CCH Federal Taxation Comprehensive Topics Chapter 22 Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Trans

1. CCH Federal TaxationComprehensive TopicsChapter 22Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Transfer Tax ©2006, CCH, a Wolters Kluwer business 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 www.CCHGroup.com

2. Chapter 22 Exhibits 1. Formula for Computing Estate Tax Liability 2. Definition of Terms 3. Community Property vs. Common Law States 4. Forms of Ownership in Real Estate—Tenancy by the Entirety 5. Tenancy by the Entirety—Example 6. Forms of Ownership in Real Estate—Joint Tenancy 7. Joint Tenancy—Example 8. Forms of Ownership in Real Estate—Tenancy in Common 9. Power of Appointment 10. Insurance Proceeds—General Rules 11. Insurance Proceeds—Example 1 12. Insurance Proceeds—Example 2 13. Insurance Proceeds—Example 3 Chapter 22, Exhibit Contents A CCH Federal Taxation Comprehensive Topics

3. Chapter 22 Exhibits 14. Annuities and Lump-Sum Survivor Benefits 15. Annuities and Lump-Sum Survivor Benefits—Example 16. Gift Tax Paid Within 3 Years of Death 17. Inter Vivos Transfers—Types 18. Inter Vivos Transfers—Examples 19. Medical Insurance Reimbursements 20. Dower and Curtesy 21. Valuing the Gross Estate 22. Deductions from the Gross Estate 23. Casualty Losses 24. Charitable Contributions 25. Marital Transfers 26. Marital Transfers—Examples Chapter 22, Exhibit Contents B CCH Federal Taxation Comprehensive Topics

4. Chapter 22 Exhibits 27. Post 1976 Gifts 28. Post 1976 Gifts—Example 29. Computing Estate Tax and Credits 30. Estate Tax Return 31. Formula for Computing Gift Tax Liability 32. Gift Tax—Overview 33. Gift Loans—General Rules 34. Gift Tax—Exclusions 35. Gift Tax—Deductions 36. Gift Tax Liability—Short Formula 37. Gift Tax Filing Requirements Chapter 22, Exhibit Contents C CCH Federal Taxation Comprehensive Topics

5. Formula for Computing Estate Tax Liability Chapter 22, Exhibit 1a CCH Federal Taxation Comprehensive Topics

6. Formula for Computing Estate Tax Liability Chapter 22, Exhibit 1b CCH Federal Taxation Comprehensive Topics

7. – Marital deduction (property passing to surviving spouse) – Charitable transfers = Taxable estate + Adjusted taxable gifts (i.e., gifts made after 1976, after $12,000 annual exclusions and gift tax deductions) = Estate tax base x Estate tax rates (see Appendix at end of text) = Tentative estate tax Formula for Computing Estate Tax Liability Chapter 22, Exhibit 1c CCH Federal Taxation Comprehensive Topics

8. Formula for Computing Estate Tax Liability Chapter 22, Exhibit 1d CCH Federal Taxation Comprehensive Topics

9. Definition of Terms Estate Purpose. An estate is created upon the death of every individual. The entity is charged with collecting and conserving all of the individual’s assets, satisfying all liabilities and distributing the remaining assets to the heirs identified by will or by state law. Chapter 22, Exhibit 2a CCH Federal Taxation Comprehensive Topics

10. Definition of Terms Estate Key Persons. An estate involves three parties: • Decedent, all of whose probate assets are transferred to the estate for disposition. • Executor, who is appointed under the decedent’s valid will (or the administrator, if no valid will exists). The executor or administrator holds the fiduciary responsibility to operate the estate as directed by the will, applicable state law, and the probate court. • Beneficiaries of the estate, who are to receive assets or income from the estate, as the decedent has indicated in the will. Chapter 22, Exhibit 2b CCH Federal Taxation Comprehensive Topics

