© 2012, College for Financial Planning, all rights reserved. Module 7 Estate Liquidity & Postmortem...

© 2012, College for Financial Planning, all rights reserved.

Module 7

Estate Liquidity & Postmortem Actions

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning

Learning Objectives

7–1 Analyze a situation to identify existing or potential estate cash requirements and/or sources of estate liquidity.

7–2 Identify the characteristics and purpose of a given premortem liquidity planning technique.

7–3 Analyze a situation to identify premortem planning techniques that could be used to meet estate liquidity needs.

7–4 Evaluate a situation to select a premortem planning technique that can be used to meet estate liquidity needs and that is consistent with a client’s stated objectives or situation.

7–5 Identify the characteristics and purpose of a given postmortem planning technique.

7–6 Analyze a situation to determine the eligibility of an estate or its beneficiaries to use a given postmortem planning technique.

7–7 Evaluate a situation to select the postmortem planning techniques that are available and advisable for an estate or its beneficiaries.

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Questions to Get Us Warmed Up

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Estate Liquidity: Cash Needs

• estate administration expenses• estate debts and claims• death taxes• miscellaneous cash needs• cash bequests

To avoid forced liquidation of estate assets and further shrinkage of the estate, these cash needsshould be reduced in a manner consistent with other client goals.

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Estate Liquidity: Cash Resources

• cash and cash equivalent assets• life insurance• employee benefits• pre-death conversion of

illiquid assets by sale or exchange for liquid assets

• closely held business interests• postmortem elections

To avoid forced liquidation of estate assets and further shrinkage of the estate, these cash resources should be increased in a manner consistent with other client goals.

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Estate Liquidity: Reducing Cash Needs (premortem)

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Technique Suggestions

Cash Expenditure Targeted: Administrative expenses

Use of will substitutes • Inter vivos trusts• P.O.D. & T.O.D.• JTWROS and TBE

Reduce or eliminate property that is difficult to appraise or administer

• Closely held business interests• Collectibles• Rental property

Avoid ancillary probate

• Place real property located in state other than client’s domicile in will substitute form

• Gift or sell such property prior to death

Reduce or eliminate possible sources of litigation for the estate

• Check for proper execution of will and inclusion of self-proving clause

• Check for clauses that disinherit family members without explanation

• Accounts receivable: avoid if possible; check credit of potential obligor prior to transaction; keep collection of income current

• Accounts payable: get agreement in writing signed by both parties; keep record of payments

Reduce client’s gross estate

• May lower attorney’s fees• May reduce appraisal fees


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Technique Suggestions

Cash Expenditure Targeted: Taxes payable by the estate

Ways to reduce the gross estate

• Give property away or sell it during life and spend the proceeds.• Qualify property remaining in the estate for valuation discounts such

as minority and marketability discounts for closely held business interests, and special use valuation for real estate used in a closely held business or farming operation.

Ways to reduce the taxable estate

• Qualify property for the estate tax charitable deduction: Property must be given by will or will substitute to a qualified charity either outright or in an approved form, such as a charitable remainder or lead trust, or in a pooled income fund.

• Qualify for the estate tax marital deduction: Interest in property given to the decedent’s surviving spouse must not be a non-deductible terminable interest; if not given outright, it must be given in a trust that qualifies for the marital deduction, such as an estate trust, a power of appointment trust, or a QTIP trust with an election.

Cash Expenditure Targeted: Cash bequests

Eiminate if possible • Review client’s will.• Eliminate bequest or substitute in-kind bequest

of illiquid asset.


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General Technique Specific Suggestions

Cash Expenditure Targeted: Debts payable by the estate

Reduce debt as much as possible prior to death.

• Do not enter into debt transactions that are unlikely to be paid off prior to death.

Incorporate will provision denying right ofexoneration for specifically devised property subject to a mortgage.

• Cannot be accomplished without a will.

Cash Expenditure Targeted: Miscellaneous cash needs

Provide cash for a closely held business after a key person’s death.

• Obtain key person life insurance policy on the owner.

Avoid need to pay family allowance.

• Have adequate life insurance that can be used in lieu of the family allowance.

• Provide survivors with other sources of income such as annuity or pension benefits.

General Technique Specific Suggestions

Area Targeted: Cash/cash equivalent assets

Increase assets in this category as client ages.

• Switch client to less risky and more liquid investments as he or she ages.

• Beware of transactions with a long payout or front-end loads.

