EA1 Study Unit 14.1-14.2 14 Estate Tax

Estate Tax Basics

• Estate taxes are wealth transfer taxes on property dispositions resulting from the transferor's death
• The federal estate tax base comprises the decedent's taxable estate and adjusted taxable gifts
• The taxable estate is the gross estate less allowable deductions
• Current-year applicable rates apply to both current and preceding years’ taxable gifts
• The rate is 18% for taxable gifts up to $10,000
• Rates incrementally increase over numerous brackets like 2% and 3%
• A maximum rate of 40% applies to cumulative taxable gifts and estates exceeding $13.61 million in 2024

The Gross Estate (GE)

• The gross estate includes the fair market value (FMV) of all property, real or personal, tangible or intangible, wherever located, to the extent the decedent had a beneficial interest at the time of death
• Items included in the GE are cash, personal residence and effects, securities, other investments such as real estate and collector items, other personal assets like notes and claims such as dividends declared before death if the record date had passed, and business interests such as interest in a sole proprietorship or partnership interest
• Special tax-avoidance rules exist for U.S. citizens or residents surrendering their U.S. citizenship or long-term residency

Decedent's Liabilities and Dower/Curtesy

• Liabilities of the decedent generally do not affect the amount of the GE unless the estate actually pays them
• The GE includes the value of the surviving spouse’s interest in property as dower or curtesy
• Dower and curtesy are common-law rights recognized in some states, usually in modified form
• Dower entitles a surviving wife to a portion of lands her husband owned and possessed during their marriage
• Curtesy entitles a surviving husband to a life estate in all of his wife’s land if they had children

Joint Tenancy and Power of Appointment

• The gross estate includes the full value of property held as joint tenants with the right of survivorship, except when the other tenant provided adequate consideration
• The GE includes 50% of property held as joint tenants by spouses or as tenants by the entirety regardless of the amount of consideration provided by each spouse
• Property interests over which the decedent had a general power of appointment (POA) is included in the GE
• A POA is a power exercisable in favor of the decedent, his or her estate, his or her creditors, or the creditors of his or her estate

Government Obligations, Gifts, and Insurance

• Bonds, notes, bills, and certificates of indebtedness of the federal, state, and local governments are included in the GE, even if interest on them is exempt from income tax
• Gifts made within 3 years of death are not included in the GE of a decedent, except for certain transfers such as transfers of life insurance and property in which a life estate was retained
• The GE includes gift taxes paid on gifts within 3 years before death
• The GE includes insurance proceeds on the decedent’s life if the proceeds are payable to or for the estate, the decedent had any incident of ownership in the policy at death such as right to change beneficiaries or right to terminate the policy, or proceeds of insurance policies given to others by the decedent within 3 years of death

Annuities, Medical Insurance, and Inter Vivos Transfer

• The GE includes the value of any annuity receivable by a beneficiary by reason of surviving the decedent if the annuity was payable to the decedent or the decedent had the right to receive the annuity or payment either alone or in conjunction with another for his or her life or for any period not ascertainable without reference to his or her death, or for any period that does not end before his or her death
• Medical insurance reimbursements due to the decedent at death are treated as property in which the decedent had an interest
• GE includes assets transferred during life where the decedent retained, at death, a life estate, an income interest, possession or enjoyment of assets, or the right to designate who will enjoy the property, a 5% or greater reversionary interest if possession was conditioned on surviving the decedent, the power to alter, amend, revoke, or terminate the transfer, or an interest in a qualified terminable interest property (QTIP) trust

Valuation of Gross Estate

• Value is generally the FMV of the property unless a special valuation rule is used
• Real property is usually valued at its highest and best use
• Land value listed on an estate tax return is the stepped-up basis
• A transfer of interests in a corporation or partnership to a family member is subject to estate tax-freeze rules, and the retained interest is valued at zero
• Valuing property at FMV (Fair Market Value) is referred to as stepped-up basis, but if an asset declined in value, it would be a stepped-down basis
• The executor may elect to value the complete estate, not individual assets, at either the date of death or the alternate valuation date with an irrevocable election
• An election can be made if it results in a reduction in both the value of the gross estate and the sum of the federal estate tax and the generation-skipping transfer tax where the valuation date is 6 months after the decedent’s death
• Assets sold or distributed before the alternate valuation date are valued on the date of sale or distribution
• Assets affected by mere lapse of time are valued as of the date of death including patents, life estates, reversions, and remainders where the value is based on years, except for changes due to the time value of money