11. Definition of Terms Gross Estate (GE) Broad Scope.Recall the broad definition of gross income: all income from whatever source derived. Code Sec. 61(a). Just as income tax law defines “income” broadly, estate tax law defines “property” broadly. No property is excluded, however small, be it real or personal, tangible or intangible, U.S. or foreign, as long as the decedent owned a beneficial interest at the time of death. Even tax-free municipal bonds are included in the gross estate, since estate tax is levied on the transfer of property, not the property itself. Chapter 22, Exhibit 2c CCH Federal Taxation Comprehensive Topics

12. Definition of Terms Gross Estate Examples.GE items include: cash, personal residence, household belongings, securities, real estate investments, collector items, notes, dividends declared prior to death (if the decedent was the stockholder of record), sole proprietorships and partnership interests. Chapter 22, Exhibit 2d CCH Federal Taxation Comprehensive Topics

13. Community Property vs. Common Law States The difference between community property and common law state systems centers around the property rights possessed by married persons. Community Property States. In community property states, a spouse’s earnings, or income from property acquired after marriage by one spouse, is deemed owned equally by both spouses. Common Law States.In common law states, such earnings or income is not deemed owned equally. Chapter 22, Exhibit 3a CCH Federal Taxation Comprehensive Topics

14. Community Property vs. Common Law States Tax effect. If the spouses file separate returns, each spouse’s return will be different, depending upon the state in which the earnings or property income is realized. (There is no tax effect if the spouses file joint returns.) Community property income would be shared equally; common law income would be taxed in full by the earner or owner of the property. Chapter 22, Exhibit 3b CCH Federal Taxation Comprehensive Topics

15. Community Property vs. Common Law States Two types of community property states are: 1. States where income from pre-marital property is shared. In Texas, Wisconsin, Idaho and Louisiana, income from property owned before marriage IS owned equally between two spouses if it is realized after marriage. 2. States where income from pre-marital property is kept separate. In California, Arizona, Washington, New Mexico and Nevada, income from property owned before marriage by one spouse is NOT owned equally between spouses, even if it is realized after marriage. Chapter 22, Exhibit 3c CCH Federal Taxation Comprehensive Topics

16. Forms of Ownership in Real Estate—Tenancy by the Entirety Chapter 22, Exhibit 4a CCH Federal Taxation Comprehensive Topics

17. Forms of Ownership in Real Estate—Tenancy by the Entirety Chapter 22, Exhibit 4b CCH Federal Taxation Comprehensive Topics

18. Tenancy by the Entirety—Example FACTS: Greg and Sue are married in 1990. In 20x1, they purchase an office building for $1 million. $900,000 of the purchase price is funded from the sale of stock that the Sue had owned before they were married. $100,000 is funded from the sale of stock that Greg had owned before marriage. Ownership is in the form of a tenancy by the entirety. Greg dies in 20x5 when the building’s FMV is $1,500,000. QUESTION: What are the estate tax consequences? Chapter 22, Exhibit 5a CCH Federal Taxation Comprehensive Topics

19. Tenancy by the Entirety—Example ANSWER: Greg’s 50% share, i.e., $750,000, is included in his gross estate but is subject to the unlimited marital deduction in the amount of $750,000. Thus his taxable estate would not include the value of the building. Sue, as surviving spouse, automatically gets Greg’s 50% interest, stepped-up to fair market value (FMV) on the date of his death. Thus, ignoring depreciation, the building’s basis increases from $1 million to $1.25 million (i.e., 50% of original cost + 50% of the $1.5 million FMV on the date of Greg’s death). When Sue eventually dies, her taxable estate will include 100% of the building’s value as of the date of her death (or as of the 6-month alternative date if so elected), unless she chooses to sell it before she dies. Chapter 22, Exhibit 5b CCH Federal Taxation Comprehensive Topics