Area Targeted: Illiquid assets

Gift or sell prior to death.

• Sale during life not only increases liquid assets (accounts receivable, notes and mortgages receivable, etc.) but also may prevent forced liquidation after death, since one has more time to realize fair market value.

• Check credit of potential buyers before transaction is finalized.• Keep current on collection of accounts, notes, and mortgages

receivable.

Area targeted: life insurance

Increase availability of this asset for use by the estate at death.

• Amount may have to be increased depending on amount of other cash assets available.

• May need to change beneficiary designation to person or entity (ILIT) that has an interest in estate being correctly administered.

Avoid inclusion of death benefit in gross estate to the extent possible.

• ILIT can give trustee discretionary authority to make loans to estate or purchase estate assets (illiquid) at fair market value; death benefit will avoid inclusion in gross estate of insured/grantor unless three-year rule applies.

Estate Liquidity: Increasing Cash Resources (premortem)

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Postmortem Actions Affecting Estate Tax

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Prerequisites Considerations

Action: Alternate Valuation Date

Alternative: Valuation of estate assets at date of death

• Value of gross estate (GE) must be reduced.

• Estate tax liability must be reduced.

• Use only when majority (in value) of estate assets have declined in value.

• If used, must apply to all assets. However, any decline in value of an asset that is attributable solely to the passage of time may not be used to reduce the value of that asset.

• There is an exception for asset sold at arm’s-length transaction within six months of death.


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Action: Valuation Discounts

Alternative: Assets will be valued at more than fair market value (FMV)

• minority—owner of closely held business interest must not be able to control business decisions

• blockage—amount of publicly traded stock is large in relation to daily trading volume

• key person—decedent was vital to operation of business

• marketability—no established market for business interest

• likelihood of dispute by IRS• cost of potential litigation including attorney’s and

appraiser’s fees• whether discounts are necessary to make estate

nontaxable• effect of discounts on other postmortem

elections such as special use, deferred payment of estate taxes, etc.


Action: Special Use Valuation

Alternative: Valuation at highest and best use (fair market value)

• estate must contain real estate used in a closely held business or farm (qualified use)

• real estate must have been in qualified use at decedent’s death

• decedent or member of family must have owned and so used such property for five out of last eight years

• property must be located in U.S. and decedent must have been a U.S. citizen or resident alien

• decedent or member of family must have materially participated in the qualified use for five out of last eight years

• value of qualified real estate must 25% of GE as adjusted

• value of qualified real and personal property must 50% of GE as adjusted

• qualified real estate must pass to a qualified heir

• maximum benefit of $750,000 ( inflation indexed)

• recapture of benefit if qualified real estate ceases to be employed in qualified use or is gifted or sold to other than a qualified heir

• effect upon other postmortem elections such as §6166 election


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Action: Allocation of medical expenses of the decedent not reimbursed by insurance on Form 706 estate tax return

Alternative: Debts may be deducted on decedent’s final income tax return (Form 1040)

• If deducted on Form 1040, only those expenses in excess of 7.5% of AGI can be deducted, and expenses must be paid prior to death or within one year of death.

• Do not deduct on estate tax return (Form 706) if estate does not need the deduction.

• Deduction on Form 706 does not waste part of deduction meeting 7.5% floor

• Deduction on form 1040 is irrevocable.• Deduction on one form precludes deduction on other.

Action: Deduction of Administrative Expenses & Losses on Estate Tax Return (Form 706)

Alternative: may also be deducted on fiduciary income tax return (Form 1041)

• In final year of estate, excess deductions can be transferred to beneficiaries but are not deductible unless they exceed 2% of AGI.

• Deduction on form 1041 is irrevocable.

• Total deduction may be spread over both returns.• Use on Form 706 only if necessary to prevent or reduce

payment of tax out of pocket.• Expense or loss can be deducted on form 1041

only in year paid or incurred; if deducted on form 706, future administrative expenses may be estimated .

• Taxes, interest, business expenses, and other items accrued at the time of death can be deducted on both estate and income tax return.


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Action: The PR Fee

Alternative: If waived, cannot be taken as a deduction on either Form 706 or Form 1041If not waived, can be deducted but is ordinary income to PR

• To waive the fee without gift or income tax consequences, PR must evidence intent to perform a gratuitous service.

• where money will go if waived—e.g., if to a skip party, it will be subject to GSTT.