Deductions from the Gross Estate

• Deductions from the GE in computing the taxable estate (TE) include ones with respect to expenses, claims, and taxes
• An amount is deductible against gross income on the decedent’s final income tax return if the right to deduct them from the GE is waived
• Expenses for selling estate property are deductible if the sale is to pay the decedent’s debts, pay expenses of administration, pay taxes, preserve the estate, or effect distribution
• Deductible expenses include funeral expenses, attorney, accountant, and executor fees, and claims against the estate including debts
• Medical expenses paid within 1 year of death may be deducted on either the estate tax return or the income tax return for the year incurred, but not both
• Unpaid mortgages on property are deductible if the value of the decedent’s interest is included in the GE
• State inheritance taxes are deductible from the gross estate, but federal estate taxes and income tax paid on income earned after the decedent’s death are not deductible
• Casualty or theft losses (deemed deductible) incurred during estate settlement are deductible if they were not deducted on the estate’s income tax return

Charitable Contributions & Marital Transfers

• Bequests to qualified charitable organizations are deductible if the entire interest of the decedent in the underlying property is donated
• Trust interests may enable deductible transfer of partial interests in underlying property
• An inter vivos contribution results in exclusion from the GE and a current deduction for regular taxable income
• Outright transfers to a surviving spouse are deductible from the GE as a marital deduction to the extent the interest is included in the gross estate if the surviving spouse is a U.S. citizen when the estate tax return is filed
• Transfers of qualified terminable interest property (QTIP) allow a marital deduction where the recipient spouse is not entitled to designate which parties will eventually receive the property
• QTIP is property that passes from the decedent in which the surviving spouse has a qualifying income interest for life and to which an election applies
• A spouse has a qualifying income interest for life if they are entitled to all the income from the property paid at least annually, and no person can appoint any portion of the property to anyone other than the surviving spouse unless the power cannot be exercised during the spouse’s lifetime

Credits Against Estate Tax

• The estate tax is imposed on the sum of the taxable estate (TE), plus gifts subject to gift tax
• Four credits are available to offset federal estate tax liability
• The applicable credit amount (ACA) is a base amount ($5,389,800 in 2024) not reduced by amounts allowable as credits for gift tax for all preceding tax years
• ACA offsets the estate tax liability imposed on a taxable estate of up to $13.61 million per spouse, computed at current rates (2024)
• The ACA was formerly called the unified credit
• Any unused amount by a deceased spouse can be used by the surviving spouse in addition to their own exclusion amount for an available exclusion amount of $27.22 million under the portability election
• A credit is allowable for death taxes paid to foreign governments and on gift tax paid on gifts made before 1977 and included in the gross estate
• Prior transfers allow credit for taxes paid on transfers by a person who died within 10 years before, or 2 years after, the decedent’s death where amounts creditable are the lesser of the estate tax paid by the prior transferor or the amount by which the assets increase the estate tax and an adjustment is made to the credit for transfers more than 2 years before the decedent’s death

Income in Respect of a Decedent

• Beneficiaries can take a deduction for the estate tax paid on income earned before death but received after the decedent’s death if it is income in respect of a decedent and reported on Schedule A

Estate Tax Payment and Return

• The executor must file Form 706, United States Estate Tax Return, if the gross estate at the decedent’s death exceeds $13.61 million in 2024 where adjusted taxable gifts reduce the threshold
• The estate tax return is due within 9 months after the date of the decedent’s death, with up to 6 months extension granted
• Payment may be extended for 1 year past the due date or up to 10 years for reasonable cause
• The assessment period is 3 years after the due date for a timely filed Form 706, extended an additional year on transferees for transfers from an estate
• Estate tax is charged to estate property, and if tax on distributed estate part is paid out of other estate property, equitable contribution from the distributee beneficiary is recoverable
• The executor is ultimately liable for payment of the taxes

Closely Held Business

• An estate including a substantial interest in a closely held business may delay part of the estate tax payment if that interest exceeds 35% of the gross estate
• A closely held business includes a corporation with 45 or fewer shareholders or 20% or more value of the voting stock in the gross estate or a partnership with 45 or fewer partners or 20% or more of the capital interests in the partnership in the gross estate