20. Forms of Ownership in Real Estate—Joint Tenancy Definition. Ownership of property by unmarried joint tenants is similar to tenancies by the entirety, except the owners have no automatic right of survivorship (also known as “unity of person”). The gross estate of the decedent includes the full value of property held as joint tenants, except to the extent of any part shown to have originally belonged to the other person and for which adequate and full consideration was not provided by the decedent. (i.e., the other tenant provided consideration). Chapter 22, Exhibit 6 CCH Federal Taxation Comprehensive Topics

21. Joint Tenancy—Example FACTS:Albert and Olga are single individuals. In 20x1, they purchase an office building for $1 million. $900,000 of the purchase price is funded from the sale of stock that the Olga had owned. $100,000 is funded from the sale of stock that Albert had owned. Ownership is in the form of a tenancy by the entirety. Albert dies in 20x5 when the building’s FMV is $1,500,000. QUESTION:What are the estate tax consequences? Chapter 22, Exhibit 7a CCH Federal Taxation Comprehensive Topics

22. Joint Tenancy—Example ANSWER: Since Albert contributed 10% of the purchase price, 10% of the building’s value, i.e., $150,000 is included in his gross estate. If Albert’s executor were unable to show that Olga had funded 90% of the purchase price, then 100% of the building’s value, or $1,500,000 would be included in Albert’s gross estate. If Olga were the beneficiary of Albert’s 10% interest, she would get a step-up in basis on 10% of the building value (50% if they had been married). Thus, ignoring depreciation, the building’s basis would increase from $1 million to $1.05 million (i.e., 90% of original cost + 10% of the $1.5 million FMV on the date of Albert’s death). When Olga eventually dies, her taxable estate will include 100% of the building’s value as of the date of her death (or as of the 6-month alternative date if so elected), unless she chooses to sell it before she dies. Chapter 22, Exhibit 7b CCH Federal Taxation Comprehensive Topics

23. Forms of Ownership in Real Estate—Tenancy in Common Definition. A form of ownership whereby each owner holds an undivided interest in property. Here, there is only unity of possession, i.e., an undivided interest in the whole property, not merely separate divisions of the property. Titles are separate and distinct. The owners have a shared ownership interest in the common areas, but upon the death of one owner, his/her ownership interest passes to the heirs, not to the surviving owners (i.e., no right of survivorship by the surviving owners). 100% of the decedent’s undivided interest in the property is included in the decedent’s gross estate. The reason: tenancies in common have no right of survivorship. Chapter 22, Exhibit 8a CCH Federal Taxation Comprehensive Topics

24. Forms of Ownership in Real Estate—Tenancy in Common Example.Condominium owners have a common interest in the coin-operated laundry mat and elevator lobby of their building. The condominium owners have varying ownership interests, commencing at different times, under separate deeds. However, they enjoy the same rights to the common areas, such as the laundry mat and elevator lobby. If one owner dies, his ownership interest passes to his heirs, not to a common owner (unless specifically bequested or made part of a separate buy-out agreement). Chapter 22, Exhibit 8b CCH Federal Taxation Comprehensive Topics

25. Power of Appointment Definition. A power of appointment (POA) is a power to determine who shall own or enjoy, presently or in the future, the property subject to the power. POAs fall into one of two classifications: general and special. General POA’s Are Includible in the Gross Estate (GE). A general POA is one in which the decedent could have appointed himself, his creditors, his estate, or the creditors of his estate an unlimited right to invade or consume property subject to the power. The value of property interests over which the decedent had a general POA is included in the decedent’s GE. Chapter 22, Exhibit 9a CCH Federal Taxation Comprehensive Topics

26. Power of Appointment Special POA’s ARE NOT Includible in the GE. A “special” POA enables the holder to appoint to others but NOT to herself, her creditors, her estate, or her estate’s creditors, an unlimited right to the property subject to the power. Also, if a holder has a limited right to the property, such as the right to invade or consume the property for the specific purpose of the holder’s health, education, welfare, or happiness, (commonly referred to as “ascertainable standards”) the right is deemed to be a special POA and is not included in the holder’s GE when she dies. Chapter 22, Exhibit 9b CCH Federal Taxation Comprehensive Topics