• if deduction is necessary to prevent estate tax, deduct on Form 706

Action: Qualified Terminable Interest Property (QTIP) Election

Alternative: If election not made, assets will not receive marital deduction (MD) in decedent’s estate & assets at death of surviving spouse won’t be included in his/her GE

• Spouse of grantor must be given usufruct or qualifying income interest for life.

• Spouse cannot have general power of appointment.

• No one, including spouse, can have right to appoint property to anyone other than the surviving spouse prior to surviving spouse’s death.

• time value of money and surviving spouse’s life expectancy, since MD only delays tax

• effect on estate of decedent to fully utilize applicable credit amount

• partial elections are allowed• effect on spouse’s estate—whether election is

necessary to allow full use of applicable credit amount

• effect of election upon other available postmortem elections and credits such as the prior transfer credit, and deferment of taxes under §6166


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Action: Qualified Domestic Trust (QDOT) Election

Alternative: Transfers to noncitizen spouse will not receive MD

• Non-U.S. Citizen spouse must receive property from decedent.

• Property must be put in a trust that meets QDOT requirements.

• Election to treat as QDOT must be made.

• No partial elections allowed.• Once made, election is irrevocable.

Action: Extension of time to pay estate tax—§6166

Alternative: Estate tax must be paid by original due date of return

• Decedent’s GE must include closely held business interest.

• The value of such interest must exceed 35% of the decedent’s adjusted gross estate.

• Several such interests may be aggregated to meet 35% requirement under certain circumstances.

• The 35% requirement must be met both with and without including all gifts required to be included in the gross estate by section 2035(a), (the three year rule).

• Can be used to defer GSTT also if business interest is given to a skip party.

• Taxes may be paid over approximately 15- year period following death; allows business to generate income needed to pay the tax.

• After election, prepayment may be made without penalty.

• Be aware of recapture potential.


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Postmortem Actions Affecting GSTT

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Action: Reverse QTIP Election

Alternative: If election is not made, spouse of grantor is considered transferor for GSTT purposes

• Spouse of transferor must be given life estate or qualifying income interest in assets.

• Regular QTIP election must have been made.• No person, including spouse of transferor, can

have power to appoint property to anyone other than spouse during his/her lifetime.

• GSTT exemption status of both spouses • Contemplated future generation-skipping

transfers by transferor’s spouse.• No partial election allowed.• Election is irrevocable once made.

Postmortem Actions Affecting Income Tax

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Action: Reporting accumulated interest on U.S. savings bonds

Alternative: Can be reported either on decedent’s final Form 1040 (pre-death interest only), or on estate’s Form 1041 (pre-death and post-death interest)

• interest must not have been previously reported by decedent

• if decedent made election to report interest prior to death, PR is bound by this election

• election must be made on a timely filed income tax return

• when pre-death interest is recognized, taxpayer gets a deduction for estate taxes paid on this amount as IRD

• if pre-death interest is recognized on Form 1040, estate gets deduction for income taxes paid as debt of decedent

• if decedent dies early in year, may be good to recognize pre-death interest on Form 1040

Postmortem Actions Affecting Income Tax

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Action: Select a fiscal year for the estate

Alternative: If PR has not elected prior fiscal year end, estate’s first fiscal year will end on the lastday of the calendar month preceding the month containing the first anniversary date of the decedent’s death

• Estate’s fiscal year must end on the last day of a calendar month.

• Estate’s first fiscal year must end not later than the last day of the calendar month preceding the month containing the first anniversary date of the decedent’s death.

• Generally best to spread income over multiple reporting periods.

• Avoid bunching of income, especially without offsetting deductions.

Action: §303 stock redemption

Alternative: Partial redemption of stock without election under this section will be taxed asdividend (ordinary income)

• Decedent’s GE must include closely held stock.• Value of such stock >35% of decedent’s adjusted

GE after including all gifts within three years of death.

• Stock of several closely held corporations may be aggregated to meet 35% requirement under certain circumstances.

• Amount redeemed under this section cannot exceed death taxes of estate plus funeral and administrative expenses.

• Can use only if corporation has the cash to redeem—therefore requires premortem planning.

• Election applies only to distributions made after death and not later than 90 days after expiration of three-year limitation for estate tax assessment under §6501(a).

• If more than one redemption, distributions are applied against total limitation in order in which they were made.

