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Principles of Taxation: Advanced Strategies Chapter 14Chapter 14 The Transfer Tax SystemThe Transfer Tax System

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Overview of System

Tax imposed on transferorTax imposed on transferor Tax is cumulative in natureTax is cumulative in nature

Amount and rate depends on prior Amount and rate depends on prior activityactivity

Integrated gift and estate system integratedIntegrated gift and estate system integrated Rates steeply progressiveRates steeply progressive

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Unified CreditSlide 14-3

Represents a lifetime exemption from transfer Represents a lifetime exemption from transfer taxestaxes

Credit first used to offset gift taxes. Any Credit first used to offset gift taxes. Any remainder used to offset estate taxesremainder used to offset estate taxes

For year 2001, this results in a exemption For year 2001, this results in a exemption equivalent of $ 675,000equivalent of $ 675,000 Exemption equivalent is amount of wealth that Exemption equivalent is amount of wealth that

can be transferred free of transfer taxescan be transferred free of transfer taxes

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Gift Tax FormulaFair market value of gifts during yearFair market value of gifts during yearLess: Annual exclusion and deductionsLess: Annual exclusion and deductionsCurrent year taxable giftsCurrent year taxable giftsPlus: Prior year taxable giftsPlus: Prior year taxable giftsCumulative taxable giftsCumulative taxable giftsX Transfer tax ratesX Transfer tax ratesTax on cumulative giftsTax on cumulative giftsLess: Tax computed on prior year giftsLess: Tax computed on prior year giftsPre-credit gift taxPre-credit gift taxLess: Unified CreditLess: Unified CreditGift tax payableGift tax payable

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Gifts

Transfers for less than adequate Transfers for less than adequate consideration in money or money’s worthconsideration in money or money’s worth

No gift until transfer completeNo gift until transfer complete

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Valuation of Gifts

Fair market valueFair market value Price that property would change hands with Price that property would change hands with

willing buyer and willing sellerwilling buyer and willing seller Difficult items to value:Difficult items to value:

LandLand Interests in closely held businessesInterests in closely held businesses Art workArt work

May need appraisalMay need appraisal

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Partial Interests

Example: Gift of income interest to Example: Gift of income interest to individual 1 for life, remainder to individual individual 1 for life, remainder to individual 22

Regulations provide guidance on how to Regulations provide guidance on how to allocate between the two individualsallocate between the two individuals

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Annual Exclusion

Up to $ 10,000 of gifts to any individual Up to $ 10,000 of gifts to any individual may be excluded from gift taxmay be excluded from gift tax

Married couples may gift splitMarried couples may gift split Election to treat any gift as made equally Election to treat any gift as made equally

by each spouseby each spouse Only present interests qualify for the Only present interests qualify for the

exclusionexclusion

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Gift Tax Deductions

Unlimited marital deduction for gifts to Unlimited marital deduction for gifts to spousespouse

Deduction for gifts to charityDeduction for gifts to charity

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Estate Tax FormulaFair market value of gross estateLess: DeductionsTaxable estatePlus: Post-1976 cumulative taxable giftsCumulative taxable transfersX Transfer tax ratesPre-credit estate taxLess: Gift taxes paid or deemed paidLess: Estate tax creditsEstate tax payable

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Gross Estate

Items included at fair market value at date Items included at fair market value at date of deathof death

May elect to value items six months after May elect to value items six months after date of death if total estate decreases in date of death if total estate decreases in valuevalue

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Items Includable in Gross Estate Property owned by decedent at date of deathProperty owned by decedent at date of death Life insurance owned by decedentLife insurance owned by decedent Portion of jointly owned propertyPortion of jointly owned property Transfers with retained life estatesTransfers with retained life estates Certain gifts made within 3 years of deathCertain gifts made within 3 years of death Gift tax paid on gifts made within 3 years of Gift tax paid on gifts made within 3 years of

deathdeath Survivorship annuity benefitsSurvivorship annuity benefits

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Property Owned by Decedent at Date of Death

