Thus these would be included in the decedent gross estate.
Valuation of Assets at Death
- Hard-to-Value Assets
Hard-to-value assets such as real estate, art, jewelry, antiques, collectibles, and closely held business interests usually require an appraisal.
Closely held businesses are difficult to value because of the unique characteristics of each.
The value of closely held businesses may be significantly reduced by using various valuation discounts.
- A minority discount is a reduction in the value of an asset transferred and is often allowed if the asset transferred represents a minority interest in a business.
- For transfer tax purposes, minority discounts (when available) often range between 15% to 50%
- A lack of marketability discount is a reduction in the value of an asset transferred and is often allowed if the asset transferred has an inherent lack of marketability.
- Lack of marketability discounts typically range between 15% to 50%, and can be used for both minority and majority interests. A lack of marketability discount can be used in combination with a minority discount to produce an even larger overall discount.
- A blockage discount is a discount attributable to the value of large blocks of corporate stock that
are listed on a public exchange. - The theory behind a blockage discount is that a large amount of stock included in the decedent’s gross estate cannot be liquidated at one time without a decrease in the stock’s market price.
- A discount may be allowed for a business in which a key person has died or becomes disabled, called a key person discount.
Valuation of Assets at Death
- Financial Securities
Exam Tip: Know how to value financial securities for estate tax purposes.
The FMV of a financial security is the average of the high and low trading price for the decedent’s death of date or the alternative valuation date.
If the valuation date is a weekend, the valuation of the financial security is the average of the applicable values for the trading day before and the trading day after.
Valuation of Assets at Death
- Accrued Dividends
If the financial security included in a decedent’s gross estate is a dividend-paying stock:
- the value of any declared dividends at the decedent’s date of death may also be included in the decedent’s gross estate.
The following graphic depics the effect of a dividend on the stock price at various points.
Valuation of Assets at Death
- Financial Securities Not Traded on Valuation Date
If the Stock is not traded on the decedent’s date of death, then the follwing formula must be used.
Valuation of Assets at Death
- Financial Securities Not Traded on Valuation Date
- Example
Valuation of Assets at Death
- The Alternative Valuation Date
Determining the Tentative Tax
- The Following Chart Shows the Tax Rate Schedule for Gifts and Estates for 2023
Exam Tip: Know the Amount of tax due on a $1,000,000 gift ($345,800). This is not a provided number and will be useful.
I thought the graph is provided.
Paying and Reporting Estate Taxes
- Penalties
The failure-to-file penalty is 5% per month up to a maximum penalty of 25 percent.
If the failure-to-file is determined to be fraudulent, the penalty is increased to 15% per month up to a maximum of 75%.
The **failure-to-pay penalty is **0.5% per month up to a maximum penalty of 25%.
If, in one month, both the failure-to-file penalty and the failure-to-pay penalty apply, the failure-to-file penalty is reduced by the failure-to-pay penalty. For purposes of this calculation, any fraction of a month counts as a full month
- The reduction of failure to file does not eliminate the need to also pay the failure to pay penalty. Watch if it asks for both penalties.
Adjusted Basis to Heirs and Legatees
- Reverse Gift
If an heir receives property from a decedent that was acquired by the decedent through a gift from the same heir within one year of the decedent’s death, the heir/donor takes the decedent’s basis (which will be the donor’s basis).
- The heir/donor does not receive a step-to fair market value in the adjusted basis of the property.
Adjusted Basis to Heirs and Legatees
- Surviving Owner
A decedent’s share of property owned joint tenancy with rights of survivorship will pass to the surviving property owners.
After the decedent’s death, the survivor determines his basis in the property by:
- adding the value of the property included in the decedent’s gross estate (Step to FMV) to his (the survivor’s) original adjusted basis.
Adjusted Basis to Heirs and Legatees
- Community Property
Community property does not have an automatic right of survivorship at the death of one spouse and at the death of a decedent who owns community property with his spouse, only one-half of the FMV of the property is included in the decedent’s gross estate.
An heir who receives a decedent’s one-half of community property will receive the one-half interest with an adjusted basis equal to the FMV at the decedent’s date of death or the alternate valuation date, whichever is used on the decedent’s estate tax return.
The surviving spouse’s one-half interest in community property will also receive a step-to fair market value at the decedent’s date of death even though it was not included in the decedent’s gross estate. This special treatment which gives a step-to fair market value adjusted basis to both halves of the property interest at the death of one spouse is only applicable to community property. Community property receives an adjustment in adjusted basis to the fair market value on both spouses’ shares at the death of the first spouse.
Comprenhensive Exam Question
Jorge and Barbara were married years ago and had one child, Christina. Jorge and his longtime friend, Denise, were recently flying in Denise’s new plane. For a brief period, Denise was distracted and lost control of the plane. Unfortunately, the plane crashed and Denise died instantly and Jorge died a few days later as a result of the injuries sustained during the crash. When Jorge died, he and Barbara owned the following property:
- Personal residence valued at $750,000 held tenancy by the entirety. The home had an outstanding mortgage of $200,000.
- Car 1 valued at $20,000 held fee simple by Jorge.
- Car 2 valued at $15,000 held joint tenancy with rights of survivorship by Jorge and Christina.
- Diamond ring valued at $50,000 held fee simple by Barbara.
- Boat valued at 120,000 held tenancy in common by Jorge and Christina (equal contribution).
- Life Insurance Policy 1 on Barbara’s life owned by Jorge. The fair market value of the policy was $350,000 and the death benefit was $1,000,000. The beneficiary is Christina.
- Life Insurance Policy 2 on Jorge’s life, owned by Jorge. The fair market value of the policy was $185,000 and the death benefit was $600,000. The only beneficiary is Denise.
- IRA account valued at $12,000,000 owned by Jorge with Christina as the beneficiary.
- Irrevocable Trust by Jorge for the benefit of Christina created five years ago. The trust is valued at $500,000, and Christina is the beneficiary at Jorge’s death.
- Unless otherwise stated, assume equal contributions were made by all parties for jointly owned property.
The accident was found to be the fault of the plane manufacturer, therefore, Jorge’s heirs received $100,000 for wrongful death and $600,000 for pain and suffering. Jorge’s last medical expenses were $40,000, his funeral expenses were $30,000 and the administrative fees for the estate were $100,000. Jorge’s will left $100,000 to a qualifying charity and the remaining probate assets to Barbara. His will states that debts and expenses will reduce the assets that will transfer to Barbara. Assuming the executor forgot to file the estate tax return, and filed and paid 40 days late and that Jorge did not make any transfers during his life, calculate Jorge’s gross estate, the estate tax due and any penalties (excluding interest) using the 2023 estate tax rates and available credits.
Question #1: Calculate Jorge’s Probate Estate.
Question #2: Calculate Jorge’s Gross Estate.
Question #3: Calculate the estate tax.
Question #4: Calculate any penalties due.