27. Power of Appointment Example 1: General vs. Special POA’s P has the power to designate how the principal of a trust will be distributed among A, B and C. At this point, P’s power is only a special POA. However, if P is given the further right to appoint the principal to herself, what was a special POA becomes a general POA. Chapter 22, Exhibit 9c CCH Federal Taxation Comprehensive Topics

28. Power of Appointment Example 2: Special POA (holder has no rights to property) Mother leaves her property in trust, life estate to Son and remainder to whichever of Son’s children he decides to appoint in his will. Son’s power is not a general POA because he cannot “invade” the corpus, only the income. Thus, regardless of whether Son exercises the power or not, none of the trust property subject to the power is included in his estate when he dies. Chapter 22, Exhibit 9d CCH Federal Taxation Comprehensive Topics

29. Power of Appointment Problem 3: Special POA (limited right under ascertainable standard) Assume the same facts as in Problem 2. In addition to having the testamentary power to appoint the beneficiary of the remainder interest, Son is given a power to direct the trustee to pay to him from time to time as much of the principal as he might request “for his support.” Although Son now has a power to invade the corpus, it is not a general POA. The power is limited to an ascertainable standard, “maintenance.” Thus none of the property subject to these powers would be included in Son’s estate when he dies. Chapter 22, Exhibit 9e CCH Federal Taxation Comprehensive Topics

30. Insurance Proceeds—General Rules Insurance proceeds on the decedent’s life are included in the gross estate (GE) if any of the following conditions exists: 1. The insurance proceeds are payable to or for the estate (including “payable to the executor”). 2. The decedent had any incident of ownership in the policy at death, such as the right to change beneficiaries, the right to terminate the policy, or the right to borrow against the policy. 3. The decedent had transferred all incidents of ownership within 3 years of death. [This point is explained in the following table.] Chapter 22, Exhibit 10a CCH Federal Taxation Comprehensive Topics

31. Tax Treatment for the Transfer of an Insurance Policy Before Death * Time Between Transfer & Death Estate Tax Treatment 3 Years or Less: Proceeds other than those allocable to premiums paid by a third party within 3 years of insured’s death (i.e., Includible Amount = (a) - [(a) x (b)  (c)], where, (a) = 100% insurance proceeds; and (b) = Premiums paid by third party within 3 years of death (c) = Total premiums paid on life insurance policy. More Than 3 Years: None included in insured’s GE (however, premiums paid by insured within 3 years of death are included in his/her GE) * i.e., Time between: 1. Date that policy is transferred by insured to a third party and 2. Date of insured’s death. Insurance Proceeds—General Rules Chapter 22, Exhibit 10b CCH Federal Taxation Comprehensive Topics

32. Insurance Proceeds—Example 1 Example 1: Estate Treatment for Insurance Proceeds FACTS: In 1985, Albert pays a single $200,000 premium for a $1 million whole life insurance policy. (A whole life policy insures a person for his/her “whole life”. Premiums may be paid in a single payment, or over a specified period, or for life.) Albert stipulates that his nephew will be the beneficiary. In 1995, Albert transfers all incidents of ownership in the policy to his daughter (i.e., she could change the beneficiary, borrow against the policy, liquidate the policy, or exercise any other incidents of ownership). Ten years after the transfer, Albert dies and $1 million is transferred to the nephew. Chapter 22, Exhibit 11a CCH Federal Taxation Comprehensive Topics

33. Insurance Proceeds—Example 1 QUESTION: How much of the $1 million proceeds should be included in Albert’s gross estate? Chapter 22, Exhibit 11b CCH Federal Taxation Comprehensive Topics

34. Insurance Proceeds—Example 1 SOLUTION: None of the $1 million not included in Albert’s gross estate because: 1. The insurance proceeds are not are payable to or for Albert’s estate; 2.  Albert had no incidents of ownership in the policy upon his death; 3. Albert had transferred all incidents of ownership more than 3 years before his death. Also, no premiums are included in Albert’s gross estate, since he paid no premiums within 3 years of his death. The nephew excludes the $1 million from gross income since these proceeds were paid by reason of death of the insured. Code Sec. 101(a). Chapter 22, Exhibit 11c CCH Federal Taxation Comprehensive Topics

