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Chapter 22 Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Transfer Tax

Chapter 22 Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Transfer Tax. ©2008 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com. Definition of Terms. Estate

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Chapter 22 Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Transfer Tax

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  1. Chapter 22Federal Estate Tax, Federal Gift Tax, and Generation-Skipping Transfer Tax ©2008 CCH. All Rights Reserved. 4025 W. Peterson Ave. Chicago, IL 60646-6085 1 800 248 3248 www.CCHGroup.com

  2. 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

  3. 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

  4. Estate Tax Return Minimum gross estate value. The executor is required to file form 706, U.S. Estate tax return, if the gross estate at the decedent’s death exceeds $2 million in 2008. Adjusted taxable gifts made by the decedent during his/her lifetime reduce this threshold dollar for dollar. Due date of return. Form 706 is due within 9 months after the date of the decedent’s death. An extension of up to 6 months may be granted. Extension of payment. Time for payment may be extended by a reasonable period, but not by more than 12 months. Showing undue hardship is required. Chapter 22, Exhibit 30a 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. Estate Tax – General Items • Unified/Applicable credit in 2008 is $780,800 or the exclusion amount is $2,000,000 • First dollar of estate greater than exclusion subject to 45% estate tax. • Estate tax returns due 9 months after death • Filing is required if estate greater than $2mill. CCH Federal Taxation Comprehensive Topics

  10. 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

  11. 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

  12. Present and future interests • Life estate – enjoyment of the property/income during a defined lifetime • Remainder – gets what is left over after the life estate is over • Reversion – property/income reverts back to grantor when life estate ends. CCH Federal Taxation Comprehensive Topics

  13. Gifts within 3 years of death • Gifts made are not brought back to the estate even if on the deathbed. • Adjusted taxable gift - the taxable portion of the gift is added to the estate tax base. • Gift of life insurance CCH Federal Taxation Comprehensive Topics

  14. 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

  15. 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

  16. 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

  17. 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

  18. 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

  19. 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

  20. 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. Chapter 22, Exhibit 12b CCH Federal Taxation Comprehensive Topics

  21. 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

  22. 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

  23. 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

  24. 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

  25. 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

  26. 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

  27. 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

  28. 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

  29. Inter Vivos Transfers—Examples Example 3: Revocable Trust Travis establishes a lifetime revocable trust naming his mother Betty as beneficiary. Travis designates himself as trustee. The transfer is incomplete as he has retained the power to revoke the trust. Upon his death, the present value of the reversionary interest would be includible in his GE. Chapter 22, Exhibit 18c CCH Federal Taxation Comprehensive Topics

  30. Inter Vivos Transfers—Examples Example 4: QTIP (with and without election) When Travis died, he left $2,000,000 in trust to his wife Betty. All future income (except capital gains) derived from the $2,000,000 is to be distributed to her annually for life. The remainder goes to charity. Chapter 22, Exhibit 18d CCH Federal Taxation Comprehensive Topics

  31. Inter Vivos Transfers—Examples Example 4 (continued) Without the QTIP election. If Travis’ executor did not make the QTIP election: (a) $2,000,000 would be included in Travis’s gross estate; (b) The marital deduction would not be allowed; (c) The trust would not be included in Betty’s GE when she died. With the QTIP election. If Travis’ executor did make the QTIP election: (a) $2,000,000 would be included in Travis’s GE (same as above); (b) The marital deduction would be allowed; (c) If on Betty’s death, the trust is valued at $5,000,000, the full value would be included in her GE. Chapter 22, Exhibit 18e CCH Federal Taxation Comprehensive Topics

  32. 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

  33. Valuing the Gross Estate Date of death. Value is the fair market value (FMV) of the property at date of death unless a special valuation rule is used. Real property is usually valued at its highest and best use. Chapter 22, Exhibit 21a CCH Federal Taxation Comprehensive Topics

  34. Valuing the Gross Estate Alternative valuation date. The executor may elect to value the estate at an alternate valuation date, which is 6 months after the date of death. If the election is made and property is distributed before the 6-month date, then the value on the day after the date of distribution will apply. Thus, there are 3 possible dates for valuing an estate: • Date of death, or, • If elected by executor (not heir), the earlier of: (a) 6 months after date of death, or (b) Date received by heir if before 6 months. Chapter 22, Exhibit 21b CCH Federal Taxation Comprehensive Topics

  35. Valuing the Gross Estate The alternative valuation date carries three requirements: • It is irrevocable. • It applies to all property of the estate (i.e., the executor cannot “pick and choose” which property to elect). • It can be made only if it results in a reduction in BOTH the value of the GE and the sum of estate tax and the generation-skipping transfer tax. Chapter 22, Exhibit 21c CCH Federal Taxation Comprehensive Topics

  36. Deductions from the Gross Estate Examples. Deductions are subtracted from the gross estate (GE) in computing the taxable estate (TE). Typical expenses include: funeral expenses, administrative expenses, debts of the decedent, claims against the estate, casualty losses and allocations of deductions on returns. Funeral Expenses. Deductible from the GE, even if they if incurred in a foreign country, or if they go beyond the “necessary.” Chapter 22, Exhibit 22a CCH Federal Taxation Comprehensive Topics

  37. Deductions from the Gross Estate Administrative Expenses. These include fees paid to the executor, lawyer, accountant, and appraiser. They are deductible if: • Allowable by local law; and • Necessary for administering the estate (i.e., for selling or distributing assets, paying debts, etc.) Administrative expenses incurred for the convenience of a beneficiary are disallowed. Chapter 22, Exhibit 22b CCH Federal Taxation Comprehensive Topics

