CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Estate Planning

1. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning Session 14Postmortem Calculations: 303, 6166, and 2032(a) (special use)

2. Session Details

3. Section 6166—Installment Payment of Estate Tax Purpose and Advantage of Election • Allows delay in payment of estate and GSTT tax attributable to a closely held business interest (CHBI) at death • Delay prevents having to liquidate business • Payments can be made in up to 10 annual installments • First payment of principal due not later than 5 years after estate tax is due • Interest before first principal and interest due annually • PR may be required to post a bond • Maximum tax payable in installments formula:

4. Section 6166—Installment Payment of Estate Tax Prerequisites for Use • Decedent must be U.S. citizen or resident alien • Decedent must die with a CHBI that constitutes 20% or more of the capital interest (partnership) or 20% or more of the value of the voting stock (corporation) • CHB defined as • sole proprietorship • partnership of 45 or fewer partners • corporation of 45 or fewer shareholders • CHB must be operative at death • Estate must owe tax after the credit amount is applied • CHBI value must exceed 35% of AGE

5. Section 6166—Installment Payment of Estate Tax 35% Requirement • Passive assets of the CHB are not used for this purpose • AGE is computed by deducting from GE • funeral and administrative expenses, claims against the estate, unpaid mortgages, or debt in respect of property included in the gross estate (Section 2053) and • theft or casualty losses to estate property not compensated by insurance or otherwise (Section 2054) • Requirement must be met both with and without including all gifts subject to 3 year rule (except gross up) in GE • Can combine two or more CHBI to meet requirement if more than 20% of the value of each business is included in GE

6. Section 303 Stock Redemption Purpose and Advantage of Election • This Code section allows the estate of a decedent who owned corporate stock, or the estate beneficiary who is to receive such stock, to report money paid in a redemption as capital gain rather than ordinary income • The redemption is made to aid estate liquidity to pay death taxes and funeral and administrative expenses owed by the estate or the beneficiary • Issuing corporation must have funds to make redemption; key person policy on decedent

7. Section 303 Stock Redemption Prerequisites • Decedent’s estate must include stock of a corporation(closely held) • Redemption must be requested either by the estate or an estate beneficiary to whom such stock is given, and who has an obligation to pay death taxes, and/or funeral and administrative expenses of the estate (limit) • Note: 303 can be used even when no tax will be due • Value of stock must exceed 35% of AGE

8. Section 303 Stock Redemption 35% Requirement • AGE is computed by deducting from GE funeral and administrative expenses, claims against the estate, unpaid mortgages, or debt in respect of property included in the gross estate (Section 2053) • Requirement must be met after including all gifts made within 3 years of death in GE • Stock of two or more corporations can be combined to meet requirement if 20% or more of the value of the outstanding stock of each corporation is included in GE

9. Section 2032(a) Special Use Purpose and Advantage of Election • Allows real estate used in a closely held business or farming operation to be valued at current use rather than fair market value (FMV) • Cannot reduce from FMV by more than inflation indexed amount ($1,090,000 in 2014) • Will reduce or eliminate estate tax for estate • May prevent having to sell the business or farm to pay tax • Can use DOD or AVD • Can use in conjunction with 6166

10. Section 2032(a) Special Use Prerequisites • Estate must contain real property used in CHB or farm • Value at current use must be less than FMV • Estate must owe tax after application of credit amount and gift taxes payable credit • The decedent was a U.S. citizen or resident at death. • The real property is located in the United States. • The real property: • is passed to a qualified heir. • was being used for a qualified use by decedent or a family member at the time of death, and for a total of 5 of the 8 years prior to death. • was owned by decedent or family members for 5 of the 8 years prior to death. • There was material participation by decedent or a family member in the operation of the farm or business for a total of 5 of the 8 years prior to decedent’s death. • The 50% and 25% tests are met. • The required recapture agreement is signed and submitted by all heirs with interests in the property.

11. Section 2032(a) Special Use 25% Test • At least 25% of decedent’s gross estate as adjusted (GEA)—GE after deducting secured debts on all assets included in GE—must be attributable to the value of the qualified real estate (using FMV) minus only secured debt against real estate • GE must include the value of property transferred by decedent during the 3-year period ending on the date of the decedent’s death

12. Section 2032(a) Special Use 50% Test • At least 50% of decedent’s gross estate as adjusted (GEA)—GE after deducting secured debts on all assets included in GE—must be attributable to the value of qualified real and personal property—including qualified business property transferred within 3 years of death (if such property continued in a qualified use until death)—minus only secured debt of decedent against qualified real estate and personal property • GE must include value of property transferred by decedent during 3-year period ending on the date of decedent’s death