35. Insurance Proceeds—Example 2 Example 2: Estate Treatment for Insurance Proceeds FACTS: Same as Example 1, except that Albert’s estate, not the nephew, is the named beneficiary. QUESTION: How much of the $1 million proceeds should be included in Albert’s gross estate? Chapter 22, Exhibit 12a CCH Federal Taxation Comprehensive Topics

36. Insurance Proceeds—Example 2 SOLUTION: All of the $1 million is included in Albert’s gross estate because the insurance proceeds are payable to Albert’s estate. (However, the $1 million proceeds are not taxable as income to the estate since these proceeds were paid by reason of death of the insured. Code Sec. 101(a). Chapter 22, Exhibit 12b CCH Federal Taxation Comprehensive Topics

37. Insurance Proceeds—Example 3 FACTS: Ten years before his death, Mike purchases a $1 million term insurance policy, with premiums to be paid in 10 equal annual installments in the amount of $10,000 each. (Term insurance insures a person for a specified “term”. If the person outlives the term, then no proceeds are payable. Term insurance is often renewable, but at higher premiums than under the previous term.) Two years before his death, Mike irrevocably transfers the policy and all incidents of ownership to a trust which pays the last two years’ premiums. QUESTION: How much of the $1 million proceeds should be included in Mike’s gross estate? Chapter 22, Exhibit 13a CCH Federal Taxation Comprehensive Topics

38. Insurance Proceeds—Example 3 SOLUTION: Mike’s gross estate should include $800,000, computed as follows: Includible Amount = (a) - [(a) x {(b)  (c)}], where, (a) = $1 million = 100% insurance proceeds. (b) = $20,000 = Premiums paid by third party within 3 years of death (i.e., 2 yrs. x $10,000). (c) = $100,000 = Total premiums paid on life insurance policy (i.e., 10 years x $10,000). Chapter 22, Exhibit 13b CCH Federal Taxation Comprehensive Topics

39. Annuities and Lump-Sum Survivor Benefits The gross estate of a decedent includes the commercial value of survival benefits for three types of annuities: • Joint and survivor annuities, whereby, payments continue to be made to a surviving spouse after the first spouse dies. • Self and survivor annuities, whereby payments continue to be made to a beneficiary after the death of the buyer. • Minimum guarantee annuities, whereby a refund feature provides for a lump-sum payment upon the death of the annuitant, unless the annuitant survives a minimum period of time. Chapter 22, Exhibit 14a CCH Federal Taxation Comprehensive Topics

40. Annuities and Lump-Sum Survivor Benefits Formula for computing includible value in decedent’s gross estate: (a) = (b) x [(c)  (d)], where, (a) = Amount includible in deceased annuitant’s gross estate. (b) = Commercial value of survivor benefits. (c) = Decedent’s contribution to purchase of annuity contract. (d) = Total purchase price of the annuity contract. In the case of a straight-life annuity, nothing is included in the gross estate of the annuitant at death because the annuitant’s interest in the contract is terminated by death (i.e., no survival benefits). Chapter 22, Exhibit 14b CCH Federal Taxation Comprehensive Topics

41. Annuities and Lump-Sum Survivor Benefits—Examples Example 1. Annuities FACTS: Kathy purchases a straight-life annuity that will pay her $10,000 a month when she reaches age 65. Kathy dies at age 70. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: Except for the payments she received before her death, nothing relating to this annuity affects Kathy’s gross estate. Chapter 22, Exhibit 15a CCH Federal Taxation Comprehensive Topics