Miscellaneous Postmortem Actions: Qualified Disclaimers

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Alternative: If no disclaimer, property will go to beneficiaries who had the right to disclaim

• Must be irrevocable and in writing.• Must be made within nine months of transfer

creating the interest (except for minors).• Benefits of property must not be accepted

prior to disclaimer.• Disclaimed interest must pass without

direction by disclaimant.• Disclaimed interest must pass to someone

other than disclaimant (except for spouses).

• Disclaimant will be treated for tax purposes as if he or she never received the property—i.e., no gift or income tax assessed.

• Disclaiming spouse can be income beneficiary of disclaimer (bypass) trust established by decedent.

• Survivorship interest in property held in joint tenancy or tenancy by the entirety can be disclaimed within nine months of death.

Miscellaneous Postmortem Actions: Spousal Elective Share

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Alternative: Spouse of decedent receives only what is given in the will

• State must have a spousal elective share statute.

• Written notice of election must be given to PR within time prescribed by statute.

• Property passing by election will qualify for MD and may prevent estate from being able to fully use applicable credit amount.

• If unconsumed prior to death, property received by election will be included in spouse’s GE.

• How it effects other beneficiaries of the estate.

Miscellaneous Postmortem Actions: Homestead, Exempt Property & Family Allowance

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Alternative: If these allowances are not made, assets will be subject to payment of claims against the estate, but estate will need fewer liquid assets

• For homestead and exempt property allowances, estate must contain property that qualifies for these under state statute.

• Written notice of claim or election must be delivered by entitled party to PR as required by statute.

• Some proof of need may be required for family allowance.

• Other estate assets may have to be sold to meet liquidity needs.

• Proper premortem planning can prevent need to pay these allowances.

Miscellaneous Postmortem Actions: Will Contests & Family Settlement Agreements

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Alternative: Provisions of decedent’s will must be enforced

• Decedent must have left a will.• Decedent must have been incompetent to

make will or the will must be defective in its execution for will contest to succeed.

• Will must be ambiguous for a successful family settlement agreement.

• Probate court must be involved in either situation.

• Cost of prosecuting probate court action versus benefit to be gained if successful.

• Ill will of other family members who will get less whether or not action is successful.

• If will contest is successful, property will be distributed by laws of intestacy.

• Family settlement agreement must be adopted by probate court

Miscellaneous Postmortem Actions: Gift Splitting


Alternative: If gifts are not split, decedent’s estate may have more adjusted taxable giftsand less applicable credit available for estate assets; decedent’s spouse may have fewer adjusted taxable gifts and more estate tax applicable credit available

• Requires mutual consent of PR and surviving spouse.

• Both spouses must not have filed a return for the appropriate period.

• All eligible gifts by either spouse during the period must be split.

• Spouses assume joint and several liability for the entire tax.

• Gifts between spouses and gifts by the surviving spouse after decedent’s death are not eligible to be split.

• Each spouse’s applicable tax credit status; gift splitting may deny decedent full use of his or her estate tax applicable credit amount.

• Failure to split may allow decedent’s estate to more fully use applicable credit amount.

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Miscellaneous Postmortem Actions: Joint Final Income Tax Return

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Alternative: If PR and spouse do not file joint return, each taxpayer would file at higher rate as married filing separately

• Decedent must be married at death.• Taxable year of decedent and spouse must

begin on same day.• Neither decedent nor spouse can be a

nonresident alien.• Spouse cannot remarry before end of

spouse’s taxable year.

• Did decedent have excess deductions or capital losses that would be lost without a joint return?

• Each taxpayer assumes joint and several liability for entire tax.

• Comparison of tax rates if joint versus separate returns are filed.

Question 1

Which of the following correctly explains why a beneficiary who received non-probate assets by will substitute may agree to the use of all, or part, of the assets to meet estate liquidity needs? I. to avoid liquidation of probate assets to meet cash

needs II. to avoid a lawsuit by the personal representative

(PR) for a prorated portion of the taxes III. to avoid an IRS lien against the nonprobate property

that the beneficiary received from the decedenta. II onlyb. III onlyc. I and III onlyd. I, II, and III

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Question 2

Which one of the following is not a way to improve the liquidity position of an estate? a. placing a non-exoneration clause in a

client’s will b. selling a client’s art collection prior to death c. eliminating specific cash bequests from a

client’s will d. assuring that any real estate purchased in

another state is titled solely in the client’s name

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Question 3

Which one of the following is a postmortem action that the surviving spouse who is not the PR can take in a common law state without the mutual consent of any other party? a. qualified terminal interest property (QTIP)

electionb. election to take against the willc. split gifts made by the decedent in the year

preceding death for which a gift tax return has not been filed

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Question 4

Which one of the following is a required characteristic of a qualified disclaimer? a. The disclaimant must select another person

to receive the disclaimed property. b. The disclaimer must be irrevocable, stated in

writing, and received by the estate’s personal representative.

c. The disclaimant may benefit from the property as long as the property is held no longer than nine months before it is disclaimed.