Basis Reporting and Beneficiary

• Those who file a Form 706, United States Estate Tax Return, must report the final estate tax value of property distributed from the estate on Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent with a copy of every Schedule A (Form 8971) to the IRS
• Beneficiaries only receive their corresponding Schedule A
• This ties beneficiaries to the estate value of an asset for later sale
• If the decedent has no estate tax filing requirement, but a return is filed for making an allocation for the generation-skipping transfer tax, a Form 8971 is still not required where the due date is 30 days after the estate tax return date
• Form 8971 is subject to the accuracy related 20% of underpayment penalty and applies to a beneficiary overstating their basis in a subsequent sale, preventing an individual from using a low basis to avoid estate tax and a high basis to prevent a gain on the subsequent sale.

Generation-Skipping Transfers (GSTs)

• The generation-skipping transfer tax (GSTT) is imposed separately from gift and estate taxes on transfers directly to or in trust for the benefit of a person at least two generations younger than the transferor on each generation-skipping transfer (GST)

Transfer Types and Direct Skip

• There are three types of GSTs: Direct skips, taxable distributions, and taxable terminations
• A direct skip is a transfer of an interest in property, subject to estate tax or gift tax, to a skip person, where the transferor is liable for the tax
• A skip person is a natural person assigned to a generation two or more generations below the transferor or a trust, all interests of which are held by skip persons
• A skip person is identified by reference to the family tree for related persons (i.e. grandchild is two generations below the grandparent) and by age differences for nonrelated persons, with one born 12 1/2 years or less after the transfer assigned to the same generation, and a new generation for each additional 25 years thereafter from the transferor's birthdate
• For example, an individual born between 37 1/2 years and 62 1/2 years after the transferor is two generations below the transferor

Taxable Distribution and Termination

• A taxable distribution is a distribution from a trust to a skip person of income or principal, other than a direct skip or taxable termination, where the transferee is liable for the tax
• A taxable termination is the termination of an interest in property held in trust, but hasn't occurred if, immediately after the termination, a non-skip person has an interest in the property or distributions are not permitted to be made to a skip person, where the termination may be by lapse of time, release of power, death or the trustee is liable to pay the tax

Exemption and Computation

• Each individual is allowed a $13.61 million exemption in 2024 that they or their executor may allocate to GST property with gift splitting applies to GSTTs or $27.22 million is allocable where inter vivos gifts are exempt if not subject to gift tax due to the $18,000 annual exclusion or the medical or tuition exclusion

• The GSTT is computed by multiplying the taxable amount by the applicable rate or the maximum federal rate multiplied by the inclusion ratio

• The maximum federal rate is 40% (for 2024) where the GSTT does not apply when neither the federal estate tax nor gift tax does and a general power of appointment includes the trust in the estate and so is not subject to GSTT

GSTT and GSDT

• Generation-Skipping Termination Tax occurs if the interest of a non-skip person terminates by reason of death, expiration of time, or another reason where a skip person becomes the recipient of the trust property and the trustee files and pays the tax
• Generation-Skipping Distribution Tax (GSDT) applies to trust distributions out of income or corpus to a beneficiary at least two generations below the grantor, while an older generation beneficiary has an interest in the trust
• The distributee is entitled to a federal income tax deduction for GSDT imposed on current distributions of trust income, the basis of property received is increased by the proportion of GSDT imposed, and the distributee reports and pays GSDT
• A trustee's GSDT payment is deemed an additional distribution to a beneficiary

Direct Skips: Gift and Estate Taxes

• A direct skip occurs when generations are bypassed and property is transferred directly to or in trust for a skip person

• Direct Skip Gift Tax (DSGT) and Estate Tax (DSET)

• The tax is imposed on gifts by an individual to a third generation or below beneficiary on the FMV of the property given where the gift tax annual exclusion and the generation-skipping tax exemption apply and the donor is liable for both the gift tax and the DSGT if the donor is liable

• The donee can add a DSGT proportion to their income tax basis in property received and the DSGT is added to federal taxable gifts, increasing the federal gift tax

• Direct Skip Estate Tax (DSET) applies when there is a bequest by an individual to a third generation or below beneficiary where the donor estate is liable for the estate tax and the DSET

• Unallocated $13.61 million generation-skipping tax exemptions are used to reduce taxable direct skip bequests where the basis is the FMV at the date of death and not increased by DSET