INTRODUCTION Constitutionality and Taxation: the federal transfer taxes (estate and gift and generation-skipping transfer tax) are excise taxes on the transfer of property and are not direct taxes (on the property itself which must be apportioned). They must be “uniform throughout the US” per Article 1, section 8, clause 1 but they do not need to be apportioned because they are not direct. Article 1, section 2, clause 3/ Article 1 Section 9 clause 4. Glossary: Future Interest: a present right to future possession or enjoyment. Types: Remainder: FI that comes into possession upon expiration of a prior interest (e.g. life estate). Reversion: interest that transferor has or retains because less than the full estate is transferred ex: A transfers to B for life then to B’s surviving children. A has reversion. Executory interest: a future interest that cuts short a vested interest. A transfers to B and his heirs but if…then to C and his heirs. Or A transfers to B for 10 years then to A then to C upon reaching the age of 30. Note: The holders of successor FIs don’t acquire property from each other but from the orig transferor. Vested v. contingent: vested if the person’s ownership cannot be defeated by a condition precedent. B for life, remainder to C (vested) v. B for life, remainder to C if C survives B but if not, to D General transfer tax info: Policies: Fairness in the we want to tax property once at every generation; vertical and horizontal- fed taxes produce horizontal; Positive economic effects: estate tax: does it discourage work/ savings/ consumption?; Administrability: We want simple system. This often conflicts with equity. No signif costs for planning, compliance, enforceability. So the taxes impose costs out of proportion w/ the revenues they generate? Difficult to assess bc much of the cost of planning will be incurred even if there isn’t a tax. We want to raise compliance and minimize disputes. Efficient tax to administer... know time to impose it (you're dead). And kids who inherit too much wealth are not productive. Conform to notions of good law- we’ve had transfer taxes since 19 th century. Justifications for transfer taxes: Fundamental purposes of the transfer taxes are to raise revenue and redistribute wealth. These are excise taxes on the transfers of property. Raise Revenue, though it’s a small % of total tax revenues/ stimulate the economy. Estate and gift taxes constitute only a 1
Transcript
INTRODUCTION Constitutionality and Taxation: the federal transfer taxes (estate and gift and generation-skipping transfer tax)
are excise taxes on the transfer of property and are not direct taxes (on the property itself which must be apportioned). They must be “uniform throughout the US” per Article 1, section 8, clause 1 but they do not need to be apportioned because they are not direct. Article 1, section 2, clause 3/ Article 1 Section 9 clause 4.
Glossary: Future Interest: a present right to future possession or enjoyment. Types: Remainder: FI that comes into possession upon expiration of a prior interest (e.g. life estate). Reversion: interest that transferor has or retains because less than the full estate is transferred
ex: A transfers to B for life then to B’s surviving children. A has reversion. Executory interest: a future interest that cuts short a vested interest.
A transfers to B and his heirs but if…then to C and his heirs. Or A transfers to B for 10 years then to A then to C upon reaching the age of 30.
Note: The holders of successor FIs don’t acquire property from each other but from the orig transferor. Vested v. contingent: vested if the person’s ownership cannot be defeated by a condition precedent.
B for life, remainder to C (vested) v. B for life, remainder to C if C survives B but if not, to D General transfer tax info:
Policies: Fairness in the we want to tax property once at every generation; vertical and horizontal- fed taxes
produce horizontal; Positive economic effects: estate tax: does it discourage work/ savings/ consumption?; Administrability: We want simple system. This often conflicts with equity. No signif costs for planning, compliance, enforceability. So the taxes impose costs out of proportion w/ the revenues they generate? Difficult to assess bc much of the cost of planning will be incurred even if there isn’t a tax. We want to raise compliance and minimize disputes. Efficient tax to administer... know time to impose it (you're dead). And kids who inherit too much wealth are not productive. Conform to notions of good law- we’ve had transfer taxes since 19th century.
Justifications for transfer taxes: Fundamental purposes of the transfer taxes are to raise revenue and redistribute wealth. These are excise taxes on the transfers of property. Raise Revenue, though it’s a small % of total tax revenues/ stimulate the economy. Estate and
gift taxes constitute only a modest part of total tax revenues collected by the federal government—estimated between 1.2% of net federal revenues, though it adds up (28.8 billion in 2008). Currently, with a $2M exemption, most people are not subject to federal estate or gift taxes Counter: Poor revenue raiser, only 1-2% of the federal budget; unlikely to significantly increase;
will never fund the federal govt Multiple tax bases. A tax system with more than one tax base is less vulnerable to the economic or
behavioral changes & better at taxing based on ability to pay bc there are diff. measures of that ability. Ability to pay. Another policy consideration is vertical equity, or progressivity (or ability to pay).
Enhance overall progressivity by taxing only the very wealth (top 1.2 percent of the population). Counter arguments and alternatives:
Creates a double tax on assets/income; Puts burden on a relatively few people; Distorts behavior-people spend a lot of money trying to avoid it; invest a lot in insurance industry and shift from building retirement to investing in insurance; Causes people to create trusts that aren't necessary. Evasion is easy and savers are penalized/spenders rewarded and fails to break up concentrations of wealth
Alt: Abolish §102; incl gifts/bequests in income. All prop taxed to bene. Take into account relative wealth of every recipient and tax less well off people w/ marginal rates
Alt: Inheritance tax - have separate set of rates for inheritances and exemptions for diff policy reason Alt: Accessions tax - inheritance tax except looks to each bene and how many gifts/bequests received
over their lifetime and tax proportionately Importance and Justifications of Estate & Gift Tax
Justifications for gift tax Backs up estate tax: If you have prop that is only taxable at death, people will give it away IV
Tries to reach estate-depleting transfers; As Justice Frankfurter said in Commissioner v. Wemyss, “[the gift tax is designed] to reach those transfers that are withdrawn from the donor’s estate.”
Gift tax backing up income tax: [this is why Congress did not repeal the gift tax in 2001 when it repealed the estate and generation-skipping transfer taxes] People also say that another function of the gift tax is to protect the income tax. The income tax is a graduated tax on the income of the owner of
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the property. In a family, one way of lessening the income tax is to transfer income-producing property to family members in lower tax brackets. The gift tax places limits on that sort of thing
Justifications for the Estate Tax. Wealth Redistribution. Estate taxation has been advocated primarily as an instrument for the
equalization of wealth; however, such a minor factor (only 8 in 100 richest Americans trace wealth to inheritance) that transfer taxes are not necessary). Anti-concentration- prevent large intergenerational concentrations of wealth like Rockefellers and Carnegies (but will they work as hard if they know it will be taxed to smithereens instead of gliding to their families?)
Discourage Idleness. Inheritance comes as a windfall, and those who benefit from such get idle. Encourage Charitable Contributions. In determining the taxable estate, §2055(a) allows a deduction
for the amount of all bequests to charitable organizations In terms of economy, saving money is not good for economic growth so threat of tax at end of day
causes you to spend at end of the day Comparison and Relation of Estate & Gift Tax
Comparison: Gift and Estate Tax. The GT may be cheaper than the estate tax for the following reasons: Appreciation in Property Value. An inter vivos transfer may be cheaper than a transfer at death if the
property appreciates in value between the date of gift and the donor’s death. 1014 provides that a beneficiary receives a stepped-up basis, that is the bene’s basis is the FMV of
the property on the date of death, so any appreciation in the value of the proerpty is never taxed as income and if person ever sells the property, doesn’t realize or recognize any gain—incentive to hold onto appreciating property until death. BUT if it is already highly appreciated resource (stock from 1901) and trying to decide
whether to sell now or give to you in estatealways hold on and give to you in estate. Or if resource is worth less than you paid, should sell it and take the loss as an income tax loss. Encourages people to retain appreciated property until their deaths but to sell before death any
property that has declined in value to get the income tax loss Other advantages to IV giving: (note when GT and ET were de-coupled, better to make lifetime gift)
Generally speaking, when tax systems are unified, gift tax is cheaper because it is Tax “Exclusive.” For gift tax purposes, the amount of a gift is defined as the value of the transferred property, excluding any gift tax imposed on the transfer. Accordingly, the gift tax is said to be computed on a “tax-exclusive” base; there is no “tax on the tax.” In contrast, the estate tax base includes the value of all the property owned at death (including any amount used to pay the estate tax), not just the property that actually comes into the hands of the beneficiaries. The estate tax must be paid from “after-tax” dollars, and the estate tax base is therefore said to be “tax-inclusive.” Ex. Suppose that both the estate and gift tax is imposed at a flat 50% rate. A donor who
makes an IV gift of $1M will incur a (tax-exclusive) GT of $500K, bringing the total out-of-pocket cost of the transfer to $1.5M. However, a decedent who dies leaving an estate of $1.5M will incur a (tax-inclusive) ET of $750K, leaving only $750K for the heirs after tax. Thus, the gift tax is $250K less than the estate tax on a comparable transfer—precisely the amount saved by excluding the gift tax from the gift tax base (i.e., $500K x 50% = $250K).
Annual exclusion; reduces taxable estate by the gift and the tax paid. Relation:
Unification of EGT achieved by positing one rate sched for both; having a single exemption (obtained through an exemption-equivalent credit, officially referred to as the unified transfer tax credit) and under 2001(b)(1)(B), treating the taxable estate as if it were the last taxable gift of the decedent.
EFFECT OF STATE LAW Exam: First, determine the nature of scope of the property in question. Then look to state law for that
determination. Second, analyze which court is making the decision. A fed ct will interpret the IRC, but it must apply those provisions to state created property rights. It will only give proper regard to, and not be bound by, the decisions of state courts that are not the highest court of that state.Comm’r v. Bosch’s Est., Facts: D created an IV trust for his wife’s benefit and gave her a general poa over the trust property.
W executed an instrument purporting to convert her gpoa to a spoa. After the D’s death, his executor obtained a determination from the state trial court that this instrument was a nullity. The Tax Court and COA accepted this determination in a proceeding for federal estate tax purposes.
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Why State litigation: By granting his wife a gpoa over the trust property, the D would still be treated as owning the property at death and the property would, therefore, be included in his gross estate. But, the value of the D’s gross estate was below the applicable exclusion amount and would not be taxed anyway. By obtaining a court determination that the wife’s gpoa had not been converted to a spoa, the wife presumably sought a stepped-up, FMV basis in the trust property pursuant to §1014(a).
Held. the decisions of lower state courts are not controlling for federal tax purposes. Instead, “proper regard”—not conclusive force—should be given to such decisions of the lower state courts. In contrast, the state’s highest court was regarded as the best authority on the state law. If no decision in the highest ct of the state bears on the point, the fed court must ascertain how the highest state ct would have ruled on the matter after giving “proper regard” to pertinent rulings by other courts of the state.
Note: “Proper Regard” to Lower State Court Decisions: Courts often look at the following factors in determining whether to give “proper regard” to a lower state court decisions: Whether: 1. the state ct decision reflects the outcome of a bona fide adversarial dispute; 2. there
are signif non-tax consequences of the dispute; 3. the state court decision represents a correct application of state law (i.e. whether would likely have been affirmed if reviewed by highest ct.).
PAYMENT & COLLECTION OF TAX Authority: Have treasury regulations get voted on then signed for commissioner, rev ruls which courts
take into account can disagree with, private letter ruling when TP will ask and the IRS will issue it, tech advice ruling saying ok or not but to binding on anyone other than taxpayer who asks for the ruling. Or IRS can change mind (as opposed to revenue ruling where supposed to follow) Tax court (deficiency) v. district court (refund).
Estate Tax Tax Returns. An estate tax return (Form 706) is due nine months after death (§6075) and must be
filed for the estate of every citizen or resident of the U.S. whose gross estate exceeds the decedent’s remaining applicable exclusion amount (§6018)—here 5 M. For filing purposes, therefore, the statute treats the estate as though it were not entitled to any deductions (e.g., administration expenses, debts, casualty losses, charitable bequests, marital deduction) and requires a return, unless the amount of the estate is fully offset by the decedent’s remaining applicable exclusion amount.
The exec or admin of the estate has primary responsibility for filing the return. If fails to act or no fiduciary has been appointed, every person in actual or constructive possession of any of the D’s prop situated in the U.S is considered an executor and is required to file a return (§2203).
Note: The estate tax return must be signed by all executors. 3 tax returns: Decedent’s final income tax return, estate tax return and estate’s income tax return.
Gift Tax Tax Returns. §6019 requires that a gift tax return (Form 709) be filed for each calendar year in which
an individual makes any gift that is not fully covered by the annual exclusion for gifts of present interests, by the exclusion for tuition or medical payments, or by the marital deduction.
Under §6075(b), the gift tax return is generally due by April 15 following the close of the calendar year in which the gifts were made. The donor has primary responsibility for filing the return. However, if the donor dies before the gift tax return is filed, the executor must file the return. Penalties may be assessed for failure to make a timely filing of the return, based on the amount of the tax due (i.e., no penalty if no tax due).
Only file if donor transfers to any donee during the tax yea more than 13k regardless of whether any tax is due. That means if you’re gift splitting, still required to file gift tax return. If given gift that falls within lifetime exemption or if gift doesn’t have a fixed value and advantage is you're giving IRS notice. When someone dies usually ask for copies of all gift tax returns they've filed. Because estate tax return is really the final gift tax return. However, does need to be filed for gift splitting under 2513.
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GIFT TAX (for transfers of property as gifts) Internal Revenue Code §2501(a) imposes a tax on the transfer of property without receipt of consideration in
money or money’s worth during the calendar year by any resident or nonresident individual. When considering whether something is a taxable gift, one should tackle four questions: 1. Is there a transfer
of property? 2. Is that transfer a gift? 3. If yes, is the gift complete? 4. And is the gift subject to any exclusions or deductions from the gift tax?
Under 2502(c) the gift tax is to be paid by the donor. Note: if a donor transfers by gift less than his entire interest in property, the gift tax is applicable to the interest
transferred (25.2511-1(e)). However, if the donor’s retained interest is not susceptible of measurement on the basis of generally accepted valuation principles, the gift tax is applicable to the entire value of the property. Ex: D, 65, transfers life estate in property to A, 25, with remainder to A’s issue or reversion to D- GT
applicable to entire value. But if per 1(h)(6) A transfers property to a trust where B receives income for life and at his death the trust
terminates and corpus returns to A provided A survives but otherwise to C, A has made a gift equal to the total value of the property less the value of his retained interest.
1. Is there a transfer? In general: §2511(a) provides that the tax imposed by §2501 shall apply “whether the transfer is in trust or
otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible.” Property’s expansive def ensures that the IRS and courts can broadly interpret 2501 and 2511.
Not considered transfers: Personal consumption and economic waste- not even a transfer
Using one’s own asset is not a gift Purchasing goods is not a gift—there may be a transfer but it was with full consideration. Wasting your own asset is not a gift (money under your mattress could be used but isn’t- no gift). But once you let someone else use that money, there is a transfer.
Transfers to political organizations- not even transfer Are excluded from the gift tax (2501(a)(4)). [Willbanks p.64] Support: well not a gift because might be getting money or money's worth---investment. Helping an
25-2511-1(h)(2)/(3) (2) the transfer of property [from A] to B if there is imposed upon B the obligation of paying a
commensurate annuity to C is a gift [from A] to C. (3) the payment of money or transfer of property to B in consideration of B’s promise to render a
service to C… 25-2511-1(h)(8)/ Rev Ruling 79-490:
gift: “D caused the economic benefit…to insure to the assignee as each payment was made…” Sole purpose of this ruling- just b/c premiums going into a trust--indirect gifts...to ee then to
trust....so we do count insurance as part of a taxable estate when you die. What if it's not payable to your estate, but goes somewhere else? Each of the premiums going to someone else gets paid as a gift even thought that trust/ person doesn’t receive the proceeds until I die. If have policy and not paying to estate- maybe to trust or a person, the premiums are a gift
Heyen : indirect transfer to family- can’t do this. Decedent had her bank transfer stock to 29 recipients- all worth less than 10k. 27 returned the shares to the family. D argued not a transfer to family. Court said it was an indirect transfer; doesn’t matter that 2 haven’t transferred stock back. Intent mattered. (support in 25.2511-1(h)(2)). Substance prevails over form. There was only one gift from mother to daughter. Failure to file a gift tax return reporting this gift was fraudulent and justified imposition of penalties.
Constructive transfer: when a first party allows a second party to dispose of the first party’s property or the second party refuses to accept a gratuitous transfer and it passes to another. Constructive transfer ex:
H having sole management power over a certain community property make a gift transfer of both H and Ws interest in the property to an adult child. W is a constructive transferor of her half interest in the community property.
Spousal election will- D’s will purports to dispose of his and SS’s property (see E.O.Vardell). 4
Contractual wills where each spouse bequeaths estate to the other but if the other does not survive, then to common descendants and the 2 joint wills are accompanied by k saying that on death of one, the SS’s will becomes irrevocable. Only really matters in IL there k will doesn’t restrict SS from spending or disposing of property--
Pyle: H died first and SS took net estate under obligation to bequeath combined interest to children and 7th Cir. Said SS made a gift, at time of H’s death, of entire marital property, reserving a life estate, with remainder to descendants. Gift of remainder interest but also because she had a reserved life estate, then included in her gross estate under 2036(a)(1).
Estate of Lidbury: no gift b/c SS didn’t give up right to consume or dispose of the property. Disclaimer:
In general: Under §2518(a), the effect of a qualified disclaimer is that no transfer is deemed to have been made to or from the person making the disclaimer, and the disclaimed interest is deemed to pass directly from the original transferor to the ultimate recipient. Note that the disclaimant cannot direct where it goes. It passes wither to the spouse of the decedent or to a person other than the person making the disclaimer. (2518(b)(4)- This provision requires that the disclaimer remove the disclaimed interest from the disclaimant’s ownership and control. Thus, a disclaimant may not disclaim a specific bequest under a will and then turn around and accept the same property as part of a residuary or intestate share). Note: 25.2511(c)(1) about indirect transfers does not apply if a donee qualifiedly disclaims the property.
Effect: 25.2518-1(b): the disclaimed interest in property is treated as if it had never been transferred to the person making the disclaimer.
Requirements: Under 2518(b) a disclaimer is qualified only if it meets the following requirements The disclaimer must be:
an irrevocable, unqualified refusal by a person to accept in interest in property, but only if it is in in writing that is signed by disclaimant (‘s representative and identifies the property 25.2518-2(b)) timely, that is, it must be received by the transferor, the transferor’s legal representative , or the
holder of legal title to the property to which the interest relates not later than the date that is 9 months after the later of the transfer creating the interest in the person is made or the day on which such person attains 21 i.e. minor could get benefits then disclaim later. Timely mailing counts 25.2518-2(c)(2).
The person has not accepted the interest or any of its benefits. Timing Examples:
D creates a revocable trust in 1990, income to B for life, remainder to R if living, if not to S. D dies in 2000 and B dies in 2001. S must disclaim (within 9 months of when D died in 2000 bc that’s when it becomes fixed and irrevocable even though S may not know what she gets until R and B are gone. 2518-2(d)(e)(5) ex 11 (763). Contrast with 12.
On May 13, 1978, B creates a trust in which C is given a lifetime income interest and a general power of appointment over the principal. C exercises the general power of appointment in favor of D upon C's death on June 17, 1989. The starting point for a disclaimer by D is June 17, 1989
If O creates an irrevocable IV trust on 4/1/1978, with income payable to O's child D for life and remainder at D's death to D's child, E, the starting point for D's and E's disclaimers is April 1, 1978
If H and W reside in a community property state and on April 1, 1978, they purchase real property with community funds and do not put the real property in their names as JTROS, and the H dies on January 3, 1985, devising his portion of the property to the W, the W can disclaim that portion within nine months of the husband's death but cannot disclaim the interest in the property that she acquired on April 1, 1978
If a joint tenancy remains intact until one tenant dies, the survivor generally has 9 months from that tenant’s death to make a qualified disclaimer of the ½ interest received by the right of survivorship
Accepting benefits examples: If you receive any benefits, you cannot disclaim.
Ex can’t disclaim in exchange for a promise to receive the cash value of it from spouse. No accepting dividends or rent or anything.
Vease: even just rearranging an estate plan is treated as if accepted and then reallocated—(distinction is if bona fide contest). Here, family wanted to carry out wishes of Walker’s
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un-executed latest will. Commissioner said trusts had resulted from a transfer of property made by Elizabeth. During her lifetime and she retained life interest in the property so includable in her gross estate Court said they were accepting and controlling the property. Take-away is can't voluntarily rearrange estate without accepting the estate and then controlling its disposition. Lesson: if will dispute and settle it then property that passes it is passing from decedent's estate directly.
Can disclaim part as long as can be segregated. can disclaim an undivided portion of an interest in property as long as it’s severable property
(2518(c)). The undivided portion must be either a specific pecuniary amount or a fraction or % of the property.
Ex: Tom bequeathed $500k to Melvin and 600 shares of stock in Co. to Ned. Melvin disclaims 200k and Ned disclaims 400 shares of stock. If al the other requirements of 2518 are met, Melvin’s and Ned’s disclaimers are valid. 25.2518-3(c) and (d)
Tom bequeathed Blackacre to Faith and Greenacre to Hope. F disclaimed 100 of 500 acres and H disclaimed a ½ interest in Greenacre. Valid under 3(b) and (d). Ex 3/4. However, can’t keep a life estate and disclaim remainder or something- keep bundle of
sticks together. 3(d) Ex. 3 and 12 (767) but see below. Life estates and remainders: An individual may disclaim a life estate or a remainder interest
if that is the only interest the individual receives. If an individual is given a fee interest in property, the disclaimer of a life estate is not a qualified disclaimer bc the individual still owns the remainder interest. (25-2518-3(d) ex 3). The reverse is also true. If an individual is given a fee interest in property, the disclaimer of a remainder interest is not a qualified disclaimer bc the individual still owns a life estate in the property (25.2518-3(b)).
Joint tenancy interests: may disclaim a survivorship interest in property held as JT Ex: Roger and Evan own S as JTROS. Either may sever the JT unilaterally under state
law. Roger dies on May 1. On September 1, Evan sends a letter to the executor of Roger’s estate disclaiming the ½ interest from Roger. Assuming the other requirements of 2518 are met, the disclaimer is valid. (25-2518-2(c)(6)).
Policy/use: You don't need it and the kid is the residuary beneficiary. Also might have situation where tax law
changed and some property is taxable or D didn't know. Rationale: post-mortem estate planning, especially b/c can decrease or increase size of marital or
charitable deduction in the estate of the D without tax costs to the person effecting the disclaimer. Maximizing Use of the Applicable Exclusion Amount. Disclaimers can be used to maximize the
utilization of the applicable excl amt. For ex, suppose that a H dies with a $10M LI policy payable to his W. §2056 grants an unlimited deduction for qualified transfers to the SS.However, if none of the deceased H’s $2M applicable exclusion amt has been used, the entire $10M will be incl in the W’s estate upon her death. To maximize use of the H’s $2M applicable excl amt, the W can disclaim her interest in the LI proceeds to the extent of the H’s unused applicable excl amt. Assuming that the H’s prop still passes to the W by will or intestate succession, this $2M will not be incl in the W’s estate upon her death and will, tf, be sheltered from transfer taxes. Thus, only $8M will be included in the W’s estate, against which her $2M applicable exclusion amount may be applied upon her death.
Fixing the Marital Deduction. Disclaimers can cure trusts intended to qualify for the marital deduction but that do not meet all of the reqs. For ex, if D H created a trust for the benefit of W, but the trust instrument also allowed the trustee to pay any part of the income or corpus of the trust to his kids at the trustee’s discretion. The kids can disclaim their interests in the trust; if this leaves the wife with the sole right to all the income annually, the transfer to the trust may qualify for the deduction.
2. Is there a gift for purposes of IRC 2501 ?
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In general: Internal revenue Code 2512(b) defines a gift: “Where property is transferred for less than adequate and full consideration in money or money’s worth, then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift.” That is, a gift made without consideration or an equivalent value received in return.
Take each gift separately. So say: “Gloria transferred the cash into the trust and Tex did not transfer money or money’s worth back” “Gloria also transferred a remainder interest to her children, who have her no consideration.” “Therefore, Gloria made a taxable gift to her H and children under IRC §§2501 and 2512(b) when she...”
Intent Unlike the income tax definition of a gift in Duberstein, donative intent is not a necessary element for of a taxable gift for federal gift tax purposes (See 25-2511-1(g)(1)). 2512(b) is couched in consideration rather than donative intent considerations. This is to foreclose estate tax loopholes; for example, someone could sell a friend a working car for $10.00 and avoid taxes by claiming she harbored no donative intent. However, because the income tax is not read in pari material with the gift tax, these differing definitions
can result in the same transfer counting as a gift for purposes of the gift tax and NOT for the income tax, subjecting the transferor to both the gift tax and the income tax.
Note: so donor dependent whether it is a gift, there doesn’t even need to be a done alive—can gift to unborn children.
Remember: a donor does not need to relinquish all her interest in the property; i.e., she can transfer a joint tenancy interest, or an interest as a tenant in common or a life estate, or a reminder.
No gift: Ask: trying to erode his or her estate; denude self of assets Goods bought outright
Ex: executor/trustee fees/commissions- as long as they are made in beginning and made throughout then not a gift, but if there's an ambiguity and don't announce it, a court could say they are a gift
Transfers mandated by law (i.e. Support of child, spouse, or divorce decree in Harris)- not even transfer Alimony and child support payments in cash are exempt under support exclusion Parents must support their minor children (administrability concerns, too).
Parameters; Pat buys 20k car for kid. State law will determine scope fo duty and support. If purchase of a car is not part of the duty, it is a gift, which exceeds the amount of gift tax annual exclusion.
Only minors! Any transfer for support is a gift unless donor has legally enforceable obligation to support the recipient. I.E., pay daughter’s rent, food, utilities for a year after college….taxed!
Spouses must support each other (terminates on divorce) What constitutes support depends on state law. (unclear if those applies to same sex couples). The right to support (as opposed to right to share in property upon death or divorce) is consideration in
money or money’s worth. Not a gift. That is, transfers of discharge of this duty are not gifts. Thus, a taxable gift is recognized only to the extent that the value of property transferred to the spouse exceeds the value of any support rights that spouse surrendered. Doesn’t make sense completely if this is a large wealth transfer like a cash payment because
you’re depleting your estate. §2516 - Property Settlements in Contemplation of Divorce. §2516 provides that if H and W enter
into a written agreement relative to their marital and property rights and divorce occurs within the 3-year period beginning on the date 1 year before such agreement is entered into (whether or not such agreement is approved by the divorce decree), any transfers of property made pursuant to such agreement (1) to either spouse in settlement of his or her marital or property rights, or (2) to provide a reasonable allowance for the minor children (for the duration of their minorities), is deemed to be transfers made for a full and adequate consideration in money or money’s worth (i.e., not a gift). Ex: H and W divorce and court awards W a 3M property settlement. Transfer not a gift because it
occurred pursuant to a divorce order. Tip: is property transferred pursuant to separation or divorce, look first to per se exclusion from
2516, if that does not exempt the transfer (maybe divorce not timely obtained) then look to Harris doctrine. Latter does not apply where divorce court retained no jurisdiction to modify the decree or if a divorce or separate maintenance decree was never obtained.
