Estate and Gift Tax Outline PDF

ESTATE AND GIFT TAX OUTLINE December 12, 2024 INCOME TAXATION SECTION 102 SECTION 1012...

ESTATE AND GIFT TAX OUTLINE December 12, 2024 INCOME TAXATION SECTION 102 SECTION 1012 SECTION 1016 SECTION 1025 SECTION 1014 Lifetime Exemption 1. You can give up to $13,610,000 until you have to pay gift taxes (lifetime) or estate taxes (upon death). a. There is an equal generation skipping tax (GST) tax exemption amount Estate Tax 1. The estate tax is 40% of the value in excess of the exemption amount. Different Ways of Making Gifts that will be Taxed 1. Outright- give a million dollar check to your son 2. Trust- give the money to a trust for your son 3. Business- contribute a million dollars to a joint business 4. Several other ways not listed State Property Law 1. Estate v. Boch- even though estate and gift tax law is a federal law, they look to state property law to determine whether a gift has been made, who the owner is, and what the rights are in the property 2. Marital property has no place in estate planning, only divorce Arguments For and Against the Estate Tax 1. Arguments for the estate tax: $33 billion added to the government, taxes are generally not due unless you have money to pay the taxes. The estate tax is the only tax where the taxpayer may not have the cash to pay the tax. You get a deduction for charitable giving in the amount in excess of their estate exemption to avoid paying the 40% on the tax. Taking that away would make people less inclined to donate. 2. Arguments against the estate tax: that is 40% of our revenue, the assets have already been taxed at least once through other taxes. Forms and Due Dates 1. Gift Tax Return (Form 709): a. Reports your made in the current year and gifts you made in the prior year b. File every year by April 15th c. Can extend to October 15th 2. Estate Tax Return (Form 706): a. Report every asset that the decedent owned when he died, has rights over, etc. b. What did you own at death, what did you give away during your life, and what else can we pull in and make subject to the estate tax c. Due 9 months after the date of death. d. Tax is due on that date. e. Can be extended 6 months, but the tax payments cannot. f. Should be able to identify which section the asset is being included under. g. Always “audited”, mainly reviewed h. 3 year statute of limitations on estate tax return from the time the form is filed. Probate 1. Assets that are in your individual name when you die. Those assets with no beneficiary designations go through the courts to be distributed. a. Minimum 6 months waiting period 2. Estate tax is not just limited to probate distributions VALUATION SECTION 2031 SECTION 2033 SECTION 2512 SECTION 2701 SECTION 2702 SECTION 2703 SECTION 2704 SECTION 2031 General rule: Section 102: gifts and inheritances are exempt from taxes. General basis 1. Basis: the amount the taxpayer is to have invested in a particular asset. What they have paid plus some adjustments  2. § 1012: cost of the assets 3. § 1016: adjustments to the basis. Gain or loss Gain or loss is determined at the time of the sale of an asset. 1. Difference between the adjusted basis and the sale price. a. Exp: if you buy Walmart at $10 and sell it at $15, then you have a gain of $5 and you pay capital gains tax on that $5. b. Capital gain tax rate is either 15% of 20% depending on your income. Basis in gifted property § 1015: the basis of property gifted is the basis of the donor. 1. Exp: if I gift Walmart stock when it is worth $15 to my child, my child has a carry-over basis under § 1015. My child will take a $10 basis and if he sells it the next day he will pay capital gains on the $5 difference. Loss Property If I gift property is loss property (value is less than the basis) then you use the carry-over basis or the donor's basis for gain purposes and use FMV at the time of gift for loss purposes. 1. Exp: if I gift Walmart stock when it is worth $9 and when the kid sells it it's worth $8, he has to use the $9 value on the date of the gift to determine what his loss is because it is a deduction on your income tax return. If he sells it for $9.50, there is no gain and no loss because you are in no-man's land. 2. Rarely you would gift loss property. The donor would take it and sell it and then gift the proceeds. a. Exp: maybe it is a family farm and you don't want to sell it. You may want to keep it in the family. If the farm is worth less than the basis you would gift loss property. 3. It is the responsibility of the taxpayer to know the value of the property is worth when they gift it. Stepped-up Basis 1. Most important: §1014 stepped up basis 2. Basis that is adjusted to FMV as of the date of death. 3. FMV may be more or less than the basis, but it doesn't matter because on the date of death reset to FMV if the asset is included in the deceased's estate for estate tax purposes. a. Exp: If I die and leave my Walmart stock. I paid $10 for it. It is worth $15 when I die. I leave it for my children and my children have a basis of $15. If it is worth $8, my children have a basis of $8. FMV at death is the basis. b. When the decedent passes away, all the capital gain goes away.  4. Exception: If the decedent received the property that is subject to the stepped up basis within one year of death, and the original donor and the devisee are the same person, there is no stepped up basis. a. Exp: I have Walmart stock. It has a lot of gain built in. Mother is terminally ill. Doctors say she will die within three months. I transfer to her a $1 million of walmart stock with a basis of $50,000. Mother dies, transfers it to me at death. Now I have a stepped up basis. I have $1,000,000 of Walmart stock that no longer has any capital gains built in. I would have Walmart stock with a $1 million basis. However, because it is within one year of death, I don't get a stepped up basis. I get it back just like I had it before. i. If you sold it you would have to pay capital gains on $950,000 so that is why people tried to get around the rule by transferring it to a family member and then receiving it back when that person dies. Other income tax things to note: 1. The highest tax bracket is 37% 2. For trusts and estates, if they earn more than $14,451, they hit the highest tax bracket. It doesn't matter if you are also in the highest tax bracket. a. A lot of people are not, specifically children of wealthy people. 