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Includes all probate propertyIncludes all probate property Property that passes by will or through Property that passes by will or through

intestacyintestacy Includes all retirement accounts such as Includes all retirement accounts such as

pensions and individual retirement accountspensions and individual retirement accounts

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Joint Ownership

Ownership where two or more persons have an Ownership where two or more persons have an undivided interest in propertyundivided interest in property

Types:Types: Joint tenancy- Ownership passes to survivors or Joint tenancy- Ownership passes to survivors or

survivorssurvivors Tenancy by the entirety- same as joint tenancy but Tenancy by the entirety- same as joint tenancy but

between husband and wifebetween husband and wife Tenancy in common- no right of survivorshipTenancy in common- no right of survivorship Community Property- property except for gifts and Community Property- property except for gifts and

inheritances acquired during marriage in a inheritances acquired during marriage in a community property statecommunity property state

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Joint Ownership

Jointly held property with rights of Jointly held property with rights of survivorshipsurvivorship General rule: Entire value of property General rule: Entire value of property

less contribution of decedent includable less contribution of decedent includable in gross estatein gross estateException: If joint owners were Exception: If joint owners were

married, 50% of value of property married, 50% of value of property includableincludable

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Joint Ownership

Tenancy in common – amount includable in Tenancy in common – amount includable in gross estate determined by state lawgross estate determined by state law

Community property – 50% owned and Community property – 50% owned and includable by each spouseincludable by each spouse

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Estate Tax Deductions

Funeral expensesFuneral expenses Estate administration costsEstate administration costs Estate casualty and theft lossesEstate casualty and theft losses Certain liabilitiesCertain liabilities Gifts or bequests to charityGifts or bequests to charity Gifts or bequests to spouseGifts or bequests to spouse

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Estate Tax Credits

State death tax creditState death tax credit Subject to a maximum limitationSubject to a maximum limitation

Credit for estate tax on prior transferCredit for estate tax on prior transfer Allowed if property passed through Allowed if property passed through

another estate during past 10 yearsanother estate during past 10 years Reduced by 20% for every two year Reduced by 20% for every two year

increment that has passed since property increment that has passed since property was previously taxedwas previously taxed

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Generation Skipping Transfer Tax

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Tax imposed on transfers that skip a Tax imposed on transfers that skip a generationgeneration Example: gift to grandchildExample: gift to grandchild

Imposed at 55% rateImposed at 55% rate Exemptions:Exemptions:

$ 10,000 annual gift tax exclusion$ 10,000 annual gift tax exclusion $ 1,060,000 exclusion allocated to every $ 1,060,000 exclusion allocated to every

transferortransferor

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State Death Taxes

Imposed by every stateImposed by every state Types:Types:

Inheritance tax imposed on the privilege of Inheritance tax imposed on the privilege of inheriting assetsinheriting assets

Rate generally based upon relationship between Rate generally based upon relationship between transferor and transfereetransferor and transferee

Estate taxEstate tax Pick up taxPick up tax

Tax equal to maximum deduction for state death Tax equal to maximum deduction for state death taxes on federal returntaxes on federal return

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Charitable Contributions

Allowed as an income, gift and estate tax Allowed as an income, gift and estate tax deductiondeduction

Full fair market value generally deductible Full fair market value generally deductible for all purposesfor all purposes

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Tax Basis Issues

Recipient taxable on any income produced Recipient taxable on any income produced by inherited or gifted propertyby inherited or gifted property

Tax basisTax basis Property acquired from decedentProperty acquired from decedent

Basis equal to fair market value on Basis equal to fair market value on date of death or alternative valuation date of death or alternative valuation datedate

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Tax Basis IssuesSlide 14-23

Property acquired by giftProperty acquired by gift Carryover basis if asset worth more than Carryover basis if asset worth more than

donor’s basisdonor’s basis Split basis if asset depreciated in valueSplit basis if asset depreciated in value

Carryover basis for gainCarryover basis for gainFair market value for lossFair market value for loss