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If neither 2516 nor Harris applies, transferor can avoid gift characterization only if transfer was made for consideration in money or money’s worth. Remember release of inheritance type rights does not quality! But release of support-
type rights does. If latter then value it and compare it to the amount transferred. Transfers Made Pursuant to Court Order When §2516 Does Not Apply. If §2516 does not
apply and a transfer of property in exchange for a former spouse’s relinquishment of her marital property rights is effected after the parties are divorced, the transfer is still not a taxable gift if it is made pursuant to a court order. In Harris v. Commissioner (Twen), the Supreme Court held that, if a property settlement agreement is approved by a divorce court that has the power to alter the agreement (i.e., not just “rubber stamp approval”) and the agreement is incorporated into the divorce decree, the transfer is not founded on the promise or agreement of the parties. Thus, the transfer is exempt from the gift tax. The Court reached this result even though the covenants in the agreement were expressly made to survive any divorce decree that might be entered
i.e., a court determination of property rights would not result in gift tax bc obligation was a legal one imposed by the court.
Note, now with 2516, analysis of applicable state law not needed, just want to see if court has power to alter tha agreement.
Rationale: Not suspicious that divorce degrees are ways of getting out of estate tax. And there's adversarial blood...why would give ex money willingly?
Remember: Applies only to spousal maintenance, child support, and the division of property pursuant to the agreement.
Qualified transfers of tuition/ medical payments - see exclusions. Transfers in “Ordinary Course of Business.” Reg. §25.2512-8.
Safe harbor and only place where donative intent factors into what is a gift for gift tax purposes. In general: A sale, exchange, or transfer of property is not considered a taxable gift if the transfer is
made in the “ordinary course of business,” even if the transfer is for less than adequate and full consideration (i.e., the transaction is a “bad bargain” to the transferor) (Reg. §25.2512-8). Such transfers are considered made for an adequate and full consideration in money or money's worth. The “ordinary course of business” exception is not limited to regularly recurring business transactions with customers: It includes all business-related transfers that are (1) bona fide, (2) at arm's length, and (3) free from donative intent (Unlike Wemyss, matters here). Ex: D owns 100% of stock of a local software company. Concerned that other companies may
raid his 5 programmers, he transfers 1k shares of stock to each of them after they work 5 years. Not a gift…ordinary course of business. But what if they were his children? Well then becomes more fact-specific and look at
donative intent and arm’s length because it looks less like a bona fide transaction. Rationale: Don’t want to restrict business. Presume you’re getting something because don’t generally
give employees or others in business transactions things if it’s not going to make you more money “Ordinary course of business”
A TP who sells property at a discount rate as part of her business doesn’t make a gift. Ex: Sell a tv for 100 even though cost 125 even if buyer is your daughter. Seller willing to sell
the TV to anyone for that price. If price is result of arms length transaction, then there is no gift. If sold to everyone for
125 and to daughter for 100 then price is motivated by donative intent and the transaction would be part sale and part gift.
“Bona fide” If it is in reality what it purports to be on paper. If there is a deed, did the recipient record it? Was
title to the stock transferred on the books of the corporation? Did the transferor charge interest on the promissory note? Did the transferor intend to collect on the debt
“Arm’s length” if terms are similar to those that strangers would negotiate.
“Free from donative intent” Depends on facts and circs. Relationship? What is the value of the property?
Intra-family members: presumption that these are motivated by donative intent and are subject to special scrutiny. A heavy burden rests on the TP to demonstrate absence of donative intent.
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Prearranged is discouraged and documentation encouraged...make it look like a first union loan; clean paper trail. Make it look arms length and bona fide. No donative intent showing.
Gratuitous services or help in kind (clean for neighbor). In General. Rendering services for someone without compensation is not a transfer of “property” and
will not be taxed as a gift. This holds true even if those services produce definite, ascertainable financial gain for the recipient. And services in kind are not gifts.
Rationale. Doesn’t deplete estate; administrability (valuation) problem. Compare: Parent gives the Titanic master, plus all the copyrights, to the child. Is the gift subject
to gift tax? Yes, it is property and the argument is that if he dies with this stuff in his estate he would be taxed much more...backstop. Contra Parent just helps child shoot child's first movie.
Way to shift economic benefit without having to pay gift tax. In Commissioner v. Hogle, the grantor created an irrevocable trust (retained no right to alter or amend
or to change the beneficial interests) for children’s benefit and managed a securities trading account for the trust. Although the grantor’s expert services conferred economic benefit on the children, the court held that the grantor’s financial investment management services did not constitute a gift.
What the facts turned on: The IRS contended that the annual earnings of the trust from trading in securities under the grantor’s direction amounted to gifts by the grantor to the trust. The court disagreed, maintaining that the grantor did not retain a beneficial interest in the trust property and, therefore, never held an economic interest or discretion in the earnings of the trust. Issue was not about personal services but whether he made gifts to the trust and court said no gifts to trust but every court reads Hogel to say personal services are not gifts.
Yes gift
If the consideration is: Not in money or money’s worth
In general, made a gift if property is transferred for less than full and adequate consideration in money or money’s worth. (2512(b))
Rationale: Administrability, depletion, valuation, backstop to estate tax. Money consideration must benefit the donor to relieve a transfer from being a gift!! The gift tax aims to reach those transfers which are withdrawn from the donor’s estate” Ex: Suppose that a parent promises to pay $10k to a child if the child graduates from college. If
the child’s promise to complete college constituted consideration in money or money’s worth, then the parent could escape transfer taxes on that $10k altogether once it was paid: No gift would be due if the value of the child’s promise equaled $10k, and no property would be received from child to offset the depletion of the parent’s estate ($10k escapes estate taxation. Moreover, if the parent dies after the child’s graduation, without having made any payment to the child, the estate may not deduct $10k for the child’s claim against the estate.
25-2511-1(h)(1)- transfers by businesses. A business entity can give a gift and it’s attributable to shareholders, partners or equity holders
A transfer of property by a corporation to B is a gift to B from the stockholders If B is a stockholder, the transfer is a gift to the extent it exceeds B’s interest in such amount as a
shareholder. 25-2511-1(h)(2)(3)- indirect
The transfer of property to B if there is imposed on B he obligation of paying a commensurate annuity to C is a gift to C.
Transfer to B in consideration of B’s promise to render service to C is a gift to C or to both B and C depending on whether the service to be rendered to C is or is not an adequate and full consid imomw.
Love and affection. Love affection, and the release of marital rights are not in consideration in money or money’s worth
(Treas. Reg. 25.2512-8;Wemyss) because they cannot add to a donor’s net estate. Agreement to Marry/ Wife’s Detriment Not Consideration. An agreement to marry does not
constitute money’s worth consideration to the donor.
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In Commissioner v. Wemyss, the Supreme Court held that the TP’s transfer of stock to his prospective wife was a taxable gift when TP made the transfer in consideration of 1. her promise to marry him and 2. to compensate her for the loss of income from trusts created by her former H that she no longer would be entitled to receive after her marriage to the TP. The Court held that the absence of donative intent by the taxpayer did not preclude application
of the gift tax. The consideration received must benefit the donor in order to prevent the transfer from being
deemed a gift because the purpose of the gift tax is to tax transfers that deplete the donor's estate. Neither the donee's promise to marry the donor nor the detriment to be suffered by the donee (the loss of trust income) constituted money's worth consideration to the donor.
Relinquishment of Marital Property Rights Not Consideration; doesn’t matter if those rights can be valued, transferred or sold. An antenuptial agreement between prospective spouses may involve a transfer of property, either
outright or in trust, in exchange for the donee's relinquishment of all of his or her marital rights in the donor's property. Under Reg. §25.2512-8/2043(b), donee’s relinquishment of such marital rights in the property or estate of the donor is not considered consideration “imomw” In Merrill v. Fahs, the Supreme Court held that a post-marriage transfer pursuant to a typical pre-
nuptial agreement was a taxable gift. Under the agreement, the donor agreed to transfer $300k to an irrevocable trust for the benefit of his wife-to-be. In consideration of the promised transfer, W relinquished all dower and other marital rights in the donor's property (so no rights to elective share, etc). The Court noted that although the gift tax statute did not specifically provide that the release of marital property rights was not to be treated as consideration in money or money's worth, the estate tax statute did state that the relinquishment of marital rights did not constitute imomw. The Court held that, because the gift tax is supplementary to the estate tax, the taxes are in pari materia and must be construed together. Accordingly, Court held that the release of marital rights did not constitute consideration and the entire transfer was subject to gift tax. Look at her husband’s estate—will not replenish estate has what he would if never married.
Note the difference: If you relinquish right to 1/3 of H’s property when he dies, not consideration (no replenishing estate, just right to share in property upon death or divorce), but if you relinquish right to support that is consideration—surrender of a claim against transferor relieves him of legal obligation to deplete estate by making payments that would not be subject to gift or estate tax.
Ex: B owes L 10k. B transfers property with 10k to L on condition that L surrender claim againt B. No net gift then. BUT surrender of right or claim against transferor fails to be consideration when satisfaction by transferor would be subject to the estate and gift tax; i.e. an IV transfer in exchange for surrender by transferee of right to dower, curtesy, elective share, or other inheritance right
Sham aka intra-family loans IRS can argue that the repayment obligation, though valid in form, lacks economic substance/is a
sham. Courts disagree about looking at intent:
Rev. Ruling 77-299 and donative intent (but really intent to forgive notes relates to whether valuable consideration was received) Facts: sale of the property to grandchild in return for installment notes that would be payable
in yearly amounts equal to the annual tax exclusion. BUT grandfather was then going to forgive each payment as it became due.
“It should be noted that the intent to forgive notes is to be distinguished from donative intent, which is not relevant.” T.C. and Service disagree truth is there is economic substance here. If gp died the gc would have to pay. But looked at fact that notes bore no interest.
Valuation date: gift on transfer of real preprty bc notes weren’t consideration. But see Haygood v. Comm’r—intent is irrelevant; value of notes = to value of property
transferred. Consideration is to be determined by objective facts; donative intent is not controlling. Note however, that the consideration should be bona fide; not in return for unsecured promise
to pay an annuity if donee couldn’t pay and was terminable ill.
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The parent’s contention that no gift occurs on the original sale because the child’s note constitutes consideration, or on the forgiveness of each annual installment because the transfer falls within the annual exclusion, has prevailed in several cases (see Haygood). However, the IRS could treat a purported installment sale as a disguised gift where the donor intends to forgive the notes as part of a prearranged plan so make it look good. To avoid the IRS’s recharacterization, the child should put money down when he
purchases property from the parent so that the transaction looks more like a bona fide business transaction
Installment gift is aborted mid-stream if donor dies before ayments become due. Might want to include in will a provision that forgives any balance due on the notes upon his death. Notes will be included in donor’s gross estate because theyw ere woned by decedent at death, thought. Or could add provision in the installment notes that the obligations will be void upon seller’s death prior to maturity. (self-cancelling instalment note0. Wont be in gross estate because asset ceases to have any value. For gift tax purposes, SCIN would have to be discoundted or periodic payments would need to be adjusted upward.
Below-market demand / No-interest loans Loans that are repaid but no interest was charged on them. The use of interest-free money can be very
valuable. Again, courts and IRS disagree
Courts: Johnson v. US (N.D. Tex 1966)- no gift on foregone interest because parents under no duty to lend or otherwise invest their money. They had a right to keep it in cash. And Crown v Comm’r (7th Cir. 1978)- no gift even thogh parent made over 18M in interest-free loans to family trusts
IRS: Rev. Rul. 73-61 says interest-free loans are subject to gift tax because the “right to use property…is an interest in property, the transfer of which is a gift within the purview of 2501.”
Below-market Demand loan: (i.e., one that lender could recall at any time) Promissory note: always a god idea to have a promissory note to: Evidence that the loan exists. Moreover from a tax perspective, if the loan is not evidenced by a
writing, it is assumed to be an interest-free demand loan In Dickman v. Commissioner, supreme court said transfer is not the property itself but the interest in
property- ie. right to use the property. The taxpayer loaned substantial sums of money to their son. The loans were evidenced by demand notes bearing no interest. Gift. Holding: The Court concluded that the interest-free loan of funds was a “transfer of property by
gift”—even though the loan was payable on demand—and that the amount of the gift was the interest that was not charged by the taxpayer for the use of the money lent. In reaching this conclusion, the Court analogized interest-free loans to the rent-free use of money: In both cases, the donor grants the use of valuable property.
The taxpayer makes two arguments, which the Court rejects: Transferor Could Have Wasted Money. The taxpayer argues that an interest-free loan should
not be made subject to the gift tax simply because of the possibility that the money might have enhanced the transferor’s taxable income or gross estate had the loan never been made. The Court responds that a taxable event occurs simply because the taxpayer transferred the use of the money to someone else; that the transferor himself could have consumed or wasted the use value of that money is irrelevant.
De Minimis Gifts. The taxpayer argues that, carried to its logical extreme, this rationale would elevate to the status of taxable gifts such commonplace transactions as the loan of a cup of sugar to a neighbor or a loan of lunch money to a colleague. The Court responds that exclusions (e.g., annual exclusion), exceptions, and credits (e.g., unified credit) clearly absorb these sorts of de minimis gifts
7872: After the Dickman case was decided, Congress enacted §7872 to regulate the income and gift tax treatment of below-market interest rate loans (including interest-free loans).
Note: Undermining Estate and Income Tax. The Court feared that failure to impose the gift tax on interest-free loans would seriously undermine the estate and income tax. First, in the case of no-interest loans from a parent to a child, any income generated from investment of the loan proceeds
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(e.g., rent, interest, or dividends) would be attributed to the child and taxed at the child’s (probably lower) marginal income tax rate. This income tax avoidance technique is called income shifting. Second, any income generated from investment of the loan proceeds would be excluded from the parent’s estate upon death; parent could therefore avoid future estate tax liability on these earnings
Administrability probs. What about transactions where parents let their kids use vacation homes/ cars/ things that are not cash- are those gifts? No. Administrability problems. As seen in contention of dissent. Not uncommon for parents to provide children with things like car or vacation houses simply on basis of family purposes. So majority punts--says IRS will NEVER do this but we'll deal with this when we have to. And dissent says the court aware for potential for abuse assumes IRS will exercise power conferred on it reasonably. Not much comfort. Should reach all transfers. So technically under Dickman, do have to pay tax on those transfers.
Note: re: Loans and forgiveness of debt No gift on loan: because debtor has a legal obligation to repay. Interest free loans
Amount of the foregone interest is a gift. (7872). This § imputes a transfer between the lender and the borrower on the last day of the calendar year (7872a) thus gift is complete on Dec. 31.
Forgiveness of debt: Complete on date transferred bc received no consideration Whether particular transaction will be gift only on each year that payments are forgiven or at the
time of the loan will depend on some important factors The transferor’s expressed intent not to collect on the loan Whether there are negotiations or even discussion of the terms of the deal between the parties Whether or not interest is charged and at what rate Whether or not promissory notes are signed Whether or not there are actual payments made Whether the lender has a security interest Whether the debtor has the ability to pay the lender’s (seller’s) health and expectation of repayment what records, if any, are kept by the lender.
Trustee gift when you have beneficial interest (25-2511-1(g)(1)&(2)) Note: A transfer by a trustee of trust property in which she has no beneficial interest does not
constitute a gift by the trustee. But might constitute gift if you are a beneficiary. Ex: D creates a trust naming E as trustee, income
to E for life, with him having power to pay corpus to F in his own discretion, remainder to F. If he invades corpus for F’s benefit, he makes a reduction of his own income interest and it’s a gift because giving up something he has right to...diminishing his own income for no consideration.
Not a gift if subject to ascertainable standards.
3. Is the gift complete? so that it is taxable under 2501? A gift is generally complete at the time of transfer, with an exception for certain property including joint bank
accounts and property that needs to have a recorded title. In general: A gift is not taxed until it’s complete “as to any property, or part thereof or interest therein, of
which the donor has parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or the benefit of another...” 25-2511-2(b) Not every donative transfer results in a gift at the time the transfer is made. Timing can be delayed until
the gift becomes complete. During donor’s lifetime: There is no gift unless the transfer by the donor is completed during the donor’s
lifetime. Incomplete transfers are those where the transferor retained sufficient powers over the transferred property ownership to preclude the gift being considered final for gift tax purposes.
Rationale: you are still exercising control over it, so you haven’t really given it away. Note the symmetry- not taxed under gift tax, but is under estate tax.
Incomplete gifts in general : Under Reg. §25.2511-2, a gift of property, whether in trust or otherwise, is incomplete to the extent that the donor reserves power to change its disposition, whether for his own benefit or the benefit of another. A grantor has dominion and control over the gift when she retains the power to designate beneficiaries even if she exercises that power in conjunction with another person who does not have
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substantial and adverse interest in the trust. When the grantor retains dominion and control, the gift is incomplete under Treas. Reg. 25.2511-2(b),(c), and (e). In general:
When completed: Under Reg. §25.2511-2(f), the relinquishment or termination of a power to change the beneficiaries of transferred property, occurring otherwise than by the death of the donor, is regarded as the event that completes the gift and causes the gift tax to apply- value is property that day the power is terminated or relinquished. Of course, if the donor retains the power until death, the trust property will be includable in his gross estate under §2036(a)(2) and 2038. Income distributions: If the donor retains a power to change beneficial interests, the initial
transfer to the trust is not a completed gift, but subsequent distributions to benes (other than the donor obviously) are completed gifts that are subject to the gift tax as the distributions occur (Reg. §25.2511-2(f)).
Separately evaluate: Evaluate each interest separately because some parts may be a completed gift. Ex: J creates IV irrev. trust and transferred 5M to FNB as trustee to pay income to L for life. At
L’s death, trustee is to distribute property to L’s children. J reserved power to add or change remainder benes, other than self. Answer: Income interest to L is a complete gift. J has given up dominion and control. Remainder, however is not a completed gift. Has control over the property despite that he cannot become a remainder beneficiary and despite that it is irrevocable.
Note: If gift becomes complete because of or at the donor's death, the transfer cannot be subject to gift tax because GT can only apply to a gift that becomes complete during donor's lifetime but it will be included in gross estate for estate tax purpose under one or more of 2036-38. Thus, a retained-power transfer can only delay, not avoid, federal transfer tax.
Note: donors usually disfavor incomplete gifts and prefer to gift property currently so that any appreciation in the value of the property will occur in the hands of the donee and escape gift taxation
Incomplete- Retained powers: Following are retained powers that make gift incomplete: Retained power to revoke the transfer
Because would have power over disposition, A transfer that is subject to revocation by the donor becomes complete only when the donor’s power to
revoke is relinquished or otherwise terminates. (once that power is released then transfer is complete). Revocable trusts- not a gift at time of creation (Will be completed when grantor released power of
revocation. 25.2511-2(f). Rationale:
dovetails with 2038 of estate tax which says that a transfer that was revocable by the grantor at the moment just prior to his death is includable in his gross estate
Otherwise, people wouldn’t make trusts because taxed even if never reaches the beneficiary or the settlor takes it all back. (25-2511-2(c).
Retained power to name new beneficiaries or change interests of the beneficiaries as between themselves (unless per ascertainable standard); (i.e. not just administrative powers). In general: Gift is incomplete not just when the donor can revoke it but any time the donor can change
the beneficial ownership 25.2511-2(c). Under Reg. §25.2511-2(c), a gift in trust generally is incomplete to the extent that a grantor reserves the power either to (1) name new beneficiaries or (2) change the interests of the beneficiaries as between themselves I.e. if the donor can amend the provisions or the trust or alter the beneficial enjoyment of the trust.
Exceptions: A retained power to vary the beneficial interests of others does not prevent the transfer from being complete for gift tax purposes if the power is: (1) one that affects only the “manner or time” of enjoyment; (2) a power exercisable only with the consent of a person having a “substantial adverse interest”; or (3) a fiduciary power limited by a “fixed or ascertainable standard” enforceable by the beneficiaries Exception 1: Manner or Time of Enjoyment. Under 25.2511-2(d) a gift is not considered
incomplete if the donor reserves the power merely to change the manner or time of enjoyment. Ex: J created IV, irrevocable trust and transferred 1M to Friendly bank as trustee to pay
income to M for his life and remainder to L J retained power to terminate the trust. At termination, trust property would be distributed to Luke. Income interest is incomplete. Remainder interest is complete because if she terminates the trust, the property will be
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distributed to L, will become a fee simple interest. Completed gift The ability to alter the time or manner of enjoyment of the property does not make the gift incomplete. 25.2511-2(d).
Ex an irrevocable trust continues for a period of 20 years, at which time the principal is paid to the beneficiary, and the donor reserves the power either to distribute the trust income annually or to accumulate the income (and distribute it to the beneficiary at the end of the trust period), the gift is complete at creation of the trust. Because the beneficiary ultimately receives the income from the trust property, the power retained by the donor relates only to the time and manner that the income is received. Completed gift.
Ex D transfers property in trust, naming herself as trustee. Income is payable to A while D lives, remainder to A upon D’s death. As trustee, D retains discretion to accumulate A’s income and add it to trust corpus. Complete. Just about when A get it but she will get it. (and e(ii) above).
Exception 2: Substantial Adverse Interest . Under 25.2511-2(e): “A donor is considered as himself having a power if it is exercisable in him in conjunction with any person not having substantial adverse interest in the disposition of the transferred property or the income therefrom.” Note: Interest is monetary (not sentimental) To the extent that the other person has a “substantial adverse interest” in the disposition of the
trust property or the income from the trust, the gift is complete. Because the person with the adverse interest generally will not acquiesce in any exercise of the power to revoke, alter or amend the transfer, the donor is considered as having relinquished dominion and control over the property transferred. (25.2511-2(e). On the other hand, if the other person does not have a “substantial adverse interest” in the
disposition of the trust property or the income from the trust, the gift is incomplete to the same extent as if the power were exercisable by the donor alone, without the consent of any other person (Reg. §25.2511-2(c)-(e)). The notion is that, if the other person has no reason not to acquiesce in the donor’s exercise of a reserved power, the power, in effect, is reserved in the donor alone
Ex: Thelma creates irrevocable IV trust nd transfers 1M to Friendly bank as trustee to pay income to sister Sue for life and remainder to niece, Nell. Thelma reserves right to add new income beneficiaries with Sue’s consent. Sue’s interest in the trust is both substantial and adverse to exercise of Thelma’s transfer so the gift of the income is complete. Remainder is complete because no power to change beneficiaries. But if Thelma reserved right to add new remainder beneficiaries with Sue then remainder is not complete because Sue doesn’t have any interest, let alone an adverse one
In Camp v. Commissioner: (not codified by 25.2511-2(e) the taxpayer executed a trust in 1932 with income payable to his W during her life, remainder to surviving issue or if none, to X. The trust instrument provided that the taxpayer could, in conjunction with X, revoke, alter or amend the trust. In 1937, the taxpayer, in conjunction w/ X amended the trust to substitute his wife as the sole co-powerholder capable of revoking, altering or amending the trust. TP said transfer was completed in ’32 (no gift tax then). Tax court said 37 and he owed gift tax.
Note: Adverse to Less Than All Interests. If a co-powerholder is adverse as to less than all interests in the property or trust, the transfer is a completed gift only to the extent of the co-powerholder’s adverse interest (see Camp v. Commissioner).
Rationale: no longer in control because must obtain consent of someone with adverse interest Exception #3: Fixed or Ascertainable Standard.
Under Reg. §25.2511-2(c),(g), 1(g)(2), a transfer involving a retained power to change the interest of the beneficiaries as between themselves is nonetheless a complete gift if to the extent that the power is a "fiduciary power ... limited by a fixed or ascertainable standard ... ." An ascertainable standard for distributions is articulated in terms of the beneficiary's
health, education, support, or maintenance. -1(g)(2). 25-2511-1(g)(2) discusses what standards are fixed or ascertainable: An ascertainable standard is one that is clearly measureable and on under which the holder is legally accountable.
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Yes: HEMS: education; support, maintenance or heath; for his reasonable support and comfort; to enable him to maintain his accustomed standard of living; or to meet an emergency. 25.2511-2(g)(2)
J transfers property in trust, with income to be paid to B for life, remainder to C, subject to J's power as trustee to distribute principal for the HEMS of B after considering all other income and assets available to B, the gift is complete and the entire value of the trust assets will be subject to the gift tax at the time the trust is created. Even though J has the power, as trustee, to invade the principal for the benefit of B, and therefore has the power to reduce C's remainder interest, J is deemed to have relinquished sufficient dominion and control over the transferred property. J does not have unlimited discretion to exercise the power. To the contrary, J's power is limited by an ascertainable standard relating to B's health, education, support, or maintenance
D creates IV irrev. trust and is trustee. Trustee must distribute income equally to kids. Discretion also to distribute principal to any kid for health, education, maintenance or support. Both income and principle are completed gifts.
Rationale: donor has given up control over the trust property bc the beneficiary can sue for distribution of trust property, and the court will enforce the standard.
Just a fiduciary duty (act in good faith) is not enough to insulate from gift tax. Retained interests: powers held by others:
If the donor has the power to replace the trustee at any time for any reason and appoint herself as trustee, she will be deemed to have the trustee’s powers. If the trustee has any discretion over distributions that is not limited by an ascertainable standard, the donor will be deemed to have those powers. This is true even if the donor has not exercised the power to replace the trustee (Reg. 20.2038-1(a)(3); Estate of Wall v. Commissioner). If the donor’s power is limited to replacing one corporate trustee with another corporate trutee or to appointing only a trustee that is neither related nor subordinate to the donor, then the trustee’s power will not be imputed to the donor (Rev. ruling 95-58). Ex: Jamal creates IV irrev trust with Friendly bank as trustee. Trustee has sole and absolute
discretion to distribute trst property among Jama’s children or to accumulate it. Also has dirscretion to distribute trust property to any of Jamal’s children for their comfort and happiness. If Jamal retains the power to relace Friendly as trustee and become trustee himself, gifts of the income and the remainder will be incomplete. Even though Jamal is not serving as trustee, powers will be imputed on him But if Jamal can only replace Friendly with another corporate trustee, as long as new trustee is
neigher related nor subordinate to Jamal, the gifts will be complete. Retained interest- power to benefit donor:
A donor can create a trust for her own benefit. If the trustee’s power to distribute income was limited by an ascertainable standard, then the gift would be incomplete (25.2511-2(b). Jenny creates IV irrev trust with Friendly as trustee. Trustee has sole discretion whether to
distribute trust income to Jenny or accumulate it. At Jenny’s death, trust proepty will be distributed to Jenny’s issue in whatever shares the trustee deems equitable As long as Jenny cant replace the trustee with herself or a related or subordinate party, the transfer will be complete because Jenny has given up all dominion or control over the preprty. Of course, the income interest is not a gift because it is for Jenny’s own benefit.
the donor could force the trustee to distribute pursuant to a standard as a result the donor would be able to control who received the property. Page 99 of Willbanks.
Miscellaneous completions Joint bank accounts:
creation is a revocable transfer because either joint owner can withdraw the entire amount on deposit. Not a completed gift until the funds are withdrawn.