13. Postmortem Elections—Example Until his death, your client, a U.S. citizen, had actively operated a ranch in Colorado as a sole proprietor for the last 20 years. His gross estate is $5.75 million, of which $1 million is the value of the ranch land and $950,000 is the value of the ranch-related personal property. The ranch real estate has a mortgage of $300,000, and the ranch personal property is encumbered by a mortgage of $100,000. Unsecured debts and administrative expenses of the estate are $200,000. The client’s total estate is given to a son in your client’s will. The client had $1.5 million of adjusted taxable gifts since 1976. If the major objective is to ensure that the client's son can continue the ranching operation, what is the most appropriate postmortem planning technique? • a QTIP election for all estate property • a Section 303 redemption • a Section 2032A special use valuation • a Section 6166 installment payment of estate taxes

14. Postmortem Elections—Answer D is the correct answer. • A Section 303 stock redemption is not possible, as the business was conducted as a sole proprietorship rather than a corporation. A QTIP election is not possible as nothing is given to a spouse. The client’s estate would owe tax due to the adjusted taxable gifts. • The computations for special use valuation and Section 6166 installment payment of estate tax follow. • SPECIAL USE: • The calculation of the 25% (real estate) and 50% (real estate and personal property) requirements are calculated against the Gross Estate as Adjusted (GEA) as opposed to the Adjusted Gross Estate (AGE) used in the percentage requirement calculation for Section 6166 (see below). The GEA is simply the Gross Estate (GE) minus only secured debts against any property included in the GE. • Therefore, the client’s GEA is $5.35 million {$5.75 million minus $300,000 (farm real estate mortgage) and $100,000 (farm personal property mortgage)}. • 25% of this amount is $1,337,500 • 50% of this amount is $2,675,000 These numbers are the targets. • The net amount of the farm real estate is $700,000 ($1,000,000 minus $300,000 mortgage). Therefore the target ($1,337,500) is not met. • The net amount of the farm real estate and the farm personal property is $1,550,000 ($1,000,000 + $950,000 minus $300,000 and $100,000). Therefore, the target ($2,675,000) is not met. • SECTION 6166: • The calculation of the 35% requirement is calculated against the AGE. The AGE is the GE minus all debts of the decedent, both secured and unsecured, and funeral and administrative expenses, and theft and casualty losses. Therefore the client’s AGE is $5,150,000 ($5.75 million minus $300,000, $100,000, and $200,000). 35% of this figure is $1,802,500. The value of the decedent’s closely held business interest must exceed this target to use installment payment of estate taxes generated by the business interest. • The value of the client’s business interest is $1,950,000 ($1,000,000 + $950,000). Therefore the target is met. • Note that these facts do not include any prior taxable gifts within three years of death, which would complicate both calculations.

15. Question 1 Carol owns 80% of IGU Corporation (one-half of the value of the stock is attributable to real estate owned by IGU). Currently, the value of Carol’s stock in IGU is 64% of her projected adjusted gross estate. Carol is examining the implications of transferring three-quarters of her IGU shares to her children from her current marriage. Her will leaves specified property valued at 10% of her estate to her husband and the remainder of her estate to her children from her former marriage. Which one of the following postmortem elections would not be adversely affected due to the proposed transfer of the IGU shares from Carol to her children from her current marriage? • a partial stock redemption under IRC Section 303 • special use valuation • the alternate valuation date • deferral and installment payment of estate tax under IRC Section 6166

16. Question 2 Which one of the following is a qualifying requirement for Section 2032A special use valuation of real property used in a business? • The business must be engaged in farming or ranching. • The family member-owner of the business must have been a material participant in the business for at least 10 years prior to his or her death. • The value of the decedent’s business interest, minus secured debts and unpaid mortgages on such property, must equal 50% or more of the decedent’s gross estate as adjusted for secured debts and unpaid mortgages on all property included in the gross estate. • The real property used in the business must exceed 35% of the adjusted gross estate.

17. Question 3 When Joe died in 2014, he was a widower with a gross estate of $5.5 million, which included a 50% partnership interest valued at $1.9 million. The partnership owned real estate valued at $1.4 million. His adjusted gross estate was $5.34 million. Joe’s will left $100,000 to a qualified charity and the balance of his estate, including the business interest, to his two nephews. They currently participate in the business and plan to hold the business interest indefinitely. Joe made no taxable gifts during his lifetime. Given the facts stated above, which one of the following correctly states why Joe’s estate cannot qualify to use the installment method of paying the estate tax (Section 6166)? • His nephews are not considered qualified heirs. • His estate does not contain any closely held shares of stock. • The value of the business interests included in Joe’s gross estate is not more than 35% of his adjusted gross estate. • His estate will not owe any estate taxes. • The closely held business does not have the prerequisite real estate ownership.

18. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning Session 14End of Slides