42. Annuities and Lump-Sum Survivor Benefits—Examples Example 2. Annuities FACTS: Same facts as Example 1, except that the annuity contract provides for Craig, her husband, to be paid $5,000 a month for life as a survivorship feature. Craig is 72 years of age when Kathy dies. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: Under these circumstances, Kathy’s gross estate includes the commercial value (i.e., “cost”) of a comparable contract that provides an annuity of $5,000 per month for the life of a male, age 72. Chapter 22, Exhibit 15b CCH Federal Taxation Comprehensive Topics

43. Annuities and Lump-Sum Survivor Benefits—Examples Example 3. Annuities FACTS: Same facts as Example 2, except that Kathy paid for only 25% of the annuity contract. QUESTION: What will be included in Kathy’s gross estate? SOLUTION: 25% of the commercial value of a comparable annuity contract that provides an annuity of $5,000 per month for the life of a male, age 72. Chapter 22, Exhibit 15c CCH Federal Taxation Comprehensive Topics

44. Gift Tax Paid Within 3 Years of Death Gross-up Procedure. Including gift tax paid within 3 years of death in the gross estate is called the “gross-up” procedure. It prevents the gift tax amount from escaping the estate tax. Chapter 22, Exhibit 16 CCH Federal Taxation Comprehensive Topics

45. Inter Vivos Transfers—Types The gross estate (GE) includes assets transferred “during life” in which the decedent retained any of the following interests: Retained life estate. Income interest or control over enjoyment of the assets or income derived. Here, the logic is easy to follow: One should not be able to escape estate tax at death after having remained in a position to enjoy some or all of the fruits of ownership during life. Chapter 22, Exhibit 17a CCH Federal Taxation Comprehensive Topics

46. Inter Vivos Transfers—Types More-than-5% reversionary interest. If repossession by the transferor-decedent of property (not merely income from the property) is conditioned upon surviving the beneficiary-decedent, then such property would be included in the transferor-decedent’s GE. Revocable trust. The value of property interest transferred by the decedent is includible in the GE if the enjoyment of the property transferred was subject, at the date of the decedent’s death, to any power of the decedent to alter, amend, revoke or terminate the transfer. Chapter 22, Exhibit 17b CCH Federal Taxation Comprehensive Topics

47. Inter Vivos Transfers—Types Interest in a qualified terminable interest property trust (QTIP). A QTIP is a bequest of property to a surviving spouse in the form of a terminable interest life estate. To “qualify” as a QTIP trust, two requirements must be met: • ALL income from the trust must be distributed at least annually to the donee spouse (i.e., the trust must be “simple”). • No one can have a power to appoint any portion of the principal or income to anyone other than the spouse during the spouse’s lifetime. Chapter 22, Exhibit 17c CCH Federal Taxation Comprehensive Topics

48. Inter Vivos Transfers—Types Election to Claim Marital Deduction. An election exists to convert the terminable interest into nonterminable property eligible for the marital deduction. The result of the election is that the marital deduction is available to the donor-spouse’s estate for the full market value of the property in the trust, regardless of to whom the remainder goes, e.g.,, the children, charity, etc. This benefit carries a price tag: the full value as of the death of the donee-spouse is included in his/her gross estate. Chapter 22, Exhibit 17d CCH Federal Taxation Comprehensive Topics

49. Inter Vivos Transfers—Examples Example 1: Retained Life Estate Travis transfers income-producing property into trust for his daughter Betty, but retains the income from the property for his lifetime. Upon Travis’s death, the total fair market value of the property will be included in his gross estate. Chapter 22, Exhibit 18a CCH Federal Taxation Comprehensive Topics

50. Inter Vivos Transfers—Examples Example 2: More than 5% Reversionary Interest. Travis transferred property into trust giving a life estate to Betty with the remainder to Cathy if Travis predeceases Carla. However, if Betty predeceases Travis, the remainder would revert to Travis. The value of the reversionary interest would be included in Travis’ estate if it exceeded 5% of the value of the property at the time of transfer into the trust. Chapter 22, Exhibit 18b CCH Federal Taxation Comprehensive Topics