(25-2511-1(h)(4)); Under Reg. §25.2511-1(h)(4), a joint account belongs to the parties, during their joint lifetime, in proportion to their respective net contributions. Accordingly, if A uses her own funds to create a joint account for herself and B, there is no completed gift to B until B draws on the account
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for his own benefit. Completion occurs when no dominion or control- i.e. when withdrawn….not when the account is set up.
Joint tenancies and tenancies in common: is it a gift when put kid’s name on deed? 25.2511-1(h)(5)- yes of ½ amount completed gift when title passes.
Prenups: marital rights are not consideration so transfer of property pursuant to a prenup is a gift. (Merrill v.
Fahs). Completed, probably, on date of marriage (but who cares because qualifies for unlimited marital deduction 2523).
Checks: Gift by check is complete when check is paid, certify, accepted by drawee bank, or negotiated for
value to a third person. Problem arises when talking about tax year because maybe check is written year end but paid next
year...so may be a difference in annual exclusions. ex: check written 12/25 then taxpayer dies on Jan 5 and the check is negotiated or paid on Jan 6 then the property is still considered property of the TP's estate. Metzger....dont need to look at it. Said as long as decedent still alive then we'll loko back to when checks are written. Unconditionally delivered and promptly paid will relate back to when written. Under the “relation back” doctrine, however, a gift is deemed complete on the date the check was
either delivered to or deposited by the donee in the donee’s account. The court in Metzger’s Estate v. Commissioner held that “where noncharitable gifts are deposited at the end of December and presented for payment shortly after their delivery but are not honored by the drawee bank until after the New Year’s holiday,…the gifts should relate back to the date of deposit” (see also Rev. Rul. 96-56)
Requirements from Rev-ruling 96-56: The check was deposited, cashed or presented in the calendar year for which completion is
sought and within a reasonable time of issuances The donor intended to make a gift The delivery of the check was unconditional The donor was alive when the check was paid by the drawee bank; and The check was paid y the drawee bank when it was first presented for payment.
Promises Not a gift until pay: "I promise you 1k when you graduate" Contract: if you contract with son to pay 25k if he quite smoking before age 21, then gift is complete
when son turned 21 and could sue Dad to enforce contract if he doen’t pay when son is 23. Promissory Notes. In general, the gratuitous promise to pay someone’s obligation in the future is not
a completed gift of property. Rather, the promise becomes a completed gift when the promisor actually makes a payment in satisfaction of that obligation
Subsection to is there a gift: what is its value? In general: Valuation of Gift. Reg. §25. 2512-1 provides that, if a gift is made in property, its value at the
date of gift shall be considered the amount of the gift. Reg. §25.2512-1 and 2031-1(b) defines “value” as the price at which the property would change hands between a willing buyer and a willing seller, both having reasonable knowledge of the relevant facts and neither being under a compulsion to sell. 25.2512-1: Price is that in the market where the public usually obtains this item, which in most cases
would be the retail market, taking into consideration the location. O’Keefe: “it is necessary to examine the history of the market for O’Keefe works, the prospects
for the market for O’Keefe works as of the date of death, the types of works to be valued, and the art market in the US.”
20-2031-1(b) states that FMV is established in market in which item is most commonly sold to the public, taking into account the location. Valuation is extremely fact specific; factors may be relevant: Similar sales; Other bids/offers; Present valuation of estimated future net yield; Expert appraisals;
Replacement costs Look at regs for particulars re: stocks and businesses, 2512-5T for interests for life or term of years or
remainder or reversionary interest.16
1) Valuation of remainder: (727)a. Non-family, use actuarial tables; depends on D's age, term of interest and applicable
interest rate IRC 7520 (gives an assumed rate of growth) (IRC 720 gives assumed rate of growth).
b. For family, IRC 2704(c)(2) – more suspiciousi. Value of the gift is the value of the property transferred less the value of the
donor’s retained interest as determined under 2702. ii. D or any applicable family member (IRC 2701(e)(2)) "retains an interest."
iii. Remainder interest = zero (unless qualified); If qualified, “value is determined under 7520—qualified means 2702(b) [an annuity interest; a unitrust interest; any noncontingent remainder interest if all other interests are annuity or unitrust; personal residence trust]. If is famliy, gift value- entire amount (D's retained interest=0) unless retained interest is qualified. So gift tax would be full value of trust even though Ann doesn't get anything right now
c. Ex.1: D establishes an irrevocable IV trust with FNB as trustee to pay the income to himself for life. At D’s death, FNB is to distribute property to daughter Sally and, if she predeceases to her issue. What result when D funds the trust? IRC 2702 applies. If income interest is not qualified (e.g. annuity or unitrust), valued at 0. So full value of trust considered a completed gift to Sally (even though no guarantee when she will receive).
d. What result when Daniel dies? Full value of trust as of d.o.d. included in his estate pursuant to 2036(a)(1) because he had the right to income for his life.
e. Ex.2: On October 19, 2010, X transfers 1M to T as trustee to pay so much income and or principal to X as T shall determine in the exercise of sole and absolute discretion. Upon X’s death, T shall distribute all fo the trust property to X’s sister. X’s retained interest (lifetime income) is valued at 0 becaue it is not a qualified interest with meaning of IRC 2702(b). Tf, X is deemed to have transferred 1M to her sister on Oct. 19, even though sister will not likely receive property for a long time.
2512-1 and 20-2031 : particulars of valuation If it’s stock and during the day traded at a high of 100 and a low of 98 the value of the gift is 99. Stock
is mean price on date of transfer Discounts (for all these, burden of proof is on TP: In general, bc assets are not in fact sold on valuation
date it is difficult to est. value unless the asset is sold in the public marketplace; even this presents difficulties because transfer restrictions or size of the property interest will also affect valuation. The law will allow a discount or require a premium on the valuation of these kinds of assets. Lack-of-marketability discount –
20-2031-1(b) states that FMV is established in market in which item is most commonly sold to the public, taking into account the location of the item. (25-2512-1 also). If the market is restricted to a limited group (like the donor’s or decedent’s immediate family members) the value fo the asset will undoubtedly be less than if there were no such restriction.
closely held business interests can claim these where value of the enterprise is initially valued by way of comparison with publicly traded enterprises, bc interests in those benefit from a liquidity premium, which is reflected in higher stock-market prices
Can also be taken if the value of the enterprise is initially computed by adding up the value of the constituent asset of the entity.
Blockage discount for stocks (25.2512-2(3)) The size or amount of property that is subject of gift or in the decedent’s estate can affect its
value. Assume the decedent owns 10k shares of stock. If all those shares were offered for sale at one time, price would decerease because the spply would exceed demand. Regulations acknowledge this and note that in such a case, the price might be that which an underwriter could obtain rather than a sale on the open market (20-2031-2(e); 25-2512-2(e).
If the donor can show that the block of stock to be valued, with reference to each separate gift, is so large in relation to the actual sales on the existing market that it could not be liquidated within a reasonable time without depressing the market, the price at which the block could be
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sold as such outside the usual market, as though an underwriter, may be a more accurate indiction of value than market quotations.
Has also been applied in cases involving estates of prominent artists (O’Keefe) . In the gift tax, the blockage rule is applied to each separate gift. (2be) so what happens if in small company and amount of stock will skew the price? Blockage
discount--not mean price. Would look for expert to value, not FMV. And have to look at each separate gift- give 200k shares of stock and co only has 1M
shares that will totally skew value but if give each person 10k then don’t need blockage discount because wont skew market
O’Keefe: Owned about 400 paintings at death worth 72M each. Ct noted that if all or substantial portion were offered at ne time, it would depress market price for each item. “the fmv of the aggregate of the works in the estate, therefore, as of the date of death, was substantially less than the total of the FMV of each individual work.” After reviewing history of her market, prospects as of DoD and types of works to be valued and art market, ct said ½ the value of the art would be discounted by 75% and other 1/2 by 25%. One acre of and in a particular location is selling for 10k an acre. Dad owns 500 acres
of land there so worth 5M? Probs not. Even if each acre was identical, highly unlikely that buyer would pay that. Price would be less, reflecting that if 500 separate parcels, each one acre in size were offered for sale on the same day, the supply would exceed the demand despite the price.
Stock is thinly traded and usually only 20k shares are traded daily on exchange. Here, transferring 200k. Broker advised trustee that any attempt to sell them all would depress price to about 7/share (trading between $9 and $11).
Minority interest discount- if giving away controlling interest in company will be worth more than if give away minority interest. Concept: based in notion that a minority interest in a closely-held business entails downside
risks that would cause a willing buyer to bid less for this interest than an amount based on the pro rata share of this enterprise represented by the interest. Applied to fractional interests in real estate too.
Ex: Rev Ruling 93-12: Facts: P owned stock at X corp. Transferred all his shares making simultaneous gifts of
20% to his 5 children. Issue: If donor transfers shares in co to children, is factor of corporate control in the fam to
be considered in valuing the transferred interest? each of 5 ids gets 20 shares of stocks so value of 100 is a million but value of any 1/5 is much less because non-controlling share
Here, 25.2512-2(a) tells us the value of stocks and bonds is the FMV per share or bond on the date of the gift. 25.2512-2(f) provides that the degree of control of the business represented by the bloc of stock to be valued I among the factors to be considered when valuing stock where there are no sales prices or bona fide bid or asked prices. When corporation with single class of stock, notwithstanding the family relationship
of the donor, the done and other Ss, the sare of other family members will not be aggregated with the transferred shares to determine whether transferred shares should be valued as part of controlling interest. Minority interests to 5 ids should be valued for gift tax purposes without regard to the family relationship of the parties. i.e., No family aggregation even if all relate. Look at each separate gift.
Ex: D wants to transfer wholly owned company to daughter. Currently D owns all 100 shares of stock in the company. FMV=1M. Stock therefore has FMV of 10l/share. D’s atty advised her that she can reduce transfer taxes by making gifts of 20 shares to B for next 3 years. D wil then bequeath remaining 40 in will. Appraiser said stock valued at 6k per share. Why? MINORITY DISCOUNT! beware IRS says that this a step transaction...breaking down 1
transactions into steps and we should look at whole thing together. if separating gifts by year probs ok but not if by as week...fact based analysis. Also want to avoid transferring the prop at minority interest to person or entity that you still control
Will the fact that child owns 60% of the corporation’s stock at D’s death prevent the estate from claiming a minority discount at that time?
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Yes, can still get minority discount as long as not step, look at different transactions differently. 40% isnt a controlling interest
Ex: instead of transferring 200k, D transferred each of her 100 family’s 2 shares of the stock. Assume same values and that broker advised that sale of 2k would not depress stock value. What value should be used here? we can't aggregate what a donor gives out...revenue ruling from reading--if give out a
bunch of differet distributions then cannot aggregate. so would be 9 no blockage discount look at all gifts separately
Transfers for partial consideration Off-set rule
“net gift” transaction- gift is made on condition that the done pay any gift tax due. Since the donor is legally liable for the gift tax under 2502(c) and the payment of it would not itself be a gift, the assumption by the done of it is an economic benefit in money’s worth to the donor.
most common example is a property subject to a mortgage- Donor transfers property worth 100k to done and done assumes a mortgage that is 65k. Net gift of 35k.
4. Is there an exemption, exclusion or deduction? Assuming the gift was complete, the final question is whether there are any deductions or exclusions available
to relieve some of the gift tax due. 2503(e):Contributions to a 529 plan. Qualified educational and medical expenses (2503(e), §529(c)(5),
Note can preload on 529 up to 5 years. Qualified transfers of tuition/ medical payments
In general: Under 2503(e), the gift tax does not apply to qualified transfers, which is any amount paid on behalf of an individual (whether or not a family member) as payment of another’s tuition (directly to educational organization) and medical bills (paid directly to providers for medical care/ insurance. Note: don’t have to be related to the person Irrelevant in case of minor children because legally obligated to pay for their edu/med expenses
Reason- Planning technique: See also nonbinding PLR 200602002—can remove tax-free large portion of assets by prepaying multiple years to tuition. Risk: might drop out, move away, etc. Tuition payments cannot be refunded and are forfeited if the grandchildren do not attend that particular school.
Only transfers paid directly to providers qualify (not excl if reimburse person or ask them to pay) Tuition paid to educational organization
Does not include room and board, books, dorm fees supplies, or expenses that are not direct tuition costs (Reg. 25-2503-6(b)(2)).
Educational organization must be one that maintains a regular faculty and curriculum and has a regularly enrolled group of students in attendance at the place where educational activities are regularly carried on, Id.
Not limited to degree candidates or by educational level and it covers part time study. Medical expenses and insurance premiums (213(e) defines)
Includes payments for diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primariy for and essential to medical care or for medical insurance premiums. (reg 25-2503-6(b)(3)). Does not apply to amounts paid for by insurance that are reimbursed by donee’s insurance. Id.
Rationale: Administrability. Many who paid for these tings for kids and grandkids had no idea that gift tax was involved- rescued a large class from being tax-evaders.
Ex: Cannot transfer money into a trust and say it must be used for tuitions. (25.2503-5(c) #2). Annual exclusion 2503(b) [and remember gift splitting 2513] 122 of CB has old rates. In general: Allows
10,000 per person per year, adjusted for inflation. Currently allows 13k of gifts made to each person per year not to b included in the total gifts for the yr. (or 26,000 in the case of split gifts by married couples). Any gift in excess of this amount is applied against the unified credit’s applicable exclusion amount, if any. Ex: Gordon stood at street corner and handed out 5 envelopes of 13k each, she would not have to file gift
tax return--to as many different people every year as you want. Remember: no getting around it like Heyen (indirect transfer where making gifts to large number of
individuals who then give back to family members of the donor) or reciprocal gifts (Grace- give to my 2 kids and your 2 kids and you do same.
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Use: So if want to reduce estate, then make gifts to whoever want to benefit OR pay medical or education or give a fractional interest in house but have to get valuation
Rationale: administrability- The function of the annual exclusion is to obviate the necessity of keeping an account of and reporting numerous small gifts and, on the other hand, to fix the amount sufficiently large to cover occasional gifts of relatively small amounts (e.g., wedding and Christmas gifts).
Remember Gift splitting election. 2513: A gift made by one spouse to any person other than his spouse shall be considered as made ½ by him and ½ by spouse.
So 2 steps here: 1. H and W can be presumed to split and then 2. They can each use their annual exclusion amounts to cover it. Example: In 2004, Wife makes following gifts: 50k to son; 50k to friend; 15k to neighbor=115k Take out 26k (her and her husband’s annual exclusion) for each gift, so 24, 24,0=48 Assume that is given ½ by spouse, so wife only has made 24k of taxable gifts.
Requirements: Both spouses must be citizens of the US Donor must not give spouse a general power of appointment over the property And donor must be married to spouse at time of gift and not remarry during calendar year Can only include gifts of present interest-not future interest! [note: must be elected by filing a gift return signed by both spouses- i.e., must signify consent on
tax return.] This was to avoid geographical discrimination-so decided to confer benefits on transactions not
involving community property in an attempt to create parity between community property and common law property states.
Note: doesn’t double the total benefit; together the couple can only qualify for 26k to one individual, H can’t give 26k to child and W gives 26kto child an they both claim that the 52k is sheltered.
Exam strategy: If the gift is not in trust look for any restrictions imposed on ability to transfer the asset. If the gift is in trust, only the income interest will qualify as present. Remember there must be mandatory payments of income; income producing property; and no restrictions on distributions. If there are not mandatory payments of income, the beneficiary must have right to demand payment (crummy right).
Requirements: Such present interest much attach to a single identifiable done
Note, in Helvering, SC said that beneficiary and not the trust was the donee. So each interest must be examined to determine if there is a present interest.
Present interest requirement to annual exclusion 25.2503-3(b) To qualify for the annual exclusion, there must be a present interest in the gift. 25.2503-3(a) says no
part of the value of a gift of a future interest may be excluded in determining the total amounts of gifts made during the ‘calendar period.’” The gift will qualify as a present interest if the transferee has an unrestricted right to the immediate use, possession, or enjoyment of the property or income from the property (such as a life estate or term certain) 25.2503-3(b). Future interests are not excludable. Future interests includes reversions, remainders and other
interests or estates, whether vested or contingent, and whether or not supported by a particular interest or estate which are limited to commence in use, possession or enjoyment at some future date or time. 25.2503-3(a).
Ex: A for 20 yearsto B until his death to C. B and C don’t have present interests. The exclusion under 2503(b) is only available to the extent of the value of a present interest transferred
to an identifiable done. To qualify as a present interest, the transferee must have an unrestricted right to the immediate use,
possession, or enjoyment of the property or the income from property." (25.2503(b); Maryland Nat’l Bank For trust interest, have to use each separately. The §2503(b) annual exclusion is not allowed for a gift of a future interest in property. Rather, the entire value of any future interest gift is a taxable gift for the year in which the gift is made (to the extent the gift exceeds the applicable exclusion amount).
Ex of present interest: cash or property in fee simple qualify
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-3(c) Ex. 6: L pays premiums on a policy of insurance on his lie, all incidents of pwnerhsip in the policy (including right to surrender the policy) are vested in M. I.e. even gifts that delay financial benefit might qualify it it’s the nature of the property rather
Transfers to minors- see below (2503(c)). Spendthrift provisions: prevents bene from anticipating or assigning interest. 3(c) Ex 4: Net income to F for life w/ remainder to G on F’s death. Trustee has uncontrolled power
to pay over the corpus to F at any time. NO other person has right to income interest so it’s PI. Normal administrative powers don’t take present interest away. (just can’t delay).
Ex: T’ee is given the administrative power to invest all 100k trust corpus in wide range of permitted investments- fine. Doesn’t affect whether benes have present possessory interest
If trustee can change an income interest but it’s a change that affects only recipient then still present income gift. And if T’ee can change the income interest for someone else, then that makes the income interest not a present interest. In other words, if A creates a trust tht says income to B power to control corpus for B then B has a present interest.
Ex of future interest: Discretion to withhold payments: 25.2503-3(c) Ex. 1 -3(c) Ex 2. Transfer insurance policy on life into trust created for benefit of D and only upon C’s
death income to D. Uncontrolled trustee discretion: 3(c) Ex 3: net income to be distribted to 3 children in such
shares as trustee in uncontrolled discretion deems advisable. 3(c) Ex 5: corpus of trust created by J consists of prop subject to a mortgage. Trust terms provide
that net income is to be used to pay the mort. After mort. is paid in full, income will be paid to K. Ex: when there is a gift of income and a gift of the remainder – there will be an exclusion for the
present value of the interest income, but no exclusion for the remainder interest (and there will be no exclusion in the year that the remainderman gets the remainder
Income interest is only considered a present interest if the payments commence immediately About trustee’s power to invade corpus
2503(b)(1)- “The possibility that a present interest may be diminished by exercise of a power is of no consequence unless the interest will pass to someone other than the done (i.e., trustee can invade corpus for comfort and happiness of grandchild but income supposed to go to child—no go for present interest. Only argument is that if it’s an ascertainable standard, you could value it...needs to be clear that there will be substantial income distribution that can be valued (if facts make it uncertain that any income will be distributed then exclusion denied). But ok if child has the remainder interests and can invade for child’s comfort or happiness) If A creates trust income to B, power to invade corpus for B, B’s income interest is a
present interest If A creates trust income to B, power to invade corpus for C, B’s income interest is NOT a
present interest because makes the value of the income interest unascertainable. Note: if power is to invade half the corpus then B has a present interest with respect to
other half income interest Rationale. Administrability. It’s hard to evaluate future worth Breakdown of requirement:
Present Ascertainable Interests. If the grantor created a trust and the trustee was required to distribute all of the net income of
the trust to the beneficiaries each year, the gift would qualify as a present interest. The value of this income interest at the time of transfer could be determined using the IRS tables.
But if J transfers 100k to trust with bank as trustee. And C is to receive all income annually and D is to receive corpus at C’s death. And the trustee has the power to distribute principal to D at any time in any amt—no annual exclusion bc the present interest is not ascertainable.
Each such interest must be capable of valuation (i.e., must be definite value in order to calculate the annual exclusion. When value is nebulous or nonexistent, there is no exclusion available).
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Use actuarial tables supplied by treasury (7520) Interests subject to the exercise of discretion cannot be valued: Non-income producing property like unimproved real property or stock in a co that never
pays (and is unlikely to start paying) dividends is transferred into trust there will be no annual exclusion. (MD)
Property should produce income. Md. National Bank v. US [how to value income interests; when is exclusion denied? Trustee
administrative powers] Gift of non-income producing property, actually showed losses. Not present right bc
couldn’t compel. Even though the actuarial tables give a value for the income interest, there is nothing to the interest. Can’t use actuarial table if not actual value! “Tables are appropriate only when there is proof that some income will be received by the trust beneficiaries.” The major question is whether there’s a right to demand money presently, not at some future time.
Dissent: Compared to publicly traded corporate stock which confers present interest even though never paid dividends. Company was profitable and retained earnings for growth. (Rosen). Unlike Rosen, Willis’ partnership in MD was not profitable…consistently at a loss. Like Rosen because choice. Here, would be valuable if make multiple family residential dwelling but choosing to use as farm and family rental. Should use the actuarial tables….which index present rights to the FMV rather than their profit histories But see Berzon where same as Rozen but denied. Also GORDON: if re-invest
dividends, not a real right because history of no and no foreseeable opp in the future. Can't create it if no present right to it. Very fact-specific...can trustee not reinvest and makes those distributions out (rosen). If kids can compell trustees..
Hackl: the exclusion can be denied even for outright gifts of non-income producing property that the donee is prohibited from assigning. (timber) Gen: a gift must provide substantial present economic benefit to qualify as a present interest for the §2503(b) exclusion. The decision is particularly important for gifts involving interests in closely-held businesses. The case highlights the tension b/t desired valuation discounts for transfer tax purposes and the §2503(b) req that only present interest gifts qualify for the annual exclusion. To accomplish the desired valuation discounts, substantial restrictions are imposed on the interests transferred by gift because the restrictions enhance the discounts. These very same restrictions burden the interest that is received by the transferee, however, and in Hackl the IRS successfully asserted that the restrictions created future interests that negated the §2503(b) annual exclusion. Facts: The Hackl case involved a H and W who created an LLC, contributed property to
it, and transferred interests in trusts for their descendants. The LLC held timber prop and the H and W expected no current income from the LLC, but they expected eventual capital gain. The LLC operating agreement contained the following provisions: (1) The husband was manager and had discretion over distributions of available cash; and (2) a member could not transfer an interest in the LLC without the consent of the manager. Such a transfer without the consent of the manager would cause the transferee to be considered an assignee with no right to become a member or to participate in the business.
H was manager of LLC and had complete discretion over any distributions So even though kids got all income, partnership had discretion. court said not present interests- nothing compelling him to pay out to kids and any economic benefit the donees might obtain is not a present interest. So what would you do? Lifetime credit
Held. future interests. the §2503(b) present interest requirement means that the donee must receive a substantial present economic benefit under all the facts and circs of the case. In this case, the donees could not expect that any income from the LLC would flow to them because the operating agreement provided that all distributions were at the discretion of the manager. Moreover, the restrictions on the transferability of the shares meant that they were essentially without immediate value to the donees. Even if a member could violate the operating agreement and sell his shares to a transferee who would then not have any membership or voting rights, such a transfer “can hardly be called a substantial economic benefit.”
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Avoiding Hackl. set up a trust and make a gift to the trust each year = to the annual excl amt for each bene. The benes should be given an unrestricted right to withdraw their share of the annual additions to the corpus so that the contributions qualify as present interests under 2503(b) (Crummey). Assuming these benes do not withdraw prop from the trust, the trust can then buy the LLC interests from the grantor. Since the trust was created as a grantor trust, however, no gain or loss is recog on the sale of these LLC interests.
2503(c): About Present interest transfers for the benefit of a minor: Provides a special exclusion for gifts for the benefit of persons less than 21 that otherwise would be considered future interest gifts under 2503(b). If the statutory requirements are met, the entire value of property transferred will be considered a gift of a present interest that qualifies for the annual exclusion under §2503(b). Says: No part of a gift to someone under 21 shall be considered a gift of future interest if the prop
(1) may be expended by, or for the benefit of the donee before his attaining the age of 21 and will to the extent not so expended pass to the donee on his attaining 21 and if the donee dies before that, be payable to the estate of the donee or as he may appoint under a gpoa as defined in 2514 (note: 25.2503-4(b) says doesn’t matter if law says minor cant exer poa).
Gen: outright gifts may not be desired for fear of youthful and unfettered dissipation/mismgmt & minor lacks capacity to sell/otherwise deal w/ the prop. Sev options in ascending order of good:
Non-trust 2503(c) transfers to minors: Guardian: Parent transfer to legal guardian- this is present interest. But guardian must obtain
court approval and investment powers restricted. Custodial gift: To avoid guardianship problem, donors will make gifts pursuant to UTMA or
UGMA, which give custodian broad powers to deal with the gift prop w/o court supervision/ allows investment decisions to be governed by the prudent person rule. (outright transfer of cash, securities, life insurance policies or other eligible property to a minor, but prop is under control of custodian who may be donor or other party w/ legal capacity). UTMA: the donor, another adult individual, or a bank, w/ statutory authority to apply the prop
and the income therefrom for the minor’s benefit with a minimum of legal supervision. The unexpended income and principal are paid to the minor at age 18 (or the age of majority under state law). If the minor dies bf then, the payment is made to the minor’s estate. The IRS has ruled that gifts under these statutes are present interests eligible for the annual gift exclusion
UGMA: Parent transfers 13k to a custodian for kid under state UGMA that permits custodian to distribute income and principal for benefit of child while child is under 21; any remaining income and principal will pass to child when she’s 21 or to her estate if she dies before 21. Disadvantages: prop must be distributed to beneficiary at age of majority. If custodian
actually uses property for minor’s support, the parent will be taxed on the income from the property. If the donor is the custodian and dies before the minor reaches 21, the property will be in the donor’s gross estate under 2036 or 2038 because the custodian had broad powers to use the property for the minor’s benefit. If the custodian is not the donor but is the parent and dies before the minor reaches 21, in gross estate again. §2041 applies bc the custodian’s powers are equivalent of a general power of appointment. Because the parent is legally responsible for supporting the child, distributions benefit the parent. This is the same as a distribution to a creditor of the parent. Biggest disadvantage: if a parent is a custodian and dies before kid reaches age of majority- included in parent's estate, so if trying to get money out of estate with these annual exclusions, then doesn't work
Trust 2503(c) transfer: 2503(c) Trust: B/c of the disadvantages/ limitations of outright gifts or gifts to custodians or guardians,
most donors prefer to create a trust to benefit minors. Flexible. Trust instruments must strictly adhere to 2503(c) language Note: § 25.2503-4(b)(1): The governing instrument cannot place “substantial restrictions” on the
trustee’s discretion here. Exclusion is lost if the trustee’s discretion to expend for the benefit of the minor is subject to substantial restriction (25.2503-4(b)(1).
Transfer will not qualify where trustee required to consider minor's situation and resources before applying funds but trust for "support, care, education, comfort, and welfare" will pass muster because those standards impose no objective limitations on trustee's discretion.