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Question 5

Carol owns 80% of IGU Corporation (one-half of the value of the stock is attributable to real estate owned by IGU). Currently, the value of Carol’s stock in IGU is 64% of her projected adjusted gross estate. Carol is examining the implications of transferring three-quarters of her IGU shares to her children from her current marriage. Her will leaves specified property valued at 10% of her estate to her husband and the remainder of her estate to her children from her former marriage.

Which one of the following postmortem elections would not be adversely affected due to the proposed transfer of the IGU shares from Carol to her children from her current marriage? a. a partial stock redemption under IRC Section 303 b. special use valuation c. the alternate valuation date d. deferral and installment payment of estate tax

under IRC Section 6166

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Question 6

Bob died with a gross estate valued at $11.6 million in 2012. The majority of his estate consists of personal use assets and publicly traded stock, which has rapidly declined in value since his death.

Bob appointed his wife, Ann, as the PR for his estate. She also will receive half of his estate. His estate is the highest marginal estate tax bracket.

During the last year of his life, Bob incurred medical expenses of $40,000, all of which were reimbursed through health insurance. Two years before his death, he gifted $20,000 to his nephew and filed a gift tax return without Ann’s consent to split gifts. Bob and Ann were in the 28% marginal income tax bracket immediately prior to his death.

Which one of the following is a postmortem election that will minimize tax liability for Bob’s estate?

a. a claim of medical expenses on his final income tax return b. a waiver of personal representative commissions from the estate by Ann c. filing a gift tax return with Ann’s consent to split gifts for Bob’s gifts to his

nephewd. an election to use the alternate valuation date for valuing Bob’s estate

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Question 7

Which one of the following is a qualifying requirement for Section 2032A special use valuation of real property used in a business? a. The business must be engaged in farming or ranching. b. The family member-owner of the business must have

been a material participant in the business for at least 10 years prior to his or her death.

c. The value of the decedent’s business interest, minus secured debts and unpaid mortgages on such property, must equal 50% or more of the decedent’s gross estate as adjusted for secured debts and unpaid mortgages on all property included in the gross estate.

d. The real property used in the business must exceed 35% of the adjusted gross estate.

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Question 8

When Joe died in 2012, he was a widower with a gross estate of $5.2 million, which included a 50% partnership interest valued at $1.8 million. The partnership owned real estate valued at $1.4 million. His adjusted gross estate was $5,050,000. Joe’s will left $100,000 to a qualified charity and the balance of his estate, including the business interest, to his two nephews. They currently participate in the business and plan to hold the business interest indefinitely. Joe made no taxable gifts during his lifetime.

Given the facts stated above, which one of the following correctly states why Joe’s estate cannot qualify to use the installment method of paying the estate tax (Section 6166)? a. His nephews are not considered qualified heirs. b. His estate does not contain any closely held shares of stock. c. The value of the business interests included in Joe’s gross estate is

not more than 35% of his adjusted gross estate. d. His estate will not owe any estate taxes. e. The closely held business does not have the prerequisite real estate

ownership.

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Question 9

Rodger, a U.S. citizen, has died in the current year. His gross estate is $6 million. His estate has a severe liquidity shortage. He was a widower and his will makes no charitable bequests. Rodger has operated this farm as a sole proprietor for the last six years.

The farm real estate has a date of death FMV of $1.3 million, and the farm related personal property has a FMV of $800,000. There are secured debts of $150,000 against the farm real estate, and $100,000 against the farm related personal property. Rodger had unsecured debts of $80,000 and administrative and funeral expenses of $70,000.

The farm is left to Rodger’s son in his will, and the son wishes to continue working on the farm. Rodger made no lifetime gifts.

Which one of the following postmortem elections can Rodger’s estate qualify for to help ease its liquidity shortage? a. Special use valuationb. Section 303 stock redemptionc. Section 6166 installment payment of estate taxes

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© 2012, College for Financial Planning, all rights reserved.

Module 7

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