  38. Deductions from the Gross Estate Debts of the Decedent and Claims Against the Estate. All enforceable claims against the estate are deductible if paid. This includes: • Accrued interest expense as of the date of death. • Unpaid federal, state & local income taxes, property and gift taxes, but not estate tax itself. The property taxes are deductible only if the property is included in the GE. •   Nonrecourse mortgages are deductible up to the amount of the property value included in the GE. Chapter 22, Exhibit 22c CCH Federal Taxation Comprehensive Topics

  39. Deductions from the Gross Estate • State death taxes • Disclaimers • In writing • Next person on the list Chapter 22, Exhibit 22c CCH Federal Taxation Comprehensive Topics

  40. Casualty Losses Tax Treatment. If sustained by the estate, they are deductible from the gross estate (GE): • Without regard to the 10% AGI floor; and • Based on estate tax value (i.e., fair market value at date of death or alternative valuation date), without regard to basis. Note that casualty losses sustained prior to death are deductible on the decedents final 1040 return and, if sustained after distribution, then deductible by the beneficiary. Chapter 22, Exhibit 23 CCH Federal Taxation Comprehensive Topics

  41. Charitable Contributions Tax Treatment. Bequests to qualified charitable organizations are deductible. Before Death.Contributions made before death do double duty. They are deductible for income tax purposes and they are nor includable in the gross estate. Chapter 22, Exhibit 24a CCH Federal Taxation Comprehensive Topics

  42. Charitable Contributions No Ceiling Limitation. The deduction is not subject to the usual 50%/30%/20% AGI ceilings for individuals, rather, 100% of the estate value is deductible, regardless of the property (ordinary or long-term capital gain) and regardless of the charity (public or private). Chapter 22, Exhibit 24b CCH Federal Taxation Comprehensive Topics

  43. Charitable Contributions Entire Interest Requirement.The entire interest must be donated. The entire interest of the decedent in the underlying property must generally be donated. Trust interests may enable deductible transfers of partial interests in underlying property. An inter vivos contribution (as opposed to a bequest) may result in exclusion of the property value from the GE and a current deduction from estate income. Chapter 22, Exhibit 24c CCH Federal Taxation Comprehensive Topics

  44. Marital Transfers Tax Treatment Estate of first to die.Outright transfers to a surviving spouse are deductible from the gross estate (GE) of the first spouse to die, to the extent the interest is included in the GE. Put differently, marital transfers are both taxable transfers and deductions, resulting is a zero estate tax effect. The deduction is unlimited. Surviving spouse’s estate.The GE of the surviving spouse must include the property that had been subject to a marital deduction by the former spouse’s estate. The value to be included in the surviving spouse’s GE is the value of the property at the surviving spouse’s date of death. Chapter 22, Exhibit 25a CCH Federal Taxation Comprehensive Topics

  45. Marital Transfers Qualifying for the Marital Deduction. To qualify for the marital deduction, it is not sufficient that property passes to the surviving spouse. The interest must be nonterminable (i.e. the surviving spouse’s interest in the property must not lapse, expire or terminate, then pass on to a third party.) Examples of nonqualifying terminable interests include: term interest, life estates and certain annuities. Chapter 22, Exhibit 25b CCH Federal Taxation Comprehensive Topics

  46. Marital Transfers—Examples Example 1: Wife’s Life Interest Disqualifies Marital Deduction. Travis dies, leaving his wife Betty, the income from property for life, whereupon the property itself passes to the grandchildren. The life interest does NOT qualify for the marital deduction in Travis’s estate, because the interest terminates upon Betty’s death (i.e., she has no control over who gets the remainder). Chapter 22, Exhibit 26a CCH Federal Taxation Comprehensive Topics

  47. Marital Transfers—Examples Example 2: Wife’s Remainder Qualifies for Marital Deduction. Travis leaves the property to his mother for life. Upon her death, the remainder passes on to his wife, Betty. The remainder DOES qualify for the marital deduction in Travis’s estate because his wife’s remainder interest is nonterminable, even though she may die before Travis’ mother dies. Chapter 22, Exhibit 26b CCH Federal Taxation Comprehensive Topics

  48. Marital Transfers—Examples Example 3: Wife’s Remarriage Restriction Disqualifies Marital Deduct. Travis dies, leaving his wife Betty a life interest in his stock portfolio. If she remarries, the life interest terminates and the stock passes on to his children. However, if she does not remarry, she can will the stocks to anyone. The marriage deduction is not allowed due to possibility, no matter how remote, that she may remarry and terminate her life interest in the stock. Chapter 22, Exhibit 26c CCH Federal Taxation Comprehensive Topics

  49. Gift Tax—Overview Definition. Gift tax is imposed on the donor (giver), not the donee (beneficiary) on the gratuitous transfer of property for less than full and adequate consideration. Giving up dominion and control. A gift transfer is complete (and taxable) when the donor has given over dominion and control such that she is without legal power to change its disposition. Only inter vivos gifts are subject to gift tax. Gifts completed when the donor is living (i.e., inter vivos gifts) are the only ones subject to gift tax. Transfers made in trust are included. Property passing by will or inheritance are not included as gifts, but are generally included in the gross estate. Chapter 22, Exhibit 32 CCH Federal Taxation Comprehensive Topics

  50. Gift Tax—Exclusions $12,000 Annual Exclusion. The first $12,000 of gifts of present interest (i.e., current, not future dominion and control) to each donee, is excluded by the donor from taxable gift amounts. Future interests. The exclusion does not apply to future interests. Chapter 22, Exhibit 34a CCH Federal Taxation Comprehensive Topics

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