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I.e. cant be substantial restrictions on trustee’s ability to use the property for the child’s benefit (can’t be only for illness or emergency- too restrictive). Can be ascertainable standard. NOT care, support, education and welfare. (69-345)
Note: a 2503(c) trust can be set up to avoid termination when the donee reaches age of majority if it gives the donee a right to demand the trust property at 21. The bene would have to be notified of right and given reasonable time to response. The donor
may think that conferring this right at 21 may cause undue risk. What if you don’t want property to be able to pass to child at 21?
Crummey [works for child or adult and need not be trust beneficiary] In general: Trust grantors often use trusts to transfer prop for the benefit of family, and it is not
uncommon for grantors to want the bene not to have outright ownership over the prop when the bene attains the age of 21 years (as required in a 2503(c) trust). Such a grantor faces a dilemma bc the grantor wants to protect the property from the possible indiscretions of the 21-year-old bene, but also wants the transfers in trust to qualify for the 2503(b) annual excl as a PI. This dilemma gave rise to the “Crummey” trust under which the property doesn’t need to pass to the donee at 21.
The Crummey trust, named after the Ninth Circuit decision in Crummey v. Commissioner, describes a trust the contributions to which qualify for the annual exclusion under §2503(b) bc the bene has an unrestricted right, exercisable annually, to withdraw from the trust an amount equal or lesser than 1) the amt transferred to the trust by the grantor during the year or 2) the max annual excl. The practical effect here is that benes are discouraged from exercising this power and rarely ever do, but the right brings the annual gifts to the trust under the PI req for the annual excl. The withdrawal right, which generally is limited to a specific period of time following a contribution to the trust (which is communicated by notice from the trustee), is referred to as a “Crummey” power. Bc a bene may obtain immediate enjoyment of trust property by exercise of the demand right, the bene has a PI in prop transferred in trust to the extent the prop is subject to the power—even if the donee doesn’t actually withdraw property from the trust. The donor tf is entitled to the §2503(b) annual exclusion with respect to contributions that are subject to such “Crummey” power For each beneficiary. So if 4 children then 52,000 will qualify.
Notice Provisions. Power holders much be given notice of their right to withdraw. They must also be given notice of contributions to the trust that trigger their right to withdraw. The notice req’s defined in the trust instrument must be strictly adhered to so that the bene will not be deemed to have a FI in prop transferred to the trust (i.e., fall outside scope of the “Crummey” trust). TF, it is generally prudent for the trust instrument to provide for notice to the trust beneficiaries within a reasonable time, in writing or orally, which gives the parties sufficient leeway.
Time to withdraw: Right to demand must be meaningful. Rev. Rul. 81-7 (where bene given no notice of additions to trust and had only 3 days to effect withdrawal—shows intent of the donor not to make a present-interest gift). 30 days is generally considered suff; in Cristofani ok at 15.
Then if the power is not exercised, the gift amts become part of the trust corpus and cease to be subject to the demand power. So 13k qualifies each yr bc the bene had the right to withdraw it.
Criticized for being illusory. Contingent beneficiaries can be given Crummey powers: Cristofani’s Estate: court allowed
annual excl for benes w/ Crummey withdrawal powers who were contingent beneficiaries in the remainder of a trust Facts: D created irrev trust for benefit of her 2 kids, who were to receive income from trust until D died then trust terminated and kids got property if they were still living. Trustee could distribute trust principal to children for HEMS. 5 grandkids were contingent benes. Both kids and grandkids given right to withdraw an amount = to annual excl w/i 15 days of a transfer by donor. IRS challenged validity of powers in grandkids but lost. Held. The Tax Court concluded that, bc the grandkids had the legal right to withdraw trust corpus w/i 15 days following any contribution, each grandkid had a present interest that qualified for the annual exclusion. The court held that Crummey does not require a vested present or remainder interest in trust corpus or income to qualify a demand right for the §2503(b) exclusion. The donor intended to benefit grandkids and there was no agreement that they would not exercise their powers of withdrawal Appointment to self or others in crummy: if the holder of the gen’l power transfers a prop
to someone else pursuant to that pwr, holder made a gift. 2514(b)
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Is this a present interest?? YES NO Outright gift of cash or property or simple income
interest in a trust Gift of interest in wholly discretionary trust or trust
where T’ee can accumulate income. Vested remainders because no right to “immediate
use, possession, and enjoyment of the property” Business:Gift of corporate stock- if the corporation is closely-held, might not pay dividends but this alone doesn’t prevent it from being a present interest.
If the stock is subject to transfer restrictions, recipient might not have immediate right to use, possess or enjoy it since she can’t sell, gift, or transfer it, then stock is not a PI and doesn’t qualify. (Rev. R 76-360).Gift to a corp. §25.2511-1(h)(1), a gift made to a co is gen treated as a gift to the individual SH, in proportion to their respective interests in the cor. However, since the SH’s enjoyment of this gift is dependent on the declaration of dividends or the liquidation of the co., the gift is a FI for which no exclusion is allowed
Gift to 2503(c) minority trust Transfer subject to Crummy withdrawal rightsGift of Bond, Note or Life Insurance Policy. Under Reg. §25.2503-3, an outright gift of a bond or note or LI policy qualifies even if the obligation bears no interest or bears interest payable only at maturity. Rationale recipient of these gifts can immediately sell the bond, note or LI policy to another party and “cash out.” Gift of promissory note Gift of partnership interest (usually) (Hackl) Not if interests are significantly restricted. Hackl
purpose of co was to hold/acquire land for long-term development and it would not make any distributions for a number of years. Also, recipients could not compel distributions or withdraw capital accounts without managerial consent or transfer interests freely.
Contribution to 529 plan
Deductions- transfers to charitable orgs and to spouses (2522, 2523)- taken after annual exclusion (2524) §2522(a) provides an unlimited deduction for transfers made for public, charitable and religious uses. §2523(a) grants an unlimited deduction for qualified gifts to a spouse.
Avoids double taxation to H and W so that H can bequeath everything to W, and it’s taxed on her death (tax at each generation).
However, this was undesireable in large states through 2009 bcause H’s exemption equivalent amount would have been wasted so in 2010, introduced portability where deceased souse can transfer his or her unused exemption equivalent to the SS.
Only for gifts that qualify under 2056 and 2523. Unified Credit..
Section 2505 provides a credit against the gift tax that allows a TP to a specific amount (exemption amount) during life before paying any gift tax
Exemption amount: $1M (in addition to the annual exclusions, transfers for spouses, charities and political orgs and for tuition and medical expenses)
Credit: $345,800 RESULT: few, if any TPs ever pay a gift tax! The exemption amount is coordinated with the unified
credit n the estate tax (§2010) so that the total amount transferred free of estate or gift tax cannot exceed the estate tax exemption amount
Estate Tax Basics Relation to gift tax: if a transfer of property is not a completed gift, incl. in gross estate. If it is a completed
gift, it will not be included in gross estate There are, however, some exceptions Basic Formula. The estate tax is imposed by §2001(a) on the taxable estate of every individual who at death
is a citizen or resident of the United States. [Note, Nonresident aliens are subject to estate tax only on property situated in the US (2101-08) A former US citizen or resident claiming nonres alien status who is subject to 877 is subject to US estate tax on worldwide net wealth if she is present in US for more than 30 days in year of
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death] “Taxable estate,” in turn, is defined under §2051 as the value of the gross estate less allowable deductions. The basic computation of the estate tax takes this form:
Gross Estate Deductions
Net Taxable Estate x Tax Rate
Tentative Estate Tax Credits
Estate Tax Gross Estate. Under §2031, the value of the gross estate of the decedent shall be determined by including to
the extent provided in this part, the value at the time of his death of all the property, real or personal, tangible or intangible, wherever situated. Note. That this is not broad and other provisions generally expand its scope.
Note: On valuation. Similar to gift tax. Rationale: prevent estate tax avoidance Willing buyer/ willing seller (discounts for lack or marketability, lack of control and blockage. Value
d.o.d. Appraisers required (20.2031-6). Note: Alternate Valuation Date. Generally, under §2031, the value of the decedent’s gross estate is
determined at the time of death. However, §2032(a) provides for an alternate valuation date. The executor may elect to value the property included in the gross estate as of a date six months after the decedent’s death, or, in the case of property already sold or otherwise disposed of by the estate, the value at the date of disposition, instead of at the date of death. However, under §2032(c), the election may only be made if it brings about a decrease in both the value of the gross estate and the amount of the estate tax
Look at Estate Tax overview for everything estate includes. Tax Rate. The tax is determined by applying the rates and computation method of §2001(c) to the taxable
estate. Under the unified rate schedule, prior gifts push the taxable estate into progressively higher rate brackets, depending on their cumulative size. Thus, to the taxable estate are added all “adjusted taxable gifts,” defined in §2001(b) as the decedent’s taxable gifts made after 1976 and not otherwise included in the gross estate. This grand cumulative total is then subjected to the rate schedule of §2001(c), from which is subtracted the tax on the decedent’s post-1976 gifts.
Gross estate The gross estate includes Property in Which Decedent Had an Interest. §§2031 and 2033. §2031(a) states
that the decedent’s “gross estate” shall be determined by including the value at the time of his death of “all property, real or personal, tangible or intangible, wherever situated.” Reg. §20.2031-1(b) provides that the measure of value for the purpose of determining the gross estate is the FMV of the property §2033 makes it clear that the value of the gross estate shall include the value of “all property” to the extent of any interest in that property held by the decedent at the time of death. To make it clear that an interest in property will be included in the D’s GE even if he does not own legal
title to all of the bundle of rights in the property, §2033 goes on to state that the gross estate shall include the value of all property “to the extent of the interest therein of the decedent at the time of his death.”
Property interests that terminate at death are not included. Section 2033 applies if the D had a property interests immediate before death & that property interest passed from D to others as a result of death.
Ex: any life estate or remainder interest held by the D at d.o.d. would be included in his gross estate. This section primarily includes probate property, i.e., property subject to creditor’s claims. Property
owned by he decedent alone or as a tenant in common is included by this section. Probate property: In decedent’s name (sole or as TIC); passes through probate by will or intestacy LI, joint property (JT/TIE); retirement benefits (IRAs or pensions); property in trust; POD acts.
D needn’t have actually possessed it [A, income to be for life, remainder to C, if C survives if not, to D. Need to be the beneficial owner- not if you’re just agent. Note: don’t decrease the value of the D’s gross estate due to rights of a SS- marital deduction territory
YES, included under 2033 NO, not included under 2033 Outright ownership/ fee interest Powers of apointment ½ community property or TiC- no survivorship interest. jtros Right to receive payment like accrued salary or bonus death benefit by contractual obligation fees of atty (but not if the value of a contingent fee is too
uncertain)
Discretionary Death Benefits. §2033 does not require inclusion of discretionary death benefits in the decedent’s gross estate. No enforceable right to them.
Barr’s Estate D made death benefit payments to a
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lottery winnings or certificate from agriculture subsidy program payable for
next 10 years and treated as property interest under state law) deferred compensation plan under 2039/2033 owed rent or other k-ual payments (not future)
deceased employee’s W. However, the BoD had the discretion to approve such payments, and such approval was given only after investigations that included inquiry into the financial circumstances of the deceased ee’s fam. SS benefits: not from decedent, but from gov’t.
Obligation/debt (but maybe deductible) Cancellation of Debt By Will. A debt owed to the decedent
may not be canceled by a will without incurring estate tax. Because the decedent could have revoked the will until death, the cancellation is the functional equivalent of a bequest, and the debt must be included in the gross estate under §2033 to the extent of its fair market value immediately before death. Ex: Dad’s forgiveness of his son’s debt at death did not avoid inclusion of the debt in the dad’s gross estate. Disguised bequest whereby the D hoped to relieve his son of the unpaid installments w/o having to include the value of those installments in his estate.
Non-charitable gift cks written but not cleared by bank Cks written in spending in commerce & later cleared and charitable gift checks written and later cleared.
Reversions- are future interests retained by a transferor. Ex: Owen creates a trust to pay income to Craig for 15 years. Whether Owen explicitly retains the right to the property after Craig’s income interest terminates or state law implies it, Owen has a reversion. If Owen dies while Craig is receiving income, Owen’s reversion will be in his gross estate. Whoever receives the reversion through will or by intestacy will receive the trust property at the end of 15 yrs.
Remainders- are future interests created by others. They can be vested or contingent, depending on the terms of the trust or deed creating them as well as on state law. Contingent remainders and other defeasible interests are property interests that are included in gross estate unless the interest is contingent on survival until the time of possession. Any contingencies will affect the value of the interest, not its inclusion in gross estate. (If Max dies before Sarah, can transfer interest in will or by intestacy.)
Copyrights, patents, right to publicity, and similar rights (V.C. Andrews case- look at 125/6 of Willbanks for valuation)
Stolen/illegal goods (Lewis stole art objects in WWII Europe; included in his gross estate though he didn’t have legal title to them because had use and economic benefit (9152005).
Life insurance on the life of another. If the insured is not the owner of the policy and the owner dies before the insured, the insurance policy is included in owner’s estate. (Ex. T buys LI and transfers to L who dies before Tom. In L’s estate).
Causes of action: if the D has a suit of action bending and if state law allows that cause to survive death, it’s included. Valued as of DOD. Pain and suffering or expenses occurred before death ok.
Wrongful Death Recoveries. Wrongful death proceeds are not includible in the decedent’s gross estate under §2033 because the wrongful death action cannot exist until the decedent has died. That is, the decedent does not possess a property interest in such cause of action at the time of his death.
Joint Interests. §2040 deals with property owned jointly by the D and one or more persons ROS. If the tenants are not H and W, the property is included in the gross estate to the extent the D contributed to the purchase of the property. In the case of a joint tenancy between H and W, however, the spouses are deemed equal owners so that 50% of the property’s value is included in the gross estate of the first to die. Transfer on death. When a TiC dies, they can transfer interest by will or intestacy, so it’s included in gross
estate by 2033. When a JT dies, that interest passes automatically to surviving JT. Transfer tax consequences depend on whether they are spouses (2040(b)) or not (2040(a)).
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Joint Tenancy. A JT is property jointly owned by two or more people that has the distinctive feature of a right of survivorship. At the death of one joint tenant, the surviving joint tenant is entitled to full ownership of the property by operation of law. Therefore, can’t pass it in your will (or at least won’t be effective). [versus if D and J are TiC and Julie dies without a will then J’s interest passes to her 2 kids equallty who then become TiC with D and D owns ½ interest and kids own ¼ interest]
Note: if made gift then terminate joint interest during life, no tax consequence on that. Note: tenancy by entirety applies only to spouses and transfer tax consequences same as JTROS.
Note: Avoiding Benefit of Applicable Exclusion Amount. Can disclaimNote: 3 years of death rule not applicable.
§2040. For estate tax purposes, property held in joint tenancy is governed by §2040, which establishes two different sets of rules different sets of rules for married and non-married JTs
Nonmarital Joint Interests. If the joint tenants are not husband and wife, §2040(a) requires inclusion of the full amount of the property in the gross estate of the first to die, unless (a) the survivor furnished part or all of the consideration with which the property was acquired; or (b) the tenants did not themselves acquire the prop but received it by gift or inheritance from someone else,
in which case only the decedent’s fractional share of the property must be included in his GE so presumption that the first JT to die provided all the consideration and the survivor(s) must establish
contribution towards purchase of the property. (e.g., if a parent devises a summer home to 2 children as joint tenants with right of survivorship, each
child is deemed to own half). Note: 2040(a) excludes conidersation that was received or acquired by the surviving JT from the decedent
for less than adequate and full consideration in money or money’s worth. Ex: Mother plans to purchase Greenacre and take title with son as JTROS. Costs 40k. Mom gives son
20k then they both purchase Greenacre contributing 20k each. 20 years later, when Greenacre is worth 100k, mother dies. She said 50k included because each provided ½ consideration but full value is included.
Exam strategy: look for any consideration, money, property or services contributed by the survivor. The amount excluded is the percentage of the cost of the property paid by the survivor.
Example. X and Y, who are not married, own personal property as JTROS. The property was purchased with funds provided solely by X. Upon X's death the property's full value (at dod) is includible in X's gross estate. If Y predeceases X, no part of the property is includible in Y's gross estate.Example. Y purchased a boat and took title in his name alone. The next year, Y sold to X, an unrelated party, a one-half interest in the boat, and title was transferred to X and Y as JTROS. The purchase price that X paid was fair value. If Y predeceases X, 1/2 of the value of the boat is includible in Y's gross estate. If X predeceases Y, 1/2 of the value is includible in X's gross estate.Example. W buys pays 100% consideration for house and gives/beqeaths to X, Y, And Z as JTROS. One third of the value of the property is included in the gross estate of the first JT to die. (2040(a)).
Note: Appreciation or Depreciation in Property Value. With respect to property that has appreciated or depreciated in value, the amount excluded is that part of the value of the property that bears the same ratio to the entire value of the property as the consideration furnished by the survivor bears to the entire consideration paid for the property. This can be expressed algebraically as follows: Amount excl= (survivor’s consideration/entire consideration paid) X’s entire current value of the property The ratio described above is applied to the date-of-death value or the alternate valuation date value of the property, whichever is applicable, whether that value is lower or higher than the acquisition value.Example. X and Y purchased securities as joint tenants with right of survivorship for $20,000. Each contributed one-half of the purchase price from his own funds. Upon X's death, the securities were valued at $60,000. The amount excluded from X's gross estate is $30,000. If at X's death the securities were valued at $15,000, the amount excluded from X's estate would be $7,500.
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Example. C and B own backacre as JT fmv 100k. Original cost of Blackacre was 50k and C paid 30k while B paid 20k. So that portion of the purchase price, 20k/50k= 40% is excluded from Colin’s gross estate (only 60k is included in Colin’s estate).Example . D pays 80k for boat and survivor (not spouse) pays 20k. D dies and boat is worth 200k on his d.o.d. So what is includable in D's estate? [so the boat was worth 100k....now 200k)= 160kExample . C and B purchase Whiteacre as JTROS. Costs 100k. C pays 25l and B pays 75k. Colin dies when Whitacre has FMV of 200k. Amount excluded: 75/100 x’s 200k= 150k excluded from Colin’s gross estate. So 50k (200k-150k) is included.
Note: What contributions count for IRC 2040 tracing purposes? - Any amount that the surviving JT pays for acquisition or improvement of the property qualifies for
consideration unless that amount was gifted by the decedent. - Paying part of the down-payment- Making mortgage payments- Paying for improvements. - Income earned on the property that is taxed to the survivor as income and then used to purchase additional - JT property qualifies as survivor contribution. - Also appreciation in value that is recognized by the survivor for income tax purposesDoes not count: money or other property obtained from the other JT (Reg. 20-2040-1(c)(4).- So: On 12/1/08, D transferred Greenacre to A as a gift. At the time it had FMV of 100k. On 3/15/09, A sold
G for 300k. A used the 300k to purchase a boat with D. The boat’s purchase price was 600k and D contributed 300k to the purchase. A and D took title as JTROS. Do then died in 2009. How much is includable in D’s gross estate under 2040 assuming the boats FMV at DOD is 900k? Answer: if the property previously received from the JT is sold and then sale proceeds are used then that means that appreciation is treated as property of A. 200k gain gets counted as a contribution. Appreciation on a gift is treated as a contribution. Worth 100k and 200k contribution from recipient. So 900 x’s 200 (the appreciation)/600= 300k. If gift were traded as boat, then full value would be attributed to the D and not set off. So has to be reduced to cash. (See below for more).
Note: Prior Gifts of Appreciated Property from Decedent. If property received by the survivor by gift from the decedent has appreciated in value between the date of the gift and the date on which the survivor contributes the property toward the acquisition of jointly held property, to what extent is the appreciation deemed to be "contributed" by the survivor? If the appreciated gifted property is used directly in the acquisition of the jointly held property, no portion of the gain constitutes a contribution by the survivor. However, in cases in which the survivor realizes gain from the sale of property gifted by the decedent and uses the proceeds to acquire joint tenancy property, the gain will be treated as "originally belonging" to the survivor within the meaning of § 2040(a), and the value of the jointly owned property attributable to such amount will be excludible from the decedent's gross estate. Ex: the decedent transferred property valued at $25,000 to her daughter as a gift. The daughter sold that property for $32,500 and invested the proceeds from the sale in various stocks and securities, taking title in joint tenancy with the decedent. These stocks and securities remained in join tenancy until the decedent’s death, at a time when the stocks and securities had appreciated in value to $160,383. Decedent’s estate may exclude $37,011 of the $160,383, which is the value attributable to the amount of the daughter’s contribution representing realized appreciation on the gift from the decedent to the daughter. The excludible amount is computed as follows:
( $32,500 - 25,000) x $160,383 = $37,011 $32,500
Note that to avoid any inclusion in the decedent’s gross estate related to this gifted property, the decedent should have placed all the property in the daughter’s name (instead of creating a joint tenancy) and retained a power of attorney so that she could still maintain some level of control over the property. Example. X and Y, who are not husband and wife, purchased securities as jtros. Although X and Y each contributed one-half of the purchase price, Y's contribution consisted of funds previously acquired from X as a gift. At X's death, the full value of the securities are includible in X's estate
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Example. In 1999, M gave daughter D securities having a value of $20,000. In 2000, D sold the securities for $25,000. Later in 2000, M and D purchased other securities as JTs for $50,000, each contributing $25,000. D made her contribution with the proceeds from the sale of the securities previously received from M. When M died in 2002, the value of the jointly held securities was $75,000. M's estate may exclude $7,500 of the $75,000, which is the value attributable to the amount of D's contribution representing realized appreciation on the gift from M to D. The excludible amount is computed as follows:( $25,000 - 20,000) x $75,000 = $7,500 $50,000 Example. Same facts as the example above, except that instead of selling the securities given to her by M, D contributes the securities to the purchase price of the joint tenancy property when the securities have a value of $25,000. M's estate must include the entire $75,000; nothing may be excluded because no part of the securities' purchase price is attributable to gain realized by D from a sale or other disposition of the securities M gave her.
Joint Interests of Husband and Wife. If property is held exclusively by husband and wife as joint tenants with right of survivorship or as tenants by the entirety, one-half of its value is included in the gross estate of the first spouse to die under §2040(b)—regardless of how the property was acquired or who supplied the consideration for its acquisition or any contributions. This applies as long as the JTs owned a qualified joint interest, meaning either (1) as tbe or JTROS if they
are the only JTs The one half interest qualifies for the marital deduction. So included in gross estate of decedent, it passes
Surviving spouse’s basis: bene receives DOD value as her basis in property received by decedent. (1014). For property that has appreciated in value, this means the beneficiary receives a stepped-up basis and will have no income tax consequences if she sells the property immediately after D’s death. One-Half Basis Step-Up. Note that §2040(b) appears to contain a paradox. On the one hand,
§2040(b) requires inclusion in the decedent’s gross estate of one-half the value of any qualified joint interest; on the other hand, §2056 grants a marital deduction that offsets in full the amount included under §2040(b). §2040(b) is designed not to raise revenue under the estate tax but rather to establish one-half as the
maximum amount of marital survivorship property that is eligible for the date-of-death basis prescribed by §1014(b)(9). This stepped-up basis for the one-half interest included in the decedent’s estate is acquired without tax cost because the inclusion is matched by a marital deduction of the same amount under §2056
Example. Blackacre was purchased for $200,000, as JTROS, and was worth $500k when D died. ½ of its value, or $25k, is included in D’s gross estate under §2040(b). The SS is entitled, in the event of a future sale of the property, to an income tax basis of $350k-$100; for the ½ interest belonging to the survivor, plus $250; for the ½ interest that was included in the D’s gross estate
Basis on Succession to Community Property. §1014(b)(6) states that the surviving spouse’s one-half share of community property receives the stepped-up basis provided that the other half is included in the decedent’s gross estate. Thus, both the deceased and surviving spouses’ one-half share of community property receives the stepped-up basis
Exam strategy: doesn’t apply to same-sex couple, even though legally married because of DOMA. Simultaneous Death of Joint Tenants. Suppose that A and B own Blackacre as (nonmarital) joint
tenants, A having paid the entire consideration for its acquisition. They are killed in an accident under circumstances that make it impossible to determine the order of deaths. The jurisdiction has adopted the Uniform Simultaneous Death Act (CB 219), which provides that under these circumstances each tenant is deemed to have survived with respect to one-half of the property.
Rev. Rul 76-303 (CB 219) held that A’s estate is taxed on the entire value of the property, while B’s estate is taxed on one-half.
2041 Powers of Appointment. Property subject to a GPOA is in the power holder’s gross estate. A power of appointment is a power that enables the donee of the power acting in a non-fiduciary capacity to
designate recipients of beneficial ownership interests in the appointive property (R3 of Property: Wills and
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Other Donative Transfers §17.1). In other words, it is to decide in a non-fiduciary capacity who will enjoy the property (See Reg 20-2041-1(b)(1). A power of appointment comes from someone else; it is not retained or reserved. [insert other definition things below in box if necessary] Under §2041, property over which the decedent had a general power of appointment is includable in the gross estate even if the power was not actually exercised and thus terminated at death.
§2041. Under §2041, a decedent’s gross estate includes the value of property with respect to which the decedent possessed a general power of appointment at the time of his death—even if that power was never exercised during his lifetime. The property is includible even if:
that power was never exercised/ able to be exercised (minor or incompetent) during the decedent’s lifetime; a minor child may be given a general power of appointment in order to qualify trust income and
principal for the gift tax annual exclusion 25.2503-4(b). WB 180. the decedent never owned the property during his lifetime and never personally possessed or enjoyed
it; and the decedent never knew that he possessed a general power of appointment.
Note: The possession, exercise, release, and lapse of a gpoa causes property to which the power pertains to to be subject to transfer (e.g. gift or estate) tax; i.e. if donor appoint the trust property to someone else, it will be a gift unless receives full and adequate consideration. 2514(b) i.e., if a donee exercises a GPOA during life, that exercise is a transfer of property by that individual
and is often a gift. Also if the Donnee releases the power (after 9 month disclaimer period) its treated as if he did in fact
withdraw the property and then transferred it to the trust bc he could have withdrawn it all for his own benefit. Darren is treated as the transferor (2514(b) giving income to himself for life and remainder to issue. Remainder is a gift to his issue. And when he dies, the trust property will be included in his estate because 2041 includes proepty exercised or released.
“General Power of Appointment.” §2041(b)(1) defines a “general power of appointment” as a power which is exercisable in favor of: (1) the decedent; (2) his estate; (3) his creditors; or (4) the creditors of his estate. Can decide in non-fiduciary capacity who will enjoy the property. Note: depends on state law. IN Md National Bank the language “to such person or persons as the D shall
designate” didn’t include decedent , decedent’s creditors, etc. In MD need the explicit words for a gpoa. Note: Reg 20-2041-3(b) if a power is subject to a condition that has not occurred then D doesn’t have a
gpoa. Note: Reg. §20.2041-1(c)(1) treats a power as general to the extent it is exercisable to discharge a
decedent’s legal obligations. Thus, for example, a parent to whom property is transferred as trustee for a minor child has a general power to the extent that the parent has discretion to use the trust property to discharge his or her own obligation to support the child
Note: the general power of appointment is not always labeled as a poa...20-2041-1b1 power of withdrawal (Crummey trusts) discretionary power as trustee to invade corpus and a beneficial interest in the trust to remove trustee and appoint others, including self power to consume even if dont take or use power as holder of life estate n real proeprty to sell the proeprty and consume its proceeds power to cause a trust to pay off creditors or satisfy support obligations. see 20-2041-1(c)
so ask what does this person own and what do they have the right to control?
Example. A settlor transfers property in trust to pay income to D for life w/ remainder to her issue. D is named the trustee of the trust and has the power to terminate the trust and thereby withdraw all property from the trust. Upon her death, D’s GE will include the value of the trust property since she possesses a general poa. To avoid this result, a third party should be named as trustee, with D remaining as the income beneficiary. Then make sure D doesn’t have power to demand any amount of trust principal during life for own benefit.
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Note: Inclusion Required Even If Decedent Never Owned or Enjoyed Property or Exercised the power. §2041 will require inclusion in the decedent’s gross estate of property which he may never have owned during his life and which he may never have personally possessed or enjoyed and whose ownership or receipt he has never actually determined by the exercise of a power of appointment. In other words, the mere possession of a general power of appointment is treated as the possession of such an important component of ownership that the decedent should be subject to an estate tax.
Power is considered exercised if not impossible ex: D never exercises her power to appoint Greenacre to whomever she wants (and if she doesn’t exer it, then
goes to kids). STILL included. ex: Matthew’s will leaves property trust to Cakvin for life, with a power to barry to appoint the remainder by
will and betty dies before Matthew, exercising her power by appointing the remainder to Calvin if Calvin survives Matthew. Betty is considered to have exercised her power of appointment if Calvin is living at Betty’s death. If Calvin dies before Betty, then Betty’s power is not exercised.
Conditional powers: if a power is subject to a condition that has not occurred, then decedent does not have a general power of apppointment
ex: Matthew’s will leaves property in trust with Friendly f/b/o Calvin. Calvin has power to withdraw 5% each year, but only when married. Calvin never married. Property will not be in Calvin’s gross estate. 20-2041-3(a) and (b)
Kurtz v. Commissioner: want spouse to first use up marital trust so family can use the one for the kids. So spouse dies and the argument is the condition never applied! So tax court buys that argument but the other doesn't ....so conditions within control as opposed to conditions in regulation.
Exceptions to general power inclusion Exception: A power of appointment …which is exercisable only in conjunction with the creator of the
power is not deemed to be a general power of appointment. 2041(b)(1)(C)(i) I.e., if power is held as beneficiary with grantor as a co-holder of power, then no gpoa. if co-holder is donor, presumed his interests outweigh those of the donee so no general power.
Exception: A power…which is exercisable only in conjunction with a person having a substantial interest in the property subject to the power, which interest is adverse to the exercise of the power of appointment is not a general power of appointment. 2041(b)(1)(C)(ii) i.e., if power is held jointly as bene with someone having a substantially adverse interest then no gpoa.
if not, co-holder ignored and power is general corporations, banks, trust companies, etc are deemed NOT to have a personal stake. Note: if co-holder and donee are both permissible appointees of inter vivos but power terminates on
donee's death, donee presumed to have aliquot portion only. (2041(B)(1)(C)(III) Exception: Ascertainable Standards. Under §2041(b)(1)(A), a power to consume, invade or appropriate
property for the D’s benefit when that power is limited by an ascertainable standard relating to the “health, education, support or maintenance” of the decedent is not considered a general power of appointment. I.e. not a general power if power to appoint to oneself is limited by ascertainable standard. Rationale: acting pursuant to creator/donor/settlor’s instructions rather than own Ascertainable standards?
Standard must relate to decedent’s health, education, support, or maintenance. Meaning of ascertainable standards: When drafting don’t be creative. Use exact language. Reg. §20.2041-1(c)(2) specifies that “support” and “maintenance” are synonymous and their
meaning is not limited to the bare necessities of life. Examples of powers which are limited by ascertainable standards are powers exercisable for the holders “support,” “support in reasonable comfort,” “maintenance in health and reasonable comfort,” “support in his accustomed manner of living,” “education, including college and professional education,” “health,” and “medical, dental, hospital and nursing expenses and expenses of invalidism.” “to meet an emergency” 25.2511-1(g)(2)
In contrast, a power to use property for the “comfort, welfare, or happiness” of the holder of the power is not limited by an ascertainable standard. Case law has also held that the following
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powers are not limited by an ascertainable standard: “Whatever purpose she desires,” “for her comfort and care as she may see fit,” “other expenses incidental to her comfort and well-being,” “reasonable needs and proper expenses or the benefit and comfort,” “proper support, maintenance, welfare, health and general happiness in the manner to which he is accustomed,” and “proper comfort and welfare.” But see Rev. Rul. 76-368: D’s spouse created testamentary trust under which income was
payable to D for life. T authorized to invade corpus and pay portions to or for use and benefit of F if its sole and unfettered discretion deemed advisable for “health, comfort, maintenance, welfare, or other purposes”- - is not a general poa even though says comfort.
Courts don’t like “continue” Rev. Rul. 77-60: Under D’s will SS granted a life estate in certain properties with the power to invade the corpus as desired in order to “continue D’s accustomed standard of living”- so it’s a general PoA
In determining whether a power is limited by an ascertainable standard, it is immaterial whether the beneficiary is required to exhaust his other income before the power can be exercised.
Rationale. If the D held a poa that could have been exercised to make him the owner of property held in trust, and the D instead exercised the power by will in favor of another person, the exercise of the power is functionally equivalent to a testamentary gift of property and will be taxed accordingly. Indeed, the mere possession of such a power, even if it is not actually exercised, could be viewed as approaching beneficial ownership of the property subject to the power. Why have it? Flexible! Not a fiduciary power: wholly discretionary/free of constraint of impartiality or other standards.TerminologyDonor: person who creates the power of appointmentDonee: recipient--person who exers the power (in general looking t what donee gets taxed onObjects aka permissible appointees: class of people eligible to receive the propertyAppointees: people for whose benefit the property is actually appointedTakers in default: people who take property absent exercise of the powerWhen and how excercisable: presently (can be immediate); testamentary (exercisable by will); Inter vivos: exercisable by instrument (deed). General v. Special: General: can appoint to anyone including himself, his creditors, his estate, creditors of his estate. Can use it to pay your bills--just that opportuity alone means youre taxed on it even if don't use it. Special: aka limited or non-general: restricted group of appointees: among my children; among my relatives; anyone other than herself, her estate, her creditors and the creditors of her estate [this isn’t taxed] Ex: D is income beneficiary of a trust created by A. A gave D power to appoint trust corpus at D’sdeath to any of D’s issue. In D’s will she appoints to her 3 children. Benefits from this tax advantage for Special POAs: Possible to give does something close to funcational equivalent of ownership without additional tax. (used regularly in contemporary estate planning to preserve flexibility in long-term trusts wihtout tax costs; a of distribution ltd by IRC ascertainabe standards is a special poa); Where RAP has been abolished...can create a dynasty trust, exempt from transfer tax, flexible, in perpetuityDistinction from “Retained powers”- what you keep after you've given something away. This is differnt- power that the D received from someone else. A power that the D retains with reqpect to property she gave away goverened by IRC 2036-8 (see treas. reg 20.2041(1)(b)(2). And powers of appointment at death come from another source; goverened by IRC 2041
Note: Lapse/ Lapse of Demand Rights and “Hanging” Crummey Powers. GPOA: lapse occurs when power can no longer be exercised. Only applies if the power is limited in time (so
can withdraw every year) and is non-cumulative. Lapse of GPOA is treated as a release of that power (2041(b)(2) which is treated as a transfer of the property by the done 2041(a)(2).
Note: the lapse is a release only to the extent that the property which could have been appointed by the done exercising the power exceeds the greater of 1) 5,000 or 2) 5% of the trust principal.
The lapse of a Crummey demand right (i.e., the powerholder does not actually withdraw property from the trust pursuant to his demand right) may cause a taxable gift by the powerholder under §2514(e), which treats
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the powerholder as withdrawing property from the trust equal to the amount of the demand right and transferring by gift that property back to the trust. However, §2514(e) provides a safe harbor rule that narrows its application: A taxable lapse occurs only to the extent that the value of the property subject to the lapsed power exceeds the greater of: (a) $5,000; or (b) 5% of the aggregate value of the assets out of which the exercise of the power could be satisfied.
For example, if 500,000 in a trust and M has right to withdraw 20k each year, this is not a lapse because her right to withdraw is limited to less than 5% of the corpus, so not treated as a transfer.
But assume that J transfers property valued at $200,000 to an irrevocable trust. The trust instrument provides for distribution of all trust income to B for life, with trust principal to be distributed on B's death to B's descendants. B is given a Crummey power (or gpoa) to withdraw $25,000 during December each year. Accordingly, if the withdrawal right is not exercised by December 31, the right lapses for that year. In any year in which B allows the power to lapse, B is treated as having transferred by gift to the trust $15,000, the amount by which $25,000 exceeds the greater of: (1) $5,000; or (2) 5% of the trust assets ($200,000 x 5% = $10,000). 187 for more.
The so-called “hanging” Crummey power may avoid the adverse gift tax consequences associated with the lapse of demand rights. The hanging power is intended to avoid a taxable lapse of the demand right because the demand right, to the extent of the amount in excess of the §2514(e) 5% or $5,000 exception, does not lapse, and continues in subsequent years until it lapses within the 5% or $5,000 exception in subsequent years. If, however, the powerholder dies before all demand rights lapse, the amount that has not lapsed is included in his gross estate.
NOTE FOR DONEE: Will have gift and estate tax consequences unless there is 260k in the trust (because then 5%). Because if don’t exercise crumy withdraw power, lapse to extent that 13k (whatever put in that month) exceeds greater of 5k or 5% of the trust. Page 188 for more.
Life Insurance Proceeds. §2042 General rule: 2042 makes plain 2 rules for the estate tax treatment of life insurance proceeds paid on a policy
on the life of the decedent. Under Section 2042, the payment receivable (i.e., not the face amount or value of the policy) from a life insurance policy are includable in the decedent’s estate if they are (1) payable to the decedent’s executor or (2) payable to others if the decedent retained with respect to the policy “any of the incidents of ownership, exercisable either alone or in conjunction with any other person.”
Broadly defined: 2042 does not define insurance on the life of the decedent, but there must be a shifting of the risk of loss from death for an agreement to be insurance and the regulations provide that the definition is broad as seen by 20.2042-1(a)(1), which provides that this section governs “life insurance of every description, including death benefits paid by fraternal beneficial societies, operating under the lodge system.”
Insurable interest: In order to take out a policy on someone’s life, you must have an insurable interest in that person. This includes oneself, family members, employees, etc. Otherwise, moral hazard.
Reasons to purchase: Support for dependants Liquidity/ cash: pay debts and estate taxes; buy out shares of a business Savings for retirement (whole life) Making charitable gifts Creditor protection
Types of Insurance. DOES IT SHIFT RISK AND DISTRIBUTE LOSS?? There are 2 primary types of insurance: Term Insurance. Term insurance provides a death benefit but does not provide cash values. Term
insurance premiums generally increase with age. If a death benefit is needed for a specific, relatively short time period, term insurance is the ideal policy. However, if the insured plans to hold the insurance for a long time and use policy cash values for retirement income, term insurance is not the proper vehicle.
Note: When to Buy Term Insurance. In general, term insurance is not the proper vehicle if the insured wants the insurance proceeds to pay any estate tax due when he dies. Instead, term insurance is proper when the taxpayer wants to cover the risk of death during a term. For example, term insurance may be appropriate if the taxpayer has young children and needs to replace his income upon his death so that his family can continue their lifestyle and pay for the
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children’s college expenses. Term insurance may also be appropriate if the taxpayer owns a business with a relatively short investment life and is obligated to purchase the co-owner’s interest upon his death (i.e., buy-sell agreement). In that case, term insurance proceeds may be used to fund all or part of the purchase price.
Permanent Insurance. Permanent insurance (a.k.a., whole life or universal insurance) combines a death benefit with a savings (i.e., cash value) element that has the effect of providing an insurance benefit that will last for the entire life of the insured. The major advantage of permanent insurance is that the increase in the investment element (cash values) occurs on a tax-deferred basis. This means that, although premiums are paid with after tax dollars, the interest income on the policy cash values accrues on a tax advantaged basis. If, however, the cash portion is underfunded, the policy will terminate in the later years, unless significant cash additions are made, because there is not enough cash value to pay the charges in the policy.
Receivable by Executor. Under §2042(1), if the proceeds of a life insurance policy on the life of the decedent are payable to the executor, the entire proceeds are includable in the decedent’s gross estate. Means payable to estate, creditor or anyone with legal obligation to pay expenses so if imposed on 3rd
party. If third party is empowered but not required- this was rev. ruling we talked about and property not included under 2042(1) but any amounts actually expended are part of gross estate.
Note about using LI to pay estate obligations: Rev. Rul 77-157:
Facts: Beneficiary of LI is a trust created y decedent/insured.Trustee empowered but not required to pay estate obligations. Assets of estate sufficient, so no need fr trust to pay
Holding: 20.2042-1(b) not implicated. Where trustee may voluntarily pay, such power to volunteer does not require inclusion of insurance proceeds. Any arrangement by which proceeds of insurance on life od decedent made available to estate raises 2042(1) issues. If bene is a trust and trustee empowered but not required to use the trst funds to assist D’s estate, as long as beneficiary is not subject to a legally binding obligation to make the payments, the power does not require inclusion in the decedent’s gross estate.
Note: Margrave: revocable trust does NOT equal estate. Receivable by Other Beneficiaries. Under §2042(2), if the proceeds of a life insurance policy on the life of the
decedent are payable to other beneficiaries, the entire proceeds are includable in the decedent’s gross estate if the decedent possessed at his death any “incidents of ownership,” exercisable either alone or in conjunction with any other person. Note: Payment of the premiums will not cause the proceeds of the policy to be includable in your
gross estate. Ex: At D’s request, Spouse purchases a life insurance policy on D’s life and D pays the premiums on
the poliy. 2 years later, D dies. Not includable because still no claim to any economic benefits, so might have some gift inplications
Note: Life Insurance on Another. If Mary takes out an insurance policy on the life of Jeff, naming herself as beneficiary, and predeceases Jeff, the life insurance policy is not includible in Mary’s gross estate under §2042 since §2042 does not apply to insurance on the life of a person other than the decedent.
However, the value of the life insurance policy may be includable in Mary’s gross estate under §2033. In the case of term insurance, Mary’s gross estate will include the replacement cost of the policy (generally, the sum of the premium payments Mary had previously made). In the case of permanent insurance, Mary’s gross estate will include the interpolated terminal reserve value of the policy (which generally approximates the cash value of the policy).
What are “Incident of Ownership.” Reg. §20.2042-1(c)(2) and (3) provide that the term “incident of ownership” includes: [rationale:
ownership/controlyours] Power to cash in the policy or receive economic benefits of it The power to change the beneficiary;
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The power to surrender or cancel the policy The power to assign the policy or to revoke an assignment The power to pledge the policy for a loan (i.e., borrow against the policy’s cash surrender value) The power to obtain from the insurer a loan against the surrender value of the policy; and A reversionary interest if the value of the reversionary interest immediately before the death of the
decedent exceeded 5% of the value of the policy. (i.e. possibility that greater than 5% of the policy or proceeds will return to the insured or the insured’s estate).xx
Must have legal right. Have to have a legal right to it. Not includable in his estate if illegally cause company to pay part of the policy’s surrender value because didn’t have any right to it. have to have a legal right to change the bene, loan or collect on polcy.
Intent doesn’t matter. Ex: you purchase insurance policy and intend to hold the policy for child’s benefit but failed to transfer it to child. We can't possibly make what D wanted the test...because she still owns it and didn't transfer she still had it so has ownership. What if instructed inruance agent to issue it to Child but accidentally issued it to D? Then problably inn D's estate according to IRS. IRS would probably say you have to prove or show but the mistake would be a defense
Doesn’t have to be practically exercisable. Does a Policy Constitute “Life Insurance?/ Incidents of Ownership: In Commissioner v. Noel’s Estate (flight insurance case), the Supreme Court held that “flight accident insurance” constitutes insurance taken out on the “life of the decedent” within the meaning of §2042(2). The fact that ordinary life insurance is payable upon an inevitable event (death) whereas accident policies are payable only upon an evitable event (accidental death) is not relevant in determining whether “insurance” exists. In both cases, the risk assumed by the insurer is the loss of the insured’s life, and the payment of the insurance money is contingent upon the loss of life. D purchased an insurance policy on his life at an airport, handed the policy to his wife, boarded the
plane and tragically died in a plane crash three hours later. Issue: does he have an economic interest in this policy if he can't do anything with it (he buys it
and goes onto airplane immediately The Supreme Court held that it is irrelevant that the D had no opportunity to exercise any incident
of ownership within the short time between the take-off and the crash. Reasoned that individual circs should not affect the estate tax laws: “It would stretch the imagination to think that Congress intended to measure estate tax liability by an individual’s fluctuating, day-by-day, hour-by-hour capacity to dispose of property which he owns. We hold that estate tax liability for policies ‘with respect to which the D possessed at this death any of the incidents of ownership’ depends on a general, legal power to exercise ownership, without regard to the owner’s ability to exercise it at a particular moment.” So Impossibility of Exercise Doesn’t Matter The fact that it may be impossible for the
insured to actually exercise any of the incidents of ownership before his or her death is not relevant. Court says won't look at ability to exer and test is do those rights exist. so we care about whether you had the power, not whether you had the ability.
“Policy Facts” Prevail Over “Intent Facts.” In general, “policy facts” (i.e., the actual terms of the insurance contract) will prevail over “intent facts” (i.e., the conduct, understanding, and intent of the parties with respect to the insurance policy). the decedent’s estate contended that the decedent assigned his rights to a flight insurance policy
when he directed the clerk to give the policies to his wife. In rejecting this approach, the court relied on the terms of the policy itself, which provided that the policy could not be assigned nor could the beneficiary be changed without a written endorsement on the policies. No such assignment or change of beneficiary was endorsed on these policies, and consequently the power to assign the policies or change the beneficiary remained in the decedent at the time of his death.
Incidents Possessed in fiduciary capacity: Decedent as Fiduciary. §2042 will not require inclusion in the decedent’s gross estate if: (1) the decedent held incidents of ownership as a fiduciary and only for the benefit of persons other than himself; and (2) the power was not retained by the decedent, but devolved upon him. 2042-1c4 [rationale: no power to control and not in his estate] I.e., S's power to change benes was not under the terms of the policy. Power was given to him as a
trustee by his W. So court makes distinction bt retained interest and something that comes back to you In Skifter’s Estate v. Commissioner the D transferred certain insurance policies on his life to his wife
more than three years before his death. The D’s wife predeceased him and, under the terms of her will, 36
the policies were to be held in trust with the decedent named as trustee. The trust provided that the daughter was to receive the income during her lifetime and, at the time of her death, the balance of trust property would be distributed to various remainder beneficiaries. The trustee was authorized to pay all or any part of the trust principal to the daughter. The decedent had no beneficial interest in the trust. The IRS argued that the decedent’s power to distribute the policies to the daughter (thereby favoring the income beneficiary over the remainder beneficiaries) was an incident of ownership.
The court rejected the government’s position. Noting that the legislative history of §2042 indicated an intention that the principles of the estate tax transfer sections (§§2036, 2037, and 2038) apply to §2042, the court concluded that the decedent’s fiduciary power did not constitute an “incident of ownership” (and, therefore, the life insurance proceeds are not includible in his gross estate): The decedent’s fiduciary power was not reserved by him at the time of the transfer. Rather, it devolved upon him at a time subsequent to the assignment to his wife. Moreover, the decedent could not have exercised his powers to derive for himself any economic benefits from their insurance policies.
In Rev. Rul. 84-179 (CB 390), the IRS accepted the result in Skifter and ruled that, for purposes of §2042(2), a decedent does not possess incidents of ownership over an insurance policy on his or her life where (1) the decedent’s powers devolved to the decedent as a fiduciary and (2) were not exercisable for his or her personal benefit, provided (3) the decedent did not transfer the policy to the trust and (4) did not furnish consideration for maintaining the policy.
Note: Economic Benefit. The decedent does recognize an economic benefit if the life insurance proceeds are to be used to pay his estate tax liability upon death. Note: Mere power to change timing. Group Term life insurance where er provided the policy and usually ees keep very little control over it. 2 cases with similar facts/ different outcomes: In Lumpkin’s Est. incidents of ownership encompasses mere power in insured to affect time or manner of enjoyment. The court held that the decedent’s right to select a settlement option under a group term policy constituted an incident of ownership, even though it affected only the time and manner of the beneficiary’s enjoyment of proceeds (like 2038). However, the court in Connelly’s Est. reached a contrary result on similar facts. Looked to Sifter which said if you received it rather than retained it, then not incident of ownership.
Incidents of Ownership Held by Corporation Controlled by Decedent. Under Reg. §20.2042-1(c)(6), the following provisions apply: treasury regs say you do not attribute if policy is payable to corporation. Estate of Levy- if policy
payable to someone else like spouse then is includable Estate of Levy: petitioner owned corporation and life insurance policies on D's life were owned by
company but payable to widow and at time of D's death, corporation had IOO and D didn't have them but he did own the corporation
Look at c(6): So here, in the Levy case, although the poicy and all rights associated are not owned by D, because paybale to wife (someone else0, includable in his gross estate. If payable to the corporation, not includable in D's estate….
To the extent the proceeds of insurance policies on a shareholder’s life are payable to or for the benefit of the corporation, the corporation’s incidents of ownership will not be attributed to the insured/shareholder. Instead, the insurance proceeds will be taken into account in valuing the corporate stock included in the decedent’s gross estate.
To the extent the proceeds of insurance policies on a shareholder’s life are not payable to or for the benefit of the corporation, the corporation’s incidents of ownership will be attributed to the insured/shareholder if he or she is a “sole or controlling” shareholder. A decedent will be considered a controlling shareholder only if, at the time of his death, he owned more than 50% of the voting power of the corporation.
Example. David is the sole stockholder of DDDD Corp. which totally owned an insurance policy on David’s life. The corporation was the beneficiary of the policy. Not includable in decedent’s estate.
Ex. Mr. S and Ms. J own 49% and 51%, respectively, of the voting stock of Acme Corp. Acme possesses incidents of ownership in the following four policies on the lives of the SHs: Policy 1 -- $250,000 policy on Mr. S’s life, payable to Acme; Policy 2 -- $250,000 policy on Ms. J’s life, payable to Acme; Policy 3 -- $250,000 policy on Mr. S’s life, payable to Mrs. S; Policy 4 -- $250,000 policy on
Ms. J’s life, payable to Mr. J. Result: Neither Mr. S nor Ms. J has any direct incidents of ownership in the policies. Will Acme’s incidents of ownership be attributed to the insured SH, causing the policies to be includible in the D’s GE under §2042? Will the insurance affect the valuation of the stock includible in the decedent's gross estate under §2031? Answer: The proceeds of Policy 4 will be included in Ms. J’s GE; the proceeds of Policy 3 will not be included in Mr. S’s gross estate; and the proceeds of Policies 1 and 2 will affect the valuation of Acme in Mr. S’s and in Ms. J’s estates.
Irrevocable Life Insurance Trusts. To avoid estate inclusion of life insurance proceeds, the life insurance policy can be held in an irrevocable life insurance trust (“ILIT”). In general: Trustee owns; trust is beneficiary of policy; anyone but me can be beneficiary of the trust; and
the trust pays the premiums, but insured can transfer money into it. So insurance trusts add that level of housekeeping like crummy trusts but if you do that then circle back to this insurance policy owned by trust were not in your estate. passes outside of estate and this was the biggest
Major downside: in estate if die within 3 years; also making a gift. Make sure: records are good and all incidents of ownership are owned by the policy. Best to buy a new
policy and have trustee pay premiums pursuant to transfers from insured and include crummy rights (25-2503-3(c), Ex 2, 6 to make sure any gift to trust to pay those premiums is present interest for annual excl. Trust Language. The trust agreement may not state that any life insurance proceeds are to be used to
pay the decedent’s estate tax liability Trustee has to own the policy so can either transfer it to the trustee or have trustee make it...so give
money to trust to make payments on new policy. See treas 25.2512-6(a) Trustee. As a general matter, the insured/grantor should probably not be named the trustee of the ILIT. If
isincident of ownership if is trustee. seems to be contrary to skifter but wisdom is to not have insured serve as trustee Moreover, the insured/grantor should also be denied the power to remove the trustee without cause and appoint another trustee. Good to have someone used to record-keeping to do these trusts...so someone who can keep the records/ pay the premiums/ sending crummey notices. and on death of insured then can have family member be trustee
The following are characteristics of ILITs: No “Incidents of Ownership.” Typically, a gift is made to the trust for premium payments (up to $26,000
per year per beneficiary if split gift by husband and wife), with the trustee applying for and owning the policy for the benefit of the trust beneficiaries. Future gifts are made as required for additional premium payments. In a properly structured ILIT, the insured can avoid the application of §2042 since all of the incidents of ownership are held by the trust—not the insured.
“Crummey” Power. ILITs frequently contain a “Crummey power” provision that allows the gift to qualify for the annual gift tax exclusion. For a Crummey power to qualify a gift as a present interest, the beneficiary must be given reasonable notice of a contribution to the trust and of his or her immediate right of withdrawal. The beneficiary must also be given a reasonable opportunity to exercise the right. The trustee should hold liquid assets or insurance with a cash value at least equal to the value of the demand rights, to rebut any claim that the rights have no substance and are merely “illusory.”
3-Year Rule. Inclusion if D made a transfer of an interest in any property or relinquished a ower with respect to any property
during the 3-year period ending on d.o.d. and Teh value of such property (or interest) would have been included in the D’s gross etate under section
2042 if retained by D on d.o.d. Moreover, the 3-year rule under §2035 does not apply as it would if the D bought the policy himself,
transferred it to the trust, and died within 3 years of the transfer. Moreover, if the policy already exists and is owned by the decedent, (1) the decedent can gift money or other property to the trust and (2) the trust can then purchase the policy from the decedent. §2035(d) provides that the 3-year rule does not apply to bona fide sales for “an adequate and full consideration in money or money’s worth.”
Community Property State. Reg. §20.2042-1(b)(2), LI purchased with community funds in a community property state is an asset of the community, rather than separate property of the insured-decedent. Thus, if community assets are used to fund an ILIT, half of the ILIT’s assets will belong to the insured-decedent and half will belong to his spouse. If the spouse dies first and was the named beneficiary of the ILIT, the value of her one-half interest in the ILIT’s policy will be includible in her gross estate under §2036.
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To avoid this result, the insured-decedent should fund the trust with his own separate property. Note, however, that for gift tax purposes the insured-decedent and his spouse may still make a split-gift to the ILIT sufficient to cover the annual premium payments.
Payment of Estate Tax Liability. Once the insured dies, his probate estate is generally responsible for paying any estate tax that is due. But what if the decedent’s probate estate contains only illiquid assets (e.g., fractional ownership interest in apartment buildings)? Must the executor “monetize” these assets to pay the estate tax? The executor may sell these illiquid assets to the ILIT in exchange for cash (i.e., the ILIT was the beneficiary of the insurance proceeds) in a bona fide sale for an adequate and full consideration. The executor may then use this cash to satisfy the estate tax liability.
Note: Transfers within 3 Years of Death. Under §2035(a), the GE includes the proceeds of a life insurance policy if: (1) within 3 years before death, the decedent transferred an interest or relinquished a power with respect to the policy; and (2) the interest or power would have given rise to inclusion under §2042 (i.e., the decedent possessed an “incident of ownership”) had it been retained by the decedent until death. Ex, if within 3 years before death the decedent took out a policy on his own life and thereafter transferred
all incidents of ownership in the policy to another person, the proceeds are includible in the GE, even though the transfer may have been subject to gift tax. The result is the same if the D transferred the policy more than 3 years before death but retained incidents of ownership which were relinquished within the 3-year period. If the D paid premiums to keep a previously transferred policy in force, the premium payments may be subject to gift tax but they do not cause the proceeds to be drawn back into the GE. So if designates irrevocably the policy’s beneficiary and then dies 4 years later, good!
Transfers for Insufficient Consideration. Under §2043, if any of the above transfers were made for a consideration, the decedent’s gross estate includes the excess of the FMV of the property at the time of death over the value of the consideration received by the decedent.
Property for which marital deduction was previously allowed §2044: QTIP Property- the value of the underlying QTIP property will be included in the spouse’s gross estate upon her death (i.e. property that qualified for the marital deduction pursuant to 2056(b)(7).
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Retained interests: 2035 Deathbed transfers; 2036 Retained life estates; 2037 reversions; 2038 revocable trusts: “The cost of holding on to the string may prove to be a rope burn.” Old Colony Trust, i.e., if you don’t give it all away, it may end up being treated as yours.
Transfers with Retained Life Estate. (2036, 2037, 2038) Rationale: ask is this the type of transfer that is intended to take effect at or after death? That is, is it
testamentary in nature? If the answer is yes, probably brought into gross estate. Exam analysis:
First, determine if the decedent owned a property interest. Second, determine if the D made a transfer of that property interest. Third, determine if the D retains a right to income from that property. This includes:
the immediate right to the income or the use, possession or enjoyment of the property at the time of her death even if no legal right.
the right to the income after someone else’s death or term of years the ability to have the income used to discharge the decedent’s support obligation.
§2036(a) Transfers with retained life estate provides that the value of the gross estate “shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth) by trust or otherwise, under which he has retained 1. for life or 2. for any period not ascertainable without reference to his death or 3. for any period which is not does not in fact end before his death: (1) the possession of or enjoyment of, or the right to the income from, the property (i.e., a retained life estate); or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”
About 2036(a)(1): (1) the possession or enjoyment of, or the right to the income from, the property (i.e., a retained life estate) even if the property doesn’t produce any income.
Ask: Did the D make the transfer? Did he retain the right to income? If not, did D use, possess or enjoy the property?
How much is included? Entire value of property (20.2036-1(c)(i). “…the amount to be included…is the value of the entire property, less only the value of any outstanding income interest which is not subject to the D’s interest or right and which is actually being enjoyed by another person at the time of the D’s death. Thus, both the retained and remainder interests will be included in the decedent’s gross estate.
About not ending before her death: If Debra establishes irrevocable IV trust with FNB as trustee to pay income to Debra for 15 years and then to distribute the trust property to her issue
If dies in year 12, then full value of trust as of d.o.d. included in her estate because she had the right to income for a period which did not in fact end before her death.
If Debra died in year 16- nothing included because she outlived it.
About a period not ascertainable without reference to his death: David establishes an irrevocable IV trust with FNB as trustee to pay income to him each quarter. The right terminates with the quarterly payment immediately preceding his death. Any income generated between last payment and trust termination distributed to David’s surviving issue. 20.2036-1(b)(i)(ii).
When David dies, the full value of the trust as of d.o.d. included because he had the right to income for a period not ascertainable without reference to his death.
What is right to income? Trust Ex:
B created an irrevocable IV trust with FNB as trustee to pay income to B for his life, remainder to bro. Full value of trust on d.o.d. is included bc he had the right to income from the property for his life.
Life estate: H establishes an irrevocable IV trust with FNB as trustee to pay income to A for life. At A’s death, FNB is to pay income to H for life. After death of A and H, trust property distributed to B. If H dies (before A) then include full value of trust on d.o.d. less value of A's life estate. (20.2036-
1(b)(1)(ii). Look at his age and look at IRS charts to see his income interest. Mortality
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D transfers bonds in trust, income to A for life, then to D for life, remainder to E. D dies before A&E. Trustee (not grantor) has absolute discretion but still distributes regularly
Examples: J creates irrev IV trust with FNB as trustee who can in sole and absolute discretion distribute trust income to J. They do so monthly. Included in J’s estate bc pattern of trust distribution indicates likelihood of express or implied agreement
What’s included for 2036?? All of it less only value of outstanding income interest which is not subject to D’s interest or right and which is actually being enjoyed b another at the time of the D’s death.
Some reminders: D transfers bonds in trust, income to A for life, then to D for life, remainder to E. D dies before A and E. Answer: Don't get thrown by assets—doesn’t matter if he doesn’t survive them. Included bc D kept an income interest. So really mechanical. Makes a transfer and keeps income interest. 2036 doesn’t’ care about contingencies- all in. D transfers bonds in trust, income to D for 15 years, remainder to E. D dies after 14 years-
Whole shebang included in D’s gross estate. What is retained enjoyment? Was there an express or implied agreement?
Possession or Enjoyment of Property. Possession or enjoyment of gifted prop is retained when there is an express or implied understanding to that effect among the parties at the time of transfer. Reg. §20.2036 -1(c)(i) provides that “an interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred
Transfer of Residence. One common §2036(a)(1) problem arises when a person transfers the family residence to a family member and then continues living in the house until death. In this situation, the decedent has transferred the house with a retained life estate in the form of retained possession and enjoyment. Here, implicit understanding or agreement allowing the decedent to retain possession and enjoyment of the house. Not if H and W: W transfers family home outright to H but still lives there until H dies 4 years later-
not includable in W’s gross estate. House life estate ex: Blackacre to issue but D can live there. When D dies, 100% of Blackacre value
is included in her estate because she retained it for life Stinks if it’s increased in value because that increase is in estate now. Same with trust.
In Rapelje’s Estate v. Commissioner (CB 271), the decedent made a gratuitous conveyance of his personal residence to his two daughters and reported the transfer as a taxable gift. However, he continued to live in the house until his death. Was included bc continued to enjoy. treated home as own and continued to enjoy it. Gives a
roadmap with how to deal with transfer and Maxwell family tried to follow it. The court notes that there was no express agreement allowing the decedent to retain possession and
enjoyment of the home. However, the court reasoned that several factors suggested that there was an implied understanding between the parties to that effect: (1) the decedent maintained almost exclusive occupancy of the residence until his death; (2) the decedent paid no rent to his daughters for the continued use of the property; (3) neither daughter made any attempt to sell her own house; and (4) neither daughter ever attempted to sell or rent the residence prior to the decedent’s death. Thus, the court concluded that the value of the residence must be included in the D’s gross estate under §2036.
Didn’t matter that he went to Florida to look for another house because he had made identical trips. Note: Avoiding §2036 by Paying Fair Rent. Inclusion in the gross estate can be avoided if the transferor
pays fair rent for the occupancy, since in that case he or she also has given the income right to the transferee. See Maxwell- no evidence that the rent charged had any relationship to the FMV of the house.
Was there full and adequate consideration? I.e. was it a bona fide sale? In Maxwell’s Estate v. Commissioner-[intra-family agreement so scrutinized to see whether bona fide
arm’s length.] The D sold her house to her son and his wife (the “Maxwells”) for $270,000 (its FMV), forgiving $20,000 of the purchase price (which was equal in amount to the annual gift tax exclusion to which she was entitled- this paid down principal) and accepting a $250,000 mortgage note for the balance. Each year during her life, the decedent forgave another $20,000 on the note, and the outstanding balance at her death was forgiven in her will. The decedent continued to occupy the house until her death and leased it at a monthly rental of $1,800. Maxwells pay costs going forward so no problem like in Rapelje. D pays rent and Maxwells pay interest—so rent is equal approximately to the interest due in each year. Held. implied agreement that the D would continue to live in the house until her death; the lease was
“merely window dressing” and had no substance. Reasoned that: (1) the D had sole possession of the 41
residence until her death; (2) there is no evidence that the Maxwells ever intended to occupy the house themselves or to sell or lease it to anyone else during the D’s lifetime; (3) the rent paid by the D to her son came remarkably close to matching the mortgage interest which he paid to her; and (4) the forgiveness of the entire mortgage debt either by gift or testamentary disposition. Moreover, the court concluded that the sale-leaseback transaction was not a bona fide sale. The court reasoned that the note had no value at all since there was an implied agreement between the parties that the Maxwells would never be called upon to make any payment to the decedent. In other words, at the time of the transaction, there was no real expectation of repayment or an intent to enforce collection of the indebtedness. Thus, the value of the house must be included in the D’s gross estate under §2036(a)(1) since she retained possession and enjoyment of the property for life.
Dissent said there was real economic substance here. Note: Avoiding Inclusion Under §2036(a)(1). The D in Maxwell should have instead made a gift to
the Maxwells in the amount of the annual gift tax exclusion, which the Maxwells would then use to pay down the principal and interest on the $250,000 note. This scheme will likely be more sustainable on audit if the timing and amount of the reciprocal payments are varied. Could also have made a qualified personal residence trust: remainder interest has low gift tax value (based on life expectancy and 7520 rates); at end of term, residence is owned by Bs; need a formal lease.
Note: Bona Fide Sales with Creation of Partnership—see below in FLP. Is it satisfying a legal obligation of support: D is deemed to have retained possession or enjoyment of the
right to income from property if the property or its income is to be used to the discharge of his legal obligations or for his pecuniary benefit. (20.2036-1(B)(2)) D as (or related/subordinate) trustee: if has discretion to use the income or principal or both for the
support of her children or spouse then included in D’s gross estate if she dies when children are minors or while she is married. Because the D is the trustee, she is in control and can decide whether or not to use the trust property to discharge her legal obligation. (Gokey- trustee was wife).
Independent, unrelated, non-subordinate T’ee: in D’s gross estate only if the T’ee is req’d to distribute income (or principal) for support of D’s minor children or spouse or if the trustee is in fact doing so.
The court in Gokey’s Estate v. Commissioner found that the separate irrevocable trusts created by the D for each of his two minor children were in fact for the support of the children even though the TP argued the standard of distribution was much wider than support because the language of the trust required that “the Trustees shall use such part or all of the net income... for the support, care, welfare and education of the beneficiary.” In making this determination, the court relied on Reg. §20.2036-1(b)(2), stating that the use, possession, right to income or other enjoyment of transferred property was retained, within the meaning of §2036(a)(1), to the extent that it is applied toward the discharge of a legal obligation of the decedent to support a dependent.
Held: D’s GE includes the value of the trusts’ property. The court emphasized that the trust mandated the trustee to use income for support and that the trustee did not have discretion.
Note: permissible Trust Provisions. The result in Gokey would not have been reached if the trust instrument provided that either: (1) “the trustee (not the settlor) may accumulate the trust income until the children reach the age of 18”; or (2) “the trustee may pay income from the trust to the children at his discretion, but not for their support until they reach the age of 18.” What if the trust instrument provided that “the trustee may pay income from the trust to the
children at his discretion but can pay for support only if not forthcoming from any other source?” Perhaps §2036 is not applicable because the power to pay income from the trust is subject to a contingency which may not occur before the settlor’s death
Note, if the settlor is the trustee, §2036(a)(1) applies even though the income “may be” applied to defray the decedent’s legal obligation. Reg. §20.2036-1(b)(2)
Custodian Accounts. If a donor dies while acting as custodian for his or her minor child, courts have held that the custodial property is includible in the donor-custodian’s gross estate under §2036(a). Ex: D transferred 300k to an account she established in a local bank for her child, age 10, under UGMA. D designated herself as custodian of the account. Died the next year. Note: Tax Planning to Avoid §2036. Inclusion under §2036(a) can be avoided by naming another
The following is another way to avoid §2036(a) while retaining control of the custodial property: Suppose the husband transfers property to a custodian account for the benefit of his child. The wife is named the custodian and invests the custodial property into a partnership in exchange for a 99% limited partner interest. The husband invests some additional property in the partnership in exchange for a 1% general partner interest. As general partner, the husband still has control over partnership distributions to the child even after the child reaches the age of majority. §2036(a) does not apply to this arrangement since the husband-donor is not acting as custodian for his child
Exceptions to 2036(a): bona fide sales, private annuities, purely discretionary trust with regard to both income and principal. (see below) 2036(a)(1) will not apply if the trustee has absolute discretion to distribute income to the decedent. In
that case the decedent doesn’t have a legally enforceable right to the income. Unless:
there is an explicit or even implicit understanding bt the D and the trustee that the trustee will in fact distribute the trust income to the decedent whenever he wants it.
State law provides that the decedent’s creditors can reach the trust income despite the trustee’s sole and absolute discretion, which can occur in states that have not adopted legislation permitting self-settled asset protection or spendthrift trusts
The trustee’s discretion is limited by an ascertainable standard relating to health, educations, maintenance or support I which case the decedent, not the trustee is actually in control of the flow of trust income.
Exception to 2036(a) inclusion: Bona fide sale for adequate and full consideration Exam strategy: Ask whether bona fide sale for adequate money or money’s worth. Kimmel and
Strangi show parameters for bringing kids into business. Was there a real reason for forming the business entity? I.e., Active business or real creditor protection? If just cooling investments or teaching kids, less sanguine. Gifts and tax breaks do not suffice. If not adequate/bona fide, the person who transfers wil have those as retained interests under 2036
D can avoid 2036(a)(1) application if transfer is a bona fide sale for adequate and full consideration. The courts have held that the consideration is adequate and full if the D receives partnership of limited liability member units proportionate to his contribution to the business. The bona fide sale requirement is only met if the D has a legitimate, nontax business reason for creating the company. All the facts and circumstances are relevant in determining whether or not such a reason exists, and each case is decided on its own merits:
Must have: full and adequate consideration – where assets are transferred into a partnership in exchange for a
proportional interest therein, so sale does not deplete the estate bona fide sale – “in good faith”; objective standard – does the sale serve a substantial business or
non-tax purpose? There must be a valid business purpose of the partnership to avoid inclusion in the gross estate Does not meet exception of only a paper transaction without substance. Kimbell Subject to heightened scrutiny where sale between family members Kimbell
Sufficient non-tax business reasons: Involving children in the family business (so long as the children actually get involved /
Pool assets Estate v. Stone: D created FLPs with his kids and transferred ongoing businesses to each
of them. The D created the partnerhsips to transfer management of the businesses to the children and settle disputes among the children regarding the operation of the businesses. The children had been active in the businesses before the transfers and assumed more significant management responsibilities afterwards.
Putting in place a mechanism to resolve disputes among partners Estate v. Stone
Creditor protection stemming from limited liability of the partners Kimbell v. US D transferred working interests in oil and gas properties that required active
business management and other trust assets to an FLP. Other justifications for the transfer included protection from creditors, centralizing management of investment assets, and preserving property as a separate family property.
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A discounted valuation of a pro-rata partnership interest does not preclude a finding that the interest is adequate consideration for the assets transferred
Issue: whether Mr. Kimbell has to include assets he transferred to partnership No, full and adequate consideration and real business reason for forming the corp.
Retain those holdings and to perpetuate investment philosophy: Estate of Schutt: D transferred DuPont and Exxon stock, which were significant portion of
family wealth, to a FLP- own buy and hold philosophy Estate of Miller: managed according to husband’s charting stocks investment philosophy.
Consolidating assets for purposes of a liquidation event (so that assets can be sold all together on liquidation) Estate of Bongard v. Commissioner Estate of Mirowski: D created LLC after her husband’s death when his invention (artificial
pacemaker!) royalties increased to millions. Wanted to jointly manage with daughters and reate a single pool for investment opportunities and providing for each of her 3 daughters on an equal basis.
Insufficient nontax business reasons Strangi: D transferred almost all of his asets to the partnership. The court rejected every
claim justification for creation of the partnership finding noneed for protection against a potential will contest by D’s step-children or aginst a potential claim by his housekeeper. Court also found that the partnership was not justified either as a joint venture of by need for centralized and active management of ivestments. Primary assets were brokerage accounts that continued to be managed the same way after creation of the partnership. possession/enjoyment includes assurance that assets will pay expenses/debts after death deferral of rent payments until after death (paid by estate) = economic benefit to deceased decedent’s lack of liquid assets after transfer evidenced implied agreement for his
enjoyment Bigelow: no pooling of assets and no change in management. Facilitating gift-giving program
is not nontax business purpose. Rosen: assets were marketable securities and cash and the partnership engaged in minimal
business or investment opportunities. D was 88 years old and had Alzheimer’s when she created the partnership,transferred almost all of her assets into it and remained financially dependent on those assets.
Hurford: needed to either be functioning business or some meaningful economic activity! One partnership held only cash and marketable securities and all investment decisions continued to be made by Chase Bank. One parnerhips held only phantom stock (could only be held or cashed out) and one collected rents because the D had leased all of the real estate prior to creation of the partnership.
Note that according to a recent case (katz’s good practice), taxpayers contemplating FLP planning should retain sufficient assets to support themselves for the remainder of their lives and to pay the estate tax that will be due upon death
Discounts for minority interest and lack of marketability: Because minority interests in a business may be entitled to a discounted value to reflect minority status, TPs transfer their property to a family LP or LLC. When the TP transfers interests in the entity to his children, those gifts will have a discounted value because they represent only a minority interest in the entity. If the D is successful in transferring a significant percentage of the entity in this way, he will only own a minority interest at death and again receive a minority discount. If interests in the entity are subject to restrictions or transferability, they will enjoy further discounts. Form v. substance: this planning technique tends to elevate form over substance. Courts will disregard
the form and tax the substance when the taxpayer ignores the formalities and treats the partnership property as his own. the TP is too greedy (ex: by transferring all of his assets, often including personal residence into
partnerships). there is no legitimate business purpose other than tax avoidance for creating the partnership.
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Ex: Suppose that a parent contributes $99 to a FLP in exchange for a 99% interest in the partnership and his child contributes $1 in exchange for a 1% interest. Is the $99 transfer a bona fide sale for an adequate and full consideration? If so, §2036 does not apply at all.
Courts will apply 2036(a)(1) to determine if the decedent has retained use, possession or enjoyment of the property. Court will find such retention where D has retained a substantial economic benefit from the transferred property which exists if there is either an express or an implied agreement that the transferred property will be used for the D’s benefit. Ex: Suppose a partnership has two partners: (1) a corporation, which is owned 100% by husband,
as a 1% general partner; and (2) husband as a 99% limited partner. The husband transfers his 99% limited partner interest to his children. As general partner, the husband (through his wholly-owned corporation) controls the children’s enjoyment of the partnership property and income by controlling distributions to them. Thus, under §2036(a)(2), the husband has the right “to designate the persons who shall possess or enjoy the property or the income therefrom,” and the value of the partnership interest is included in the husband’s gross estate upon his death This result can be avoided by transferring the husband’s limited partnership interest to his wife
before the wife transfers the interest to their children. In this way, the wife is the transferor, while the husband retains the §2036(a)(2) right. Consequently, §2036(a)(2) is inapplicable
RETAINED BUSINESS INTERESTS: 2036(b) might apply if D retains right to vote stock or right to preferred stock. Right to vote stock (2036(b)):
The right to vote stock does not give the decedent power to control the beneficial enjoyment of the stock. (Byrum) because the decedent had fiduciary obligations to the minority shareholders and because he was not trustee and thus could not control the distributions from the trust. 2036(b)(1): for purposes of subsection (a)(1), retention of right to vote (directly or indirectly) shares of
stock of a controlled corporation shall be considered retention of enjoyment of transferred property. (b)(2) Controlled corporation—at least 20% of the total combined voting power of all classes of
stock during last 3 years. In United States v. Byrum, a trust grantor who could not appoint himself as trustee because needed
corporate trustee transferred voting stock in certain closely held corporations to a trust to pay income to his children and reserved the right (1) to vote the shares of stock; and (2) to disapprove the sale or transfer of any trust assets, including the transferred stock. Settlor owned 71%. The IRS argued that the decedent’s voting control of the corporations amounted to a taxable accumulation power under §2036(a)(2) by way of being able to withhold dividends from the trust. However, the Supreme Court rejected this argument on several grounds: (1) The power over corporate
dividend policy was in the board of directors, and the members of the board were at most subject to the decedent’s power of persuasion in the context of their fiduciary duties under corporate law to all stockholders; and (2) the trustee of the trust possessed an intervening right to accumulate income in case the corporate board flooded the trust with dividends. Thus, the Court determined that such retained powers did not cause inclusion in the gross estate
Byrum was overruled by 2036(b) which provided that the right to vote will be retention of the enjoyment of the transferred prop if the corp is controlled by the D. Control means that the D during the 3 year period ending on the DOD owned or had the right to vote stock possessing at least 20% of total combined voting power of all classes of stock. This attribution rules of 318 apply to determine D’s ownership of stock. Congress acted to overrule the Byrum result by enacting §2036(b). This provision states that the
retention of the right to vote (directly or indirectly) shares of stock of a controlled corporation shall be considered to be a retention of the enjoyment of transferred property under §2036(a)(1). A “controlled corporation” is defined as a corporation in which the decedent at any time after the transfer of the property and within 3 years before death owned, either actually or constructively by application of §318, or had the right to vote, at least 20% of the total combined voting power of all classes of stock. What is an indirect voting right? Ex, if D transferred stock in trust with an understanding or
agreement that the trustee would vote stock in accordance with directions from the decedent, the trustee’s voting rights may be attributed to the D. On the other hand, a D is not treated as having retained the right to vote stock transferred in trust merely because a relative was the trustee who
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voted the stock. Thus, the D in Byrum could have also avoided application of the later-enacted §2036(b) by designating his wife to vote the shares of stock transferred to the trust
§2036(b) Does Not Apply to Partnerships. By its terms, §2036(b) applies to transfers of stock in a controlled corporation; it has no application to transfers of interests in a partnership.
Applicable retained interests/Estate freezes (2701): Comes into play with transfer of stocks
Give low-value common stock to kids, pay gift tax but younger generation gets appreciation value Keep preferred stock with relatively high value and dividends Ex: Assume the D owns all the stock in a co and wants to transfer ownership of the co to his daughter
with the least EGTs. D transfers his common stock back to the co and receives in return 2 classes of stock: preferred and common. D structures the preferred stock to absorb most of the current value of the co. D then transfers common stock, with it all future appreciation of value of co, to daughter. With little or no value in the common stock, D will pay no gift tax. When D dies, only the value of the preferred stock will be in his GE under 2033. The D has frozen the value of his asset at its value at the time of the gift to his daughter. If D doesn’t enforce his right to dividends on preferred stock, he can shift additional value to his daughter at no extra cost.
2701 Applies applies to a transfer of interest I a corporation or partnership to a member of transferor’s family where transferor or family member retains any applicable retained interest except for interests for which market quotations are readily available retained interest then = 0 value.
Section 2701(a)(4) requires that the junior equity, the common stock transferred to the next generation have a value = of the greater of 10% of all equity interest plus any debt owed the transferor or an applicable family member. This prevents D from shifting all future appreciation to next generation at no gift tax cost.
2036(a)(2) and 2038(a)(1)- retained power to determine enjoyment of property In general: When the D has the power to control the beneficial enjoyment of the property, that prop will be
included in her gross estate under 2036(a)(2) or 2038(a)(1). The provision that will cause the greatest value to be included will control, but there will never be more than 100% of the property’s value included in the GE.
§2036(a)(2) provides that the value of the gross estate “shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth) by trust or otherwise under which he has retained 1. for life 2. for any period not ascertainable without reference to his death or 3. for any period which is not does not in fact end before his death (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.” look above for ending before death and ascertainable without reference to death ex. Ex: D transfers prop in trust, income to A for life, remainder to B and names herself trustee. D retains the
right to not pay income to A and instead accumulate for B. B will obtain possession of the accumulated income at the same time that he takes the corpus. All of this is includable in D’s estate under 2036(a)(2) Don’t have to be trustee to control. Answer doesn’t change if D names T, whose not related/
subordinate to serve as trustee and D retains right to compel T to accumulate income and add it to B’s remainder interest.
Note, for 2036, has to be during life: so if Karen reserves right to designate who will receive trust property in her will then NOT 2036(a)(2) but will come in under 2038(a)(1).
I.e. Karen creates an irrevocable IV trust with FNB to distribute income to children and grandchildren. K reserves right to designate who will receive trust property in will. 2038(a)(1) includes only the remainder because she does not have power to amend the income interest. If
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Karen had power, exer in will to add or eliminate income beneficiaries as well as remaindermen, then entire dod value of trust will be in gross estate under 2038(a)(1).
Meaning of reserved right: The right to designate the person or persons who shall possess or enjoy the property or income includes a reserved power to designate the person or persons to receive the income or to possess or enjoy nonincome producing property during the D’s life or any other period. (20.2036-1(a).)
(20.2036-1(a).) Immaterial
Whether power exercisable alone or only in conjunction with others regardless of whether other has an adverse interest.
Whether the exercise of the power was subject to a contingency beyond the D’s control which did not occur before his death.
Designating persons has nothing to do with a power over the transferred property itself which does not affect the enjoyment of the income received or earned during the D’s life (that’s what 2038 is for). Nor does it apply to a power held solely by another person than the D (unless the D reserves the
unrestricted power to remove the trustee and appoint self then seen as having powers of trustee). §2038, In general: the gross estate includes any property transferred during the D’s life if the D possessed at the moment of death the power to alter, amend, revoke or terminate alone or in conjunction with anyone or where that power is relinquished during the 3-year period ending on the date of the decedent’s death.§2038(a)(1), includable if a decedent made a lifetime transfer (except in the case of a bona fide sale for an adequate and full consideration in momw) of an interest in property and if at the time of death the enjoyment of the interest remains subject to a change through the exercise of a power held by the decedent alone or in conjunction with another person[i.e. doesn’t matter if the person has an adverse interest here] (3) to alter, amend, revoke, or terminate the transfer (or where any such power is relinquished within 3 years of his death) the interest subject to such power will be included in the decedent’s gross estate. I.e. brings into gross estate
The property transferred by the decedent If the decedent has the power to alter amend, terminate or revoke and
Ex: Including an power affecting time or manner of enjoyment; i.e. to accumulate income even if only one person will get the income and the remainer. (1(a)(3))
The decedent had the power at the moment of death. Power deemed to have existed at death even relinquished within 3 years of death Power deemed to have existed at death even (1(b)).
If it could not be exercised without prior notice or if the revocation would be delayed after the exercise of the power or or, under Porter v. Commissioner, if reservation of a power to alter or amend a transfer of property will
result in inclusion of the property in the decedent’s gross estate even though the power could not be exercised in favor of the decedent or his estate. Therefore, per §2038, a power to name new benes or to rearrange the beneficial interests among a
limited class of beneficiaries will produce inclusion in the gross estate Power to revoke doesn’t disappear because holder is incompetent. Different from gift tax: to change timing here counts as a power to alter enjoyment). 20.2038-1(a)(3) Exceptions: if there’s a contingency; if the power to alter enjoyment is subject to an ascertainable standard,
however, property is not includible in gross estate under 2038. Exception for 2038 only- Power Subject to a Contingency. Reg. §20.2038-1(b) states that §2038 is not
applicable to a power the exercise of which was subject to a contingency beyond the decedent’s control which did not occur before his death (i.e., a power that can only be exercised if a specific contingency occurs). Reg. §20.2036-1(b)(3) is not limited this way. In Jennings v. Smith d created irrevocable trusts for his kids. By the terms of the trust, the trustees (of
whom the decedent was one) were given power in their absolute discretion to use any or all of the trust income as they determined “reasonably necessary to enable the beneficiary in question to maintain himself and his family, if any, in comfort and in accordance with the station in life to which he belongs.” Also, the trustees had the power to invade the trust corpus in the event the beneficiary in question “should suffer prolonged illness or be overtaken by financial misfortune which the trustees deem extraordinary.”
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Held. that since the benes had not suffered prolonged illness or financial misfortune (i.e., since the contingencies had not happened before the decedent’s death), the D’s power to invade the trust corpus did not bring the trust property within the reach of §2038. Similarly, the contingency that would justify exercise of the power to distribute trust income had not happened before the decedent’s death. Therefore, the trust income was also not includible in the decedent’s gross estate under §2038.
Note: for ascertainable language standard- Can go in and say look how we've lived up to now and give us the money to live in this want similarly.
Similarities between 2036(a)(2) and 2038(a)(1) Note: They apply regardless of whether power is exercisable alone or in conjunction with others—this
means unlike gift tax 25.2511-2(e), no safe harbor if that other person has a substantial adverse interest. Judicial exceptions developed to the inclusion rule. The portion that is HEM-ed will not be included.Similarity Examples: D created an irrevocable trust to pay the income to her children for their lives. After death of all the D’s
children, the trust property is to be distributed to her descendants. There are 3 T’ees, one of whom is D. D has the discretion to add or delete income or remainder benes as long as all trustees agree. Answer: The trust will be in Decedent’s gross estate under 2036(a)(2) and 2038 because D has retained for her life the right to determine who will enjoy the prop and has at the moment of her death, the power to alter, or amend the trust. Doesn’t matter under either one that can only act in conjunction with other 2 trustees
D creates an irrevocable trust, transferring property to himself as trustee to pay income to his son, A for life, At A’s death, the trust property is to be distributed to A’s surviving issue. D retains the right to revoke the trust, but only with As consent. Upon revocation, the trust property reverts to D. Answer: includable under both. Irrelevant that Adam must consent and never would because has substantial adverse interest.
Differences between 2036(a)(2) 2038(a)(1)retained for life without reference to death or for period that does not end before death
power exists as of date of death (need not be retained) and applies regardless of power source
applies even to right exercisable in a contingency, regardless of whether contingency occurs
does not apply to contingency power if contingency did not occur before DoD
requires inclusion of entire property inclusion only of spec. prop subject to D’s pwr.That is: 2036 looks at life (period without reference to death or doesn’t end just before death) v. 2038- looks at exact
time of death. 2036 explicitly applies regardless of contingency not being met whereas 2037(a)(1) doesn’t apply to
contingency power if contingency didn’t occur before DOD. 2036 will generally include more...2036 requires inclusion of entire property whereas 2038 requires inclusion
only of specific property in D’s power (control income or remainder?) If both apply as often do, then rely on whatever is more (probs 2036)
Differences example: D establishes an irrevocable IV trust with himself as trustee or the benefit of son, S. Trustee is required to pay
the income to S at least quarterly. At S’s death, the trustee is to distribute the trust property to S’s issue. The trustee has the sole and absolute discretion to distribute some or all of the trust property to S after his marriage. S does not marry before D’s death. The ability to distribute corpus is a power to determine who will enjoy the trust property and 2036(a)(2) applies. It is immaterial that the power to distribute the trust property is subject to a condition that has not in fact occurred and over which D has no control. (20.2036-1(b)(3). Section 2038(1)(1) doesn’t apply because the contingency had not occurred before D’s death. (20.2038-1(b).
M creates an irrev IV trust and is serving as trustee when she dies. Trustee is to distribute income quarterly to daughter, R, and trustee also had power to distribute principal to R but only if her H died or divorced. Not included under 2038(a)(1) bc her power is subject to a contingency that never happened Will be included under 2036(a)(2).
Note: Amount Included in Gross Estate. the entire interest subject to such power will be included in the decedent’s gross estate. The value of such interest is its FMV on the date of the decedent’s death. Note: Powers Not Affecting “Enjoyment.” §2038(a) does not reach powers to alter, amend, revoke or terminate unless an exercise of the power will change “enjoyment” of the transferred interest in property. Under this theory, trust property has escaped inclusion under §2038 despite the grantor’s retention of the following powers: (1) a
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power to add property to the trust; (2) a power to substitute property of “equal value”; and (3) a power to amend the trust to clarify the original language (e.g., to reflect changes in the tax law), if it does not enable the grantor to “shift economic benefits” Courts have disagreed on whether a power to amend the trust to enlarge the power of a trustee to shift enjoyment of the property among the beneficiaries constitutes a power to change “enjoyment” of the transferred interest in property.
Transfer. Section 2038 focuses on power had at moment of death to alter, amend, revoke or terminate transfer but 2036(a)(2) includes in gross estate any property transferred by D when D retains right to designate persons who will possess or enjoy property or income from it. Note: both sections require the D actually make the transfer of the property that is to be included in GE. United States v. O’Malley, the settlor named himself a co-trustee and gave the trustees discretionary pwr
to distribute income currently or accumulate it and add it to corpus. The inclusion of the original principal was not in dispute; rather whether the accumulated income should be included in the D’s estate. Issue: whether the decedent had ever “transferred” the income additions to the trust principal. Holding: The court answered in the affirmative, noting that all income increments to trust principal
were traceable to the D himself by virtue of (1) the original transfer and (2) the exercise of the power to accumulate. Thus, the ct found that the accumulated income should be included in the decedent’s gross estate since he should be treated as transferring the accumulated income to the trust.
Note: Someone Else Transfers Property to Avoid §2036. Assume that the decedent-husband had transferred property to a trust for the benefit of his children. The decedent is the trustee, and the trust instrument provides that the trustee may distribute the income or corpus from the trust at his absolute discretion. Upon his death, the trust property will be included in the decedent’s estate pursuant to §2036(a)(2) since the decedent, as trustee, retained the right to “designate the persons who shall possess or enjoy the property or the income” from the trust. In other words, the decedent is empowered to distribute the trust income to the income beneficiaries or to accumulate it and add it to the principal, thereby denying the income beneficiaries the privilege of immediate enjoyment. How can this result be avoided? The decedent’s wife (or any other person) should have transferred the property to the trust. Care should be taken to document that this transfer was from the wife’s separate property. The decedent may still be named the trustee of the trust and retain control over the distribution of the trust income and corpus to his children. This arrangement is permissible because the husband is not the same person transferring property to the trust.
36/38: Power to Designate/Remove Trustees- enough control to include in gross estate? A settlor who keeps the power to designate himself as a trustee will be treated as holding all administrative and dispositive powers of the trustee, even if the settlor never actually designated himself as a trustee or never exercised any powers as a trustee. It is immaterial whether the settlor retained the power to remove the existing trustee from office. (So could, under 36 affect who get it and 38 affect when). In Farrel’s Estate v. US, the D established an irrevocable trust for the benefit of her grandchildren. Two
individuals were names as trustees, with discretionary power to distribute or accumulate all or part of the income from the trust. The trust instrument provided that the decedent could appoint a successor trustee if a vacancy occurred, but she could not remove a trustee and thereby create a vacancy. Moreover, the trust was silent as to whether the decedent could appoint herself as a successor trustee in the event of a vacancy. The court held that the contingent right of the decedent to make herself a trustee in the event of a
vacancy was a legally enforceable right, which bore directly on the designation of the persons to possess or enjoy the trust property or income under §2036(a)(2). Thus, the court held that the trust property must be included in the decedent’s gross estate.
Estate of Wall v. Commissioner- retained the right to remove the corporate sole trustee and replace it with another corporate trustee, which has to be independent. Court said right to replace did not equal the right to exercise the powers of the trustee. She might have thought a beneficiary could move away or something making it impractical to maintain personal contact with the trust department. Not equivalent to retained rights. Ms. Wall did not retain an ascertainable and enforceable power to affect the beneficial enjoyment of the trust property.
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Rev. Ruling 95-58- Questioned whether a grantor’s reservation of an unqualified power to remove a trustee and appoint a new trustee (other then the grantor) is a reservation that will include in in 2036(a)(2). Nope, not includable. If can be yourself or someone you can control, that's different. An independent trustee is presumed to be acting in bene's best interest. Needs to be a corporate successor not related or subordinate or individual. The IRS generally equates independence with the status of being other than a “related or subordinate
party” within the meaning of §672(c). Thus, if the grantor retains the power to remove and replace the trustee with a related or subordinate party, the property is included and the gift will be deemed incomplete. A related to subordinate individual is someone who does not have a substantial beneficial interest in the trust which would be adversely affected by exercise or nonexercise of power and who is either 1. The grantor’s spouse (but only if living with the grantor), parent, issue, sibling or employee (2) a corporation or employee of a corporation in which the grantor has significant control or 3. An employee of a corporation in which the grantor is an executive.
Ex: Dan sets up trust and reserves right to remove trustee and replace with anyone other than himself or his spouse. Still included because there are other related or subordinate parties as defined in 672(c).
Power to Distribute or Accumulate Income- included If the settlor-trustee retains the discretion (“alone or in conjunction with any person”) to distribute or accumulate income, the trust property will be included in the settlor’s estate pursuant to §2036(a)(2) since the settlor, as trustee, retained the right to “designate the persons who shall possess or enjoy the property or the income” from the trust. In other words, the settlor is empowered to distribute the trust income to the income beneficiaries or to accumulate it and add it to the principal, thereby denying the income beneficiaries the privilege of immediate enjoyment. In United States v. O’Malley, the settlor named himself a co-trustee and gave the trustees discretionary
power to distribute income currently or accumulate it and add it to corpus. The court held that because the trustees retained the right to distribute or accumulate income, they could deny to the income beneficiaries the privilege of immediate enjoyment of that income. This power is sufficient to be deemed the power to designate the person who was to enjoy the income and property from the trust. Thus, the court held that the settlor must include all the trust principal, including the accumulated income, in his gross estate.
Note: §§2036(a)(2) and 2038(a)(1). When the IRS argues that a settlor-trustee’s power to distribute or accumulate trust income constitutes a right to “designate the persons who shall possess or enjoy the property or the income” from the trust under §2036(a)(2), it will also tend to argue that this same power constitutes a right to terminate the trust and distribute all of the trust property to designated beneficiaries under §2038(a)(1).
Exception: Ascertainable standards: Neither 2036 not 2038 make any reference to ascertainable standards but courts have interpreted these sections to include the exception. Powers that are limited by ascertainable standards relating to health, education, maintenance and
support will not cause inclusion under either 2036(a)(2) or 2038(a)(1). Note: Typically, this rule comes into play where the grantor names himself trustee and retains the power to
distribute income or invade the trust corpus for the “health, education, maintenance or support” of the beneficiaries
Rationale: we care about control- benes can go into court and say give me a payment… Powers limited by an ascertainable standard include:
“reasonably necessary to enable the beneficiary in question to maintain himself and his family…in comfort and in accordance with the station in life to which he belongs”, Jennings
“in the case of prolonged illness or financial misfortune,” Jennings “in the case of sickness” Old Colony “support and general welfare- maybe Leopold Emergency is ascertainable. 25.2511-1(g)(2)
Powers NOT limited by ascertainable standard include: “desirable in view of changed circumstances”; “best interests” Old Colony Trust “if necessary and proper”- Leopold comfort, welfare, and happiness
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In Old Colony Trust Co. v. United States (2036), the trust instrument provided that the settlor-trustee could, in his absolute discretion, increase percentage of income payable to the income beneficiary “when…such increase is needed in case of sickness, or desirable in view of changed circumstances.” In addition, the trustee had the discretion to cease paying income to the income beneficiary and add it all to principal “during such period as the [trustee] may decided that the stoppage of such payments is for his best interests.” The court held that both “sickness” and “[if] desirable in view of changed circumstances” constitute
ascertainable standards. In particular, the court concluded that the latter standard is “roughly equivalent to maintaining the [income beneficiary’s] present standard of living.” In contrast, the court held that the “best interests” standard is so loose that the trustee is in effect uncontrolled.
In Leopold v. United States, Look for the “Magic Words.” the decedent had created trusts for his daughters naming himself as co-trustee and giving the trustees the power to pay income for the beneficiaries’ “support, education, maintenance and general welfare” or to accumulate the income and pay it over to each beneficiary when she reached age 21. In addition, the trustees had the power to distribute the trust corpus to any beneficiary to the extent the trustees judged such a distribution to be “necessary and proper.” The court held that the trustees’ power to pay or accumulate income for the beneficiaries’ support,
education, maintenance and general welfare was subject to an ascertainable standard. The trustees were “required” by the standards to distribute only that part of the income as was necessary under the standard, and the daughters had an enforceable right to enjoy that portion of the trust income. Therefore, the actuarial value, at the time of the decedent’s death, of this portion of the outstanding income interest was excluded. The accumulated income interest was likewise excluded since the trustees could not prematurely distribute the accumulated income (unlike the trust corpus); the accumulated income would be paid to the daughters when they reached 21.
Moreover, the court held that the trustees’ power to distribute trust corpus as they thought “necessary or proper” was not subject to an ascertainable standard. Thus, the court required the corpus of each trust to be included in the decedent’s gross estate under §2038(a)(1).
focus on best interest/necessary and proper is difficult to ascertain whereas health/accustomed manner is ascertainable
Exception: Administrative Powers. In general: Trustees’ administrative and management powers can include power to invest the trust money,
to buy and sell trust property, to allocate receipts between income and principal, to borrow money, etc.. These powers (though they can affect the beneficial enjoyment of the property) will not cause the trust to be included in the D’s gross estate under 2036(a)(2 or 2038(a)(1).
Rationale: the decedent as trustee is bound by fiduciary obligations in exercising these powers and is subject to review and control by the court. As a result, the D does not have unfettered control to determine beneficial enjoyment.
In Old Colony Trust Co. v. United States, the court held that administrative powers do not constitute powers to designate the persons who shall possess or enjoy the trust property or income and are, therefore, not subject to §2036. These administrative powers may include the discretion to acquire investments and the right to determine what is to be charged or credited to income or principal. The IRS tried to argue that broad administrative powers pertaining to trust investments and trust
accounting could, in substance, be powers to accumulate income and/or invade trust principal. The idea was that a power of a trustee to invest in non-income-producing growth property or to treat receipts as “principal” amounted to a power to accumulate and that, by the same token, a power to invest in income-producing property or to treat receipts of property as “income,” amounted to a power to invade the trust property for the income takers. The court rejected this argument. Instead, it relied on the fundamental principle of the law of trusts to the effect that such powers are never beyond the ultimate control of a court of equity to prevent abuse of the respective interests of income and remainder beneficiaries.
Holding onto admin powers (even though can invest, mortgage, loan) of trustee short of distributing it...those powers aren’t enough to be powers that would subject trustee to determining what possesses/enjoys property.
Reciprocal Trusts- included. 51
In general: The transferor cannot circumvent §2036(a)(2) or 2038 by using a “conduit” to avoid retention of an interest in the property transferred.
An objective test: It is enough that the trusts are inter-related and leave the parties in the same economic position they would have been in if they had created trusts for themselves (Grace). Reciprocal trusts From Grace – does not matter if there was not a deal, court looks at whether trusts are interrelated and
settlers are in same economic position Do the two vehicles look so similar that the donor is trying to give more money to his family?
What they are: If one person transfers property to another person under an agreement or understanding that the transferee will make a transfer in trust with income to be used for the benefit of the first person for life, with remainder at death to other beneficiaries, the first person will be viewed as the grantor or transferor of property with a retained life estate.
Policy: thought form of a transaction usually governs and taxpayer have a right to structure their affairs to minimize impact of taxes, when they ignore the formalities or subvert the form, courts will exalt substance over form to prevent tax evasion. If quid pro quo trusts, the court will strike down and include the property in your estate.
Exam strategy: remember reciprocal trust doctrine can be extended to transfers that are not in trust. There does not need to be an agreement, only inter-related transfers that leave parties in approximately same position as if made transfers themselves.
Example. H and W, each owning separate property, establish separate trusts for each other’s benefit. The husband’s trust gives the wife a life estate with remainder to their children, and the wife’s trust gives the husband a life estate with remainder to their children. If the two trusts are of approximately equal value and are established around the same time, each spouse will be treated as the grantor of the trust created by the other spouse on the ground that they each established an equivalent trust with reciprocal benefits
In United States v. Grace’s Estate, the husband created a trust with income to his wife, and the wife created a trust, virtually identical in terms, about two weeks later with income to her husband. The Supreme Court stated that the test to be used is whether or not the trusts were “interrelated” and the principal factor to be considered was “whether the trusts created by the settlors placed each other in approximately the same objective economic position as they would have been in if each had created his own trust with himself, rather than the other, as life beneficiary.” The Court rejected a test involving the subjective intent of the settlors since this intent is difficult to determine.
Applying this test to the present case, the court concluded that the value of the trust created by the wife must be included in decedent-husband’s estate for federal estate tax purposes. The two trusts are interrelated because: (1) they are substantially identical in terms; (2) they were created at approximately the same time; (3) the transfers in trust left each party, to the extent of mutual value, in the same objective economic position as before.
Red flags: right before new gift tax; same time. They don't care about subjective tests-- they say objectively, these parties in same economic situation. Look at substance rather than form
Note: Factors Relevant in Ascertaining “Interrelatedness.” The following factors should be considered in ascertaining the requisite objective interrelatedness: (1) The relative sizes of the trusts; (2) the relationship of the settlors; (3) the identity of the trust provisions; and (4) the relative contemporaneousness of creation.
Note: Avoiding the “Reciprocal Trusts” Doctrine. The reciprocal trusts doctrine can be circumvented by varying the terms of the trust provisions. For example, one of the trusts can provide that the trust corpus will be distributed to the beneficiary upon his attaining age 30, while the other trust can provide for a distribution at age 35. Alternatively, one of the trusts can grant the beneficiary a limited power of appointment.
Reversions—2037 2037. “the value of the gross estate shall include the value of all property to the etent of any interest therein of
which the decedent has at any time made a transfer…(except in the case of a bona fide sale for an adequate and full consideration in money or money’s worth) by trust or otherwise…Under §2037(a), the gross estate includes interests gratuitously transferred by the decedent during life if: (1) the beneficiaries can obtain
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possession or enjoyment only by surviving the decedent; and (2) the decedent possessed a reversionary interest that was worth more than 5% of the value of the property immediately before death
Definition: A reversion is a future interest in proepty that is retained by the transferor. There are 2 sections that govern reversions. 2033 and 2037.
Pattern: Income to A for life, then to D if living, otherwise to B. Applies if:
the decedent made a transfer in trust or otherwise the possession or enjoyment of the property can be obtained only by surviving the decedent and the decedent retains a reversionary interests and the value of it immediately before the decedent’s death
exceeds 5% of the value of the property. Note, like 2036 and 2038 there is an exception for bona fide sales for adequate and full consideration in
money or money’s worth. Rationale: testamentary effect. Examples:
D creates an irrevocable IV trust to pay income to A for life. At A’s death, the trustee is to distribute the trust property to D if he is living, otherwise to B. D predeceases both A and B. The value of the trust property minus the value of A’s life estate will be in D’s gross estate if his reversion, value under the applicable valuation tables, exceeds 5% of the value of the trust property. In this situation, B will only obtain possession of the trust property if D dies before A. If A had died first, the trust property would have been distributed to Dwight.
Does 2037 apply if: D establishes a trust to pay income to A for life, remainder to B
2037 doesn’t apply, once trust is established, D’s death is irrelevant D establishes a trust that accumulates income for 30 years then distributes to B
2037 doesn’t apply, once trust established, D’s death irrelevant D establishes a trust to pay income to A for life, remainder to B if living, otherwise back to D.
2037 doesn’t apply, although B must survive A, need not survive D (reversion in estate under 2033; pass from D to heirs at D’s death).
D, with independent trustee to pay income to A for life, remainder to D if then living or If not to B. B must survive to inherit, 2037 If D predeceases A, is transfer out of D’s estate?
2037 doesn’t apply, so long as D has greater than 5% chance of taking (under actuarial tables) What will be included in D’s estate?
Value of trust property minus value of A’s life interest Note: if D’s death is irrelevant but still has a reversion, covered by 2033.
Ex: D creates an irrevocable IV trust to pay income to J for life. At J’s death, the trustee is to distribute the trust property to Amanda if she is living, otherwise to Donna. Donna predeceases J and A. Section 2037 doesn’t apply because Donna’s death is irrelevant; Amanda will obtain possession of the trust property as long as she survives.
Note: will the value of the reversion be diminished because immediately before death, the possibility of the decedent’s survival is almost nonexistent? 2037(b) says reversionary interest will be valued “without regard to the fact of the decedent’s death by
usual methods of valuation, including the use of tables of mortality and actuarial principles, under regulations…
Roy: See also 25.7520-1(b)(3)- use actuarial tables unless decedent is terminally ill when gift is completed- incurable illness or other deteriorating condition such that there is a 50% probability that she will die within 1 year of gift being completed. Cannot use the actual life expectancy of the decedent involved; otherwise, emasculating 2037 and making it only apply in narrow cases where someone is killed suddenly or accidentally.
2035- Transfers within 3 years of death Exam: Just look out for gifts made within 3 years of death. Most of these are not brought back in—only if life
insurance or retained interest or gift tax. Once the gift and estate taxes were unified, there was no longer a need for this really, because gifts are taxed at
same rate as transfers at death and there is one unified exemption amount. But there’s still an advantage to the 53
gift tax being tax exclusive that we want to capture. However, to truly capture that, the gift tax on all gifts would need to be included in the gross estate. Congress hasn’t gone that far.
2035 Gifts Within 3 Years of Death: 2035 basically performs 2 functions: (a) Certain Property Included in Gross Estate. Under §2035(a), if a decedent, within 3 years before death,
transferred an interest (or relinquished a power) which, had it been retained until death, would have triggered inclusion of the underlying property under the following then the value of the property is includible in the gross estate just as if the decedent had actually retained the interest (or power) until death. 2036 (retained life estates or right to possession of property), 2037 (certain reversions), 2038 (retained
power to alter, amend, revoke, terminate) or 2042 (proceeds of life insurance), Note: for 2036-38 to apply, D must have owned the property, made a transfer and retained an
interest that would trigger 2036-8 and transferred that retained interest w/i 3 yrs of death LI: included in gross estate amount receivable by a beneficiary on life of D if D owned the policy
and transferred it within the 3 years immediately preceding his death. Ex: L transfers policy where son is beneficiary to son.
Does not apply if the beneficiary herself, or someone else, purchased the life insurance policy even if they did so within 3 years of death. Ex: S purchases policy on father with S as bene. As long as L didn’t own any incidents of
ownership in the LI policy at his death or did not transfer any incidents of ownership in the 3 years preceding his death, the 500k will not be in L’s gross estate under 2035(a) or 2042(2).
Example. Suppose that A created a trust many years ago to pay income to herself for life with remainder at her death to her kids. Having discovered that if she continues to receive income until death the trust property will be includible in her GE under §2036(a), A assigns her outstanding income interest to the children for no consideration. If she survives for at least 3 years after the assignment, A will succeed in removing the trust property from her gross estate. If she dies within 3 years, however, the trust property will be includible under §2035(a).
Note: Bona Fide Sales. The scope of §2035(a) is limited by §2035(d), which makes the 3-year rule inapplicable to bona fide sales for adequate and full consideration.
(b) Inclusion of Prior Gift Taxes Paid. §2035(b) increases the decedent’s gross estate by the amount of any gift taxes paid by the decedent or the estate on gifts made by the decedent (or by the decedent’s spouse) within 3 years before death it applies to outright gifts as well as gifts of life insurance and retained interests. ex: Terry gave each of her 5 kids 250k and died 18 months later. Her gross estate doesn’t include the
1,250,000 in taxable gifts because these were outright transfers to her children but gift tax she paid on these transfers will be included under 2035(b).
Brown v. US- step transaction. F: Betty is mere conduit of Willet. Willett arranged his will and other docs so the entire estate was
placed in a marital trust. Betty was named the income bene. Insurance trust also created to hold insurance on Betty’s life. Purpose appeared to be payment of estate taxes at Bettys death. To fund the LI trust, W made a gift to Betty of 3.1 million, which was then used to purchase the LI.
Thought it was better for Betty to pay the gift taxes because she was younger than Willet and so more liable to outlive 3 year rule.
Since Betty did not have the financial resources to pay the tax from her separate property, Willet gave her the money to pay the gift taxes in the form of two checks totaling $1,415,732, which she deposited in her own account. The next day she drew two checks from her personal account, payable to the IRS for the identical amount, to satisfy the gift tax liability. Betty was, however, under no legally enforceable obligation to use the funds in that fashion.
W died w/i 3 yrs and estate tax return filed showed no tax liability. IRS said substance over form. If 2 parties to a transaction are sufficiently related…we have…applied the step transaction analysis
w/o any finding that the intermediary was legally bound to comply w/ the prearranged plan.
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Note: Applies to All Gift Taxes Paid. Note that §2035(b) operated independently of §2035(a). Thus, the gross-up requirement applies to gift taxes paid by the decedent on gifts made within 3 years before death, even if the underlying gift is immune from inclusion. Rationale. The function of this “gross-up” of gift taxes is to eliminate any incentive to make deathbed gifts to remove an amount equal to the gift taxes from the decedent’s gross estate. Recall that the gift tax is levied on a net basis, so that gift taxes paid are not included in the gift tax base. The estate tax, on the other hand, is levied on a gross basis, so that estate taxes paid are included in the amount taxed. Gifting vs. Retaining Property Until Death. Advantage of gifting is that any gift tax paid is no longer included in the gross estate and, tf, not subject to estate tax. Disadvantage recipient does not receive a stepped-up basis in the prop.
Transfers for consideration: What if sold rather than transferred? The gross estate doesn’t include transfers that were made for adequate
and full consideration in money or money’s worth. 2036, 2037 and 2038 explicitly exempt them. The sufficiency of the consideration depends on the nature of the interest at issue.
Sale of a life estate: Section 2036(a)(1) includes in the gross estate the value of property where the D retained a right to income
for life. Where the D is entitled to all income, the full value of the trust principal is included in her gross estate. If the D decides to sell her retained life estate, the current rule is that she must receive as consideration the full value of the trust principal bc that’s what would have been included in her gross estate pursuant to 2036(a)(1).
United States v. Allen: D created an irrevocable IV trust and reserved 3/5 of the income for her life. When she was 78, she sold life estate for its actuarial value to her son. Died unexpectedly a short time later. Held: D had not received adequate and full consideration even though son was bona fide purchaser and had paid the actuarial value of the life estate. “it does not seem plausible, however, that Congress intended to allow such an easy avoidance of the taxable incidence befalling reserved life estates. This result would allow a TP to reap the benefits of property for his lifetime and, in contemplation of death, sell only the interest entitling him to the income, thereby removing all the property which he has enjoyed from his GE.” undermines 2036, so imposed whether gratuitous transfer or selling- still included in her estate.
Sale of a remainder: TP can avoid 2036(a)(1) by selling the remainder interest for adequate and full consideration, i.e. the
actuarial value of the remainder interest. D’Ambrosio v. Commissioner: Court held that payment of the actuarial value of the remainder interest
was adequate and full consideration. AS a result, nothing was in Ds gross estate even though D had retained right to income for life. So 2035 3-year rule doesn’t apply. (See also Kelley). Rationale: Time value of money. Value of a remainder is the prevent value of the right to receive
the property in the future. If the D receives this amount and then invests it without ever invading the principal or the accumulating interest, the D will have the full FMV of the property in his GE albeit in the form of the investment rather than the property itself. The only thing missing is the appreciation in value of the original property. But there is nothing that says that a D can’t employ appropriate estate planning techniques to minimize potential estate tax liability.
Family limited partnerships: 2 step analysis
did D receive adequate and full consideration on the creation of the family limited partnership? If the D receives partnership interests proportionate to her contribution of property to the
partnership this step has been met Was there a bona fide sale?
Need arm’s length transaction Must be legit non-tax business purpose for creation of FLP.
Only if this second step is also satisfied will the D be taxed on the value of the partnership interest, with discounts for lack of marketability and minority interests as appropriate
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Failure to meet this test will cause the underlying partnership assets (undiminished by any discounts) to be included in the gross estate rather than the partnership interests (which may be significantly discounted for minority status and lack of marketability).
DEDUCTIONS. In General. §2051 provides that the value of the taxable estate shall be determined by deducting from the
value of the gross estate the deductions provided for in the statute. The taxable estate, thus determined, is the base against which the tax rates of §2001 are applied. Note: Deductions are limited to amount of the property in the gross estate. Role of state law: The expense must be an administration expense within the meaning of 2053- a question
of federal law. The expense must be allowable though under state law. (20.2053-1). If amt is approved by local law that can be the amount it’s deductible (like if can only get 5% of estate
for exec’s commission under state law but you get a decree that says 7%, you can only deduct 5%). Must be bona fide.
Certain Expenses. §2053 allows deductions from gross estate (as are allowable by jurisdiction’s laws whether within or without the US, under which the estate is being administered)for the below. Note: Amounts must be bona fide in nature 20.2053-1(b)(2). Settlement or court decree can establish
amounts. Deduction also allowed if not paid (20.2053-1(d)(4) as long as not a vague or uncertain estimate (see p. 560).
Funeral Expenses. §2053(a)(1) allows a deduction for funeral (not memorial) expenses to the extent allowable by the law of the jurisdiction under which the estate is being administered. Funeral expenses include such items as the undertaker’s charges and the costs of a funeral service. In addition, Reg. §20.2053-2 provides that funeral expenses include a “reasonable expenditure for a tombstone, monument, or mausoleum, or for a burial lot, either for the decedent or his family, including a reasonable expenditure for its future care. Funeral expenses may even include a family member’s expenses in traveling to the funeral and, six months later, to the cemetery for the tombstone setting.
Administration Expenses. §2053(a)(2) allows a deduction for any item that is allowable as an administration expense under the local law governing the administration of the estate. However, Reg. §20.2053-3(a) provides that such expenses must be “actually and necessarily incurred in the administration of the decedent’s estate” (i.e., in the collection of assets, payment of debts, and distribution of the property to persons entitled to it. Has to be that land will plunge in value not just that bene doesn’t want land.). As a result, no deduction is allowed for expenditures that are not essential to the proper settlement of the estate but are incurred for the individual benefit of the heirs, legatees or devisees. 2035(a)(2) and 642(g) The most common administration expenses are: (a) the executor’s or administrator’s commissions; (b)
probate fees; (c) appraisal fees; and (d) attorney’s fees incurred by beneficiaries in litigation brought to establish their respective interests in the estate, so long as the litigation is “essential to the proper settlement of the estate.”
Note: Estimating Executor’s Commissions and Attorney’s Fees. Reg. §20.2053-3(b) and (c) recognize that at the time the estate tax return is filed, the amounts of the executor’s commissions and attorney’s fees will often be as yet undetermined. The regulations provide that the deduction may be based on an estimate of the amount to be paid. If the actual expense is later determined to be less than the estimated amount, additional estate tax on the difference must be paid Usually accepted practice to be similar to those of similar size and character in jurisdiction.
Claims against the Estate. §2053(a)(3) authorizes deductions from the gross estate for amounts paid to satisfy “claims against the estate.” However, §2053(c)(1)(A) further provides that such deductions “shall, when founded on a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money’s worth.” As the court in Leopold explains, one rationale of this limitation is to prevent testators from depleting their estates by transforming bequests to the natural objects of their bounty into deductible claims Note: can deduct if actually paid by the estate but exception for claims not more than 500k. (-4(c)). To be deductible a claim must be
A personal obligation of the decedent that was enforceable as of the decedent’s DOD Against the estate (not against a particular share of the estate)
Ex: the last visa bill or property settlement that terminates on wife’s death or remarriage.56
Claim not deductible if Not bona fide; contested; not yet mature.
Relevance of post-death events: can take into account what happens after death. Can deduct what amounts paid/if amount is ascertainable with reasonable certainty and will be paid (20.2053-1(d). Ex: 2 years after D’s death, estate settled claims through payment of 1M because D was negligent. This is deductible. Ex. 2: Settled for 500k and jury estimated the value of the services were 75k- probably can deduct for full settlement amount(20.2053-1(b)(2)(ii)(A)-(B). If joint and severally liable can deduct half.
If family member look at page 555 (b)(2)(ii): not trying to discourage just want to make sure you don’t get something you shouldn’t.
Unpaid Mortgages on Property. (other indebtedness in respect of property included in the gross estate.) §2053(a)(4) authorizes a deduction for unpaid mortgages and other debts in respect of property to the extent the value of the property (undiminished by the mortgage or debt) is included in the gross estate
Note: Any income taxes on income received after the death of the decedent or property taxes not accrued
before his death or any estate, succession, legacy or inheritance taxes shall not be deductible under this section (2052(b)(1)(B))
Rationale: the heirs should be taxed only on the net value of the property that is transferred to them (i.e., after these expenses and debts are paid).
2053(b): Other administration expenses: deduction for expenses incurred in administering property not subject tot claims, which is included in the gross estate. What does this mean? Refers to property not in the probate estate under state law. Ex: D dies owning Blackacre as a JTROS and paid 100% price. Blackacre not included in Ds probate
estate but is in D’s taxable estate under 2040. YES, expenses incurred in the sale of Blackacre are deductible under 2053, even though not probate property.
Losses. §2054 deduction for losses incurred during the settlement of the estate if the loss arises from fire, storm, shipwreck or other casualty or from theft, when the loss is not compensated by insurance or otherwise. Under Reg. §20.2054-1, if the loss is partly compensated, the excess over the compensation may be deducted.
State death taxes 2058 Transfers for Charitable Uses. §2055 Unlimited- Ts to avoid estate tx by leaving entire net estate to charity Marital Deduction. 2056(a): for purposes of tax imposed by 2001 (estate tax), the value of the taxable estate
shall, except as limited by subsection b [terminable interest] be determined by deducting from the value of the gross estate any amount equal to the value of any property, which passes or has passed from the D to his SS but only to the extent that such interest is included in determining the value of the gross estate (IV or not). I.e,: current, unlimited marital ded.: if H bequeaths all of his property to W, all of it is deductible so that H
has a taxable estate of zero. All of the spousal wealth will be taxed on W's death (unless W consumes it Note: There are exceptions to the terminable interest rule for: life estates with powers of appointment;
QTIPs; and estate trusts. Rationale.
Primary motivation was to provide equality b/t common law property and community property states. Tax advantages of owning community property: community property is owned 50-50 by H and W
so if H dies first, only 1/2 of the value of the community property is included in his gross estate (other half already being owned by surviving spouse) Any gift of community prperty is treated as a gift by each spouse of 1/2 of the value of the
property. Since H and W separate taxpayers, each donor spouse can use any of his or her unused gift or
estate tax credit (if any) to reduce or eliminate tax. Also, only tax once at each generation after adoption of generation-skilling transfer tax. Under philosophy that marriage is one economic partnership/unit
Basic steps/ requirements Decedent must be subject to the estate tax
D must be a citizen or resident of the US or must own property located in the US Property passes to spouse who is a US citizen
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To qualify as a “spouse,” an individual must be validly married to the decedent (at the time of death) under state law in the state in which the decedent died. If the individual was separated from the decedent and had filed for divorce, he or she is still considered the decedent’s “spouse.”
DOMA means same sex couples excluded even if married in the state legally. Man and woman who are married. And has to be us citizen (because we want to make sure we can get that tax when she dies which we can’t if she’s French, unless goes into a qualified domestic trust.)
Might allow common law if the state recognizes it. Recipient spouse survives
Whatever state says- though uniform simultaneous death act or similar legislation might say each person deemed to have survived with respect to her own property and jointly owned, survived with respect to ½ so no property passes and no marital deduction. PA is 120 days requirement
Best: will can define survival. USDA application or similar laws can cause unnecessary taxation if a coupl’s estate plan has
property going from the richer to the poorer spouse so that both can claim the benefit of the unified credit. To protect estate planning like this, couple can include a clause in their wills that determines the order of death. The clauses should be mirror images. Language: If my H and I die in circs where order of death cannot be determined, then my
H shall be deemed to survive me.” H: If my…then I shall be deemed to have survived W Property must be in gross estate (easy)
Without this rule, the property passing to someone other than the SS might be sheltered from tax. Only the net value passes (happens when property subject to lien or mortgage). Ex: H creates irrevocable trust to pay income to himself and remainder to W. Creation of the
trust is completed gift of remainder interest property however in H’s gross estate at death because he retained the right to income for his life 2036(a)(1).
Property passes from decedent [very liberally construed. Can be bequest devise, joint tenancy, appointed, gifts. If elective share---only what you take...not all the property you could take.]
Note about deficiency in requirement whoever’s messing it up might be able to disclaim (see above). Specifics on the “Passing From the Decedent.” Requirement §2056(c) states that an interest in
property shall be considered as “passing from the decedent” to his or her surviving spouse if: The interest is bequeathed or devised to the spouse by the decedent; (i.e. probate property/intestacy) The interest is inherited by the spouse from the decedent;
The interest was, at the time of the decedent’s death, held by the decedent and the spouse in joint ownership with right of survivorship;
The decedent had a power to appoint such interest and he appoints it to the spouse; or The interests consists of insurance proceeds on the life of the decedent receivable by the spouse. Consider:
Disclaimers: O’s will leaves all property to C but if C disclaims any property or predeceases O, property to O’s wife, W. When O dies, he owns property valued at 10M. C effectively disclaims his interest in 6M and that property is distributed to W Owen is transferor so in effect he's giving his wife 6 M so she could use marital deduction
Settlement of Disputes : Assume O’s will doesn’t provide for a gift to W if C disclaims or predeceases. After O’s death W and C agree that W will receive 4M. Under state law, W would be entitle to half (5M) as elective share. 4M can qualify If W signed a prenup waiving rights though, and C gave her money because the right thing to
do, would not qualify bc bona fide claim to that property. Terminable Interest Rule. (if non-deductible terminable interest, cannot qualify for marital deduction)
In general: A terminable interest is one that will fail on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the SS will terminate or fail. Where one occurs, no deduction shall be allowed… I.e. Any interest in property that is subject to a condition, including expiration of period of time.
Must ask whether as of the moment of the gift or the D’s death there is any chance that the 58
condition defeating or terminating the interest might occur. Whether the condition actually occurs is irrelevant!
i.e. Give to spouse for 2 years or until she remarries and then to my kids or unless trustee thinks she doesn't need it.// Or contingency and someone else gets the property.
Rationale. The terminable interest rule arises from the basic premise of the marital deduction that property which qualifies for the deduction in the estate of the first spouse to die will eventually be taxed in the estate of the surviving spouse. Accordingly, no marital deduction should be allowed if an interest in property given to the SS might, after the termination of that spouse’s interest, pass to someone else without being included in the surviving spouse’s gift or estate tax base.
Ask: Is the interest terminable? Look at the moment of death; doesn’t matter what happens after (thus, who cares if 2 weeks after
Hs death, children purchase W’s interest for FMV). Does it pass to a third party upon the occurrence of the condition? Ex: H dies and leaves house to
testamentary trust: income to W for life, remainder to children. Can H’s estate take a marital deduction for W’s interest. NO! When would we tax it??
Ex: income to child until she attains 21 then remainder to wife? Could value with actuarial and value the remainder, so yes, ok for marital deduction. If not a
terminable interest, if it's fixed and non-contingent, then can get the deduction. Ask: Is the terminable interest of the non-deductible type?
If upon termination the property passes ONLY to the spousedeductible. Some terminable interests are deductible bc no one other than the SS will receive an
interest in the property even though they will fail on the lapse of time copyrights, patents, license of limited duration, annuity.
If upon termination the property passes to someone other than the SSnon-deductible. i.e. if it passes to the SS and an interest in the same property passes from the D to another
person. 2056(b)(1)(A) say not if an interest in property passes or has passed for less than adequate
and full consideration from D to any person other than SS and (B) says if by reason of such passing such person (or heirs or assigns) may possess or enjoy any part of such property after such termination of failure of the interest so passing to the SS
i.e. life estates (unless executor elects for QTIP treatment), terms of years, and similar arrangements are not included in the gross estate unless the remainderman paid full and adequate consideration imomw, the interest is non-deductible.
Support allowance: usually paid during probate or for a specific time period. If the property that generates the income used for the allowance passes to someone other than the SS, the support allowance will be a non-deductible terminable interest.
Ask: Any exceptions to the terminable interest rule? Estate trust exception: If D leaves property in trust of the benefit of the SS and at the spouse’s
death the property passes to her estate, the value of the property will qualify for the marital deduction but it cannot pass from the D to any person other than the SS. 2056(b)(1). ex: H dies and leaves 4M in trust income to be paid in trustee’s discretion to W for life,
accumulated income and remainder to W’s estate. Advantage: the trustee can have discretion to distribute income to the SS or accumulate it;
income need not be distributed annually as in a poa or QTIP trust. Also trust property need not produce income and trustee need not make it productive.
Use: when D has stock in a closely-held co. that he wants to keep in the family or when a SS has sufficient resources of her own and does not need the income from the trust.
Transfers conditioned on survival for 6 months as long as SS survives for 6 months 2056(b)(3): interest passing to SS shall not be considered as interest which will terminate
if the death will cause termination or failure only if occurs within period of 6 months after death or common disaster or .... I.E. I leave everything to my Spouse so long as she survives me for 6 months. Not a terminable interest. Reason: won't have 2 probate proceedings close together, etc. 1M to wife if she dies
within one year...wife is alive and gets it--nope...more than 6 months. If 2 months after the h's death
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Requirements: Spouse must in fact survive by the requisite time period. If she does, then she
will receive the property. Time period cannot exceed 6 months.
Exception- can provide that the property will not pass to SS if both D and S die as a result of a common disaster.
Should every estate include a 6-month or common disaster survivorship clause? NO! Assume H has used up his transfer tax exemption nd has 3.5M of remaining assets
and W has not made any prior gifts and has no assets. H dies in 2011 and leaves everything to W, subject to 6 month survivorship condition; if W doesn’t survive for 6 months, the 3.5M to children.
If W dies after 2 months, the kids pay tax! If no survivorship provision, property would have passed to wife and been sheltered by her exemption.
Power of appointment trust §2056(b)(5) Income to W, remainder subject to W’s IV or testamentary gpoa, which is exercisable
by SS alone and in all events (unlike regular power of appointment). The general power of appointment must be exercisable by the spouse in favor of
herself or her estate. Since the general power of appointment will cause the property subject to the power to be included in the gross estate of the surviving spouse at her death under §2041, there is no reason not to permit the transfer to qualify for the marital deduction even though the spouse’s life estate is a terminable interest.
Right to income must be real: SS must be entitled to all income from the trust or a specified portion. (20.2056(n)-5(f)(1)). Note: can't be fixed dollar amount that's why it matters how draft. 2056(b)(10):
For purpose of paragraphs 5,6, and 7(B)(iv), the term specific portion only includes a portion determined on a fractional percentage basis For b5 only the right to income and right to appoint specific portion must be
over the same property. Right to make the property productive. Property must produce income; if it’s non-
income-producing, the trustee must have the power to dispose of that property and invest in income-producing assets. 20.2056-(b)-5(f)(5).
Payable annually or at more frequent intervals: if it doesn’t say in trust, if state law interprets a reasonable interval to be annually, will qualify. 20.2056(b)_5(e); 20.2056)b)-5(f)(2).
Trustee can’t have discretion to accumulate/withhold income unless provision that SS can compel. (20. 2056(b)-5(f)(5); (8). And administrative powers must not deprive SS of beneficial enjoyment of the trust income -5(f)(4). Can’t have ascertainable standards because even though can require distributions, she would not be treated as the owner of the trust income. -5(f)(5); (7).
Power of appointment requirement. SS must have power to appoint trust property to herself during her life or to her estate at death 2056(b)(5). Alone and in all events. SS and only SS must have power to appoint the property
(must need not consent; no contingencies on ability to appoint). But trust can designate that she gets power to appoint either during life or death. OK if she’s trustee. Needs to not be a standard. -5(g)(3).
Differs from QTIP: she can appoint to anyone, including someone other than herself.
20.2056(b)-5(g): can’t just safeguard property without giving spouse the express enjoyment. Must provide beneficial enjoyment
Ex: H dies and leaves 4M in trust income to W for life remainder pursuant to W’s power of appointment; if W doesn’t exercise, remainder goes to kids. Interest terminates? Yes. Who goes to on death? To kids. If we didn't have the exception, this would not be deductible. DOES qualify under 2056 b5. whole shebang qualifies. On her death (per 706). [doesn’t matter if she never gives anything to kids (2056b5f7).
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Ex: what if provision that if she becomes incompetent then all to kids? doesnt qualify becaus automatically goes to kids. ...she can no longer control it. needs the right to control by self. Doesnt matter if she became incompetant or not, when he dies jst look at the contingency
Note if has poa over ½ then ½ qualifies here. 2056b-5c5 ex. 2...take smaller Stub income. the income is earned between the last distribution date preceding the
SS’s death and the DoD. Must be subject to SS’s power to appoint 20.2056)b)-5(f)(8). Why have one? Flexiblity. Might want a co-trustee to help manage it. Very similar to
outright ownership. Downside is they get remarried to the poolboy and he gets everything and kids get nothing or cinderlla circumstancs....thus the QTIP trust....vastly male, lots of divorces. Doesn't fit with economic partnership but does fit ith idea that we only tax at one generation. Different because terminable interest that goes to someone else other than surviving spouse and if we didn't have this rule, it woudln't get taxed. Can decide down the road to leave it all to charity. non-tax disadvantages: available to creditors, (could have spendthrift provision), also that she could change her mind and decides not to leve it to the kids but to poolboy or something not nefarious...wants to start a charity for cats. Her power to pull out corpus for another distinguishes from qtip.
QTIP trust. Under §2056(b)(7), a life estate in a “qualified terminable interest property” (QTIP)
will not be treated as a terminable interest, and hence the full value of the property—not merely the life estate—qualifies for the marital deduction.
Must meet strict requirements. Requires The SS be entitled to all the income (or a specific portion of it) payable annually
or more frequently. Note unproducitive property ok again as long as SS has power to demand that
the trust property be made profitable. No person has a power to appoint any part of the trust property to anyone other
than the SS during her life The executor elects QTIP treatment. §2056(b)(7)(B)(i)(III),
the decedent’s executor elects on the estate tax return (Form 706, Schedule M) to treat the property as QTIP. The election must be made on a timely filed return or, if a return is not timely filed, on the first return that is filed after the due date
Note: Partial QTIP Elections. The decedent’s executor may elect to treat only a portion of the property as QTIP. Thus, for instance, the executor may decide not to make a QTIP election for that portion of the property equal to the decedent’s remaining applicable exclusion amount
However, under §2044(a), the value of the underlying QTIP property will be included in the spouse’s gross estate upon her death
If meets these requirements, qualifies for marital deduction. Right to income. Same as GPAT trust. Power to appoint during spouse’s life. No on needs power to appoint here. If there is
a poa, must be exercisable only in favor of the spouse. Power to appoint at or after spouse’s death. If there Is a power to appoint the trust
property after the spouse’s death it can be in anyone and it can be limited. Specific portion. Same as above. Only fraction or percent not amount. Stub income. the income is earned between the last distribution date preceding the
SS’s death and the DoD. 20.2056(b)-7(d)(4) provides that the stub income need not be subject to a spouse’s power of appointment in a QTIP trust.
Marital Deduction Formula Clauses. When a married couple owns more than the exemption amount, it is important to structure their estate
plans so that the property is sheltered in each estate by the unified credit. Family can also use annual exclusion gifts, qualified payments of tuition and medical expenses and
family limited partnerships to minimize estate tax impact.61
Portability from 2010 Act: a deceased spouse dying in 2010 and after can (in effect) transfer his or her unused exemption equivalent amount to his or her surviving spouse. portability basically says we will save that exemption. Can elect to use it. Reduces amount of work
have to do. What are arguments against portability? Some will argue that one of the good things is that it forced spouses to share assets during life so everyone had to have enough proeprty in own name to take advantage of exemptions. But with portability, one spouse who earns or inherits the property can keep it all in his name. Leads to imbalance.
Before portability what would be best? split up assets- everyone owns half and everyone takes advantage of own exemption and optimally property goes to kids on second death
Equal ownership: Suppose that husband and wife live in a community property state. Husband dies, leaving community property worth $10M. Thus, the husband and wife are each regarded as owning one-half of the value of the couple’s community property, or $5M. Or they both own about 5M of property in any state. Applicable Exclusion Amount Trust.
Each should leave an amount equal to the exemption amount in a trust for the benefit of the survivor but that trust should not qualify for the marital deduction. [credit shelter or by-pass trust] will be in D’s taxable estate and because it is funded with an amount equal to the exemption equivalent, no tax will be due because of the unified credit. (2010).
The remainder of the property should be left to the SS in a a manner that qualifies for the marital deduction…so one that qualifies as a QTIP or GPAT for the benefit of his wife and contribute the remaining $$ to that trust. §2056(b)(7) allows an unlimited marital deduction for the value of QTIP property passing from the husband to the wife. Thus, this amount will also escape estate tax.
There are 2 formulas for computing the amount of the marital bequest and the credit shelter bequest: Pecuniary Clause. Under a pecuniary clause, either: (1) the marital bequest is expressed as a
general bequest of assets having an ascertainable dollar value, leaving the residuary estate to pass to the credit shelter trust; or (2) the credit shelter bequest is expressed as a general bequest of assets having an ascertainable dollar value, leaving the residuary estate to pass to the marital deduction trust. The dollar value allocated to the pecuniary trust is determined so as to take full advantage of the decedent’s remaining applicable exclusion amount and produce an estate tax of zero. Example. The following example of a pecuniary formula clause describes the amount of the
deductible marital bequest needed to produce an estate tax of zero while taking advantage of the unified credit: “If my spouse survives me, I give to my spouse an amount equal to the minimum marital deduction necessary to eliminate (or reduce as far as possible) the federal estate tax on my estate, after taking into account all other property passing to my spouse under this will or outside this will that is includible in my federal gross estate and qualifies for the federal marital deduction, and after taking into account the federal unified credit
Fractional Share Clause. Under a fractional share clause, either: (1) the marital bequest is expressed as a fractional share of the residuary estate, with the balance passing to the credit shelter trust; or (2) the credit shelter bequest is expressed as a fractional share of the residuary estate, with the balance passing to the marital deduction trust. Again, the fractional share formula clause is designed to produce an estate tax of zero while taking full advantage of the decedent’s remaining applicable exclusion amount. Example. The following is an example of a fractional share formula clause: “If my spouse
survives me, I give to my spouse a fractional portion of my residuary estate, determined as follows: the numerator of the fraction shall be an amount equal to the minimum marital deduction necessary to eliminate (or reduce as far as possible) the federal estate tax on my estate, after taking into account all other property passing to my spouse under this will or outside this will that is includible in my federal gross estate and qualifies for the federal marital deduction, and after taking into account the federal unified credit; and the denominator of the fraction shall be an amount equal to the value of my residuary estate
Disadvantages of Fractional Share Bequests. There are 2 disadvantages associated with fractional share bequests First, as a practical matter, fractional share bequests may create considerable
administrative difficulties. A fractional share of each piece of the decedent’s prop must be 62
allocated to each trust based on the fractional share percentages. Thus, for example, the executor must allocate the expenses related to each property based on these percentages
Second, fractional share bequests eliminate some of the planning that can be done with property that is expected to appreciate in value. In general, for instance, property that is expected to appreciate should be placed in the credit shelter trust since that property (including the appreciation) will never be taxed to the beneficiaries, so long as the beneficiaries do not retain a general power of appointment over the property. In contrast, property placed in the marital deduction trust will be taxed (including the appreciation) upon the surviving spouse’s subsequent death. However, this planning technique cannot be implemented with fractional share bequests because a fractional share of each property will be allocated to both the marital deduction trust and credit shelter trust
Unequal ownership: It is impossible to know which spouse will die firs and if the poorer one does, the benefit of the unified credit is lost to his estate. This can be remedied by giving the poorer souse an amount equal to the exemption amount during his life. If don’t want to cede control can ive property in trust and gift will qualify for the marital deduction as
long a he has right to income for his life and trust is either GPAT or QTIP 2523(e), (f) If the rich spouse doesn’t want to lose the benefit of the trust property, she can retain a secondary life
estate. Doing so will not cause the property to be in her gross estate because her spouse will be treated as the transferor. 25.25239f)-1(f) (Ex 10/11).
Credits. A credit is subtracted from the tentative amount of tax and reduces tax liability dollar for dollar Note: estate tax is a flat tax so deduction benefits al TPs the same. Credits, though, reduce the amount of tax and therefore usually provide a greater benefit The following credits are allowed against the tax otherwise payable:
Unified Credit. The unified credit in §2010 provides a credit for the amount of tax on the “applicable exemption amount.” This is the amount that the decedent can pass free of tax. In 2010, was 5 M. Coordinate with the 2505 gift tax credit so that a decedent cannot transfer more than the applicable exemption amount whether during life or at death.
2011 provides a credit for the amount of any state estate inheritance, succession, or accession tax. It was repealed in 2001, but returned in 2011
Credit for Tax on Prior Transfers. §2013 provides a credit for estate taxes paid on prior transfers of property to the decedent by a person who died within 10 years before the decedent’s death.