3. How do you deal with this? If you distribute income out of a trust then the trust gets a deduction, a distributable net income (“DNI”) so that it has no income that is taxable, then the beneficiary will pick up the income on his income tax return and get the much larger tax bracket run. 4. There are trusts that are referred to as IDGTs- intentionally defective grantor trust a. Creating a trust that is defective by internal revenue code standards. b. It is where you make a completed gift during your lifetime to an irrevocable trust, but it is an incomplete gift for income tax purposes c. This means that the person who makes the gift, the donor, will continue to pick up all of the income that is associated with the gift itself. i. Anything it earns, the donor who no longer owns the asset, no longer benefits from the asset, continues to pay taxes on the assets. d. The reason you do this is because it results in effectively making additional gifts to the recipients without using any of your gift tax exemptions. e. Exp: I created a trust for my son for $1 million. It earns 5% per year, $50,000. Normally the trust would pay income tax on the $50,000 at 37%, or we would distribute out the income and the son would pay the taxes. If you don't want to do either of these then you would make an IDGT. Create the trust, make it intentional and defective, now I show for the year $50,000 of income. I pay from other assets, the tax associated with that $50,000. My son's trust now has $1,050,000. If you distribute it or if the trust pays it, it would be $50,000 less 37% of taxes.  Either way, that would reduce the value of the trust. If I pay the taxes on it it's a benefit because the trust gets to keep its gross amount and I have effectively reduced the value of my overall estate by paying the taxes. Valuation 1. General overview: identify the property interest, the date of value is either the date of death or 6 months after (alternate valuation date), determining FMV and then determining what code section causes the property to be included. 2. Valuation is the most important thing with regard to estate tax return, etc. 3. To complete an estate or gift tax return you have to: a. Identify the property that has been transferred that needs to be reported on the return. b. Determine date that the property is to be valued i. Decedent: date of death ii. Gift: date the gift is complete 1. Look at acceptance 2. Can't be an incomplete gift- intent, but no transfer c. Use an accepted method of valuation. i. Value is the FMV of the property. Gross Estate 1. Definition of gross estate: § 2031 a. Starting point for all estates b. The gross estate includes the value of all property, real or personal, tangible or intangible, to the extent provided by § 2033 through § 2046. c. The most important factor in determining value are the facts. i. In general, we don't care about facts that happen after the date of death or after the date the gift is complete. 1. There are exceptions, but this is the general rule. 2. Gift tax section: § 2512 a. Same as 2031. 3. Regulation 20.2031-(b) a. Defines FMV b. It is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. c. The very premise upon which all valuation is based. d. The problem with gifts and estates is that we are valuing it at a time where it has not transferred in a normal willing buyer and willing seller scenario.  i. Usually we are asking how much it was worth on the date of death. e. Almost all IRS controversies are going to deal with valuation. Tangible Personal Property 1. The physical things you collect 2. Generally we use the yard sale value for personal property a. Sentimental value is $0. b. Lump it all in anand throw it on the tax return. c. Exception: you need to get a copy of your clients homeowners insurance. If they have homeowners insurance that insures multiple things that add up to $100,000, you are going to have to list those. Then you can lump everything else in. If you have any kind of antiques, coin collections, etc., these are the kinds of things they are looking for. d. Personal Property that must be appraised 3. Any asset worth more than $3,000 must be appraised. a. Typically jewelry, art, or antiques. 4. If you have a collection of items that is worth more than $10,000 it must be appraised. 5. Reg § 20.2031-6(b) sets out the rules of a professional appraisal for any single items in excess of $3,000 and any collection of items that are worth more than $10,000. Securities 1. Publicly traded marketable securities (Walmart stock) 2. Reg § 20.2031-2(b)(1) 3. FMV is trading value a. Opening value and closing value are irrelevant b. Take the average of the high and the low of the day to find the trading value. 4. What if you die on a day the market is closed? a. Take the high and low of the most recent trading prior and after the date of death and weigh them. i. Exp: someone dies on Saturday. Take the high and low on Friday and high and low on Monday and weigh them. ii. The Friday’s average gets a ⅔ wight the Monday’s average gest a ⅓ weight Bonds 1. Similar valuation if it is a publicly traded bond. a. I’m assuming it is the same valuation as securities. 2. If it is a private bond, take the actuarial value. Promissory Notes 1. Valued at the outstanding principal plus accrued interest  2. Reg § 20.2031-4 3. Exp: If you loan someone $100,000 at 4% interest and they are making payments, upon their date of death you would calculate the principal and the accrued interest. a. If they are not making payments or if they are a dead-beat debtor, you could argue that it is either worthless or you should take a discounted value. In general, you will value it at unpaid principal plus accrued interest. Real Property 1. Don’t forget that this includes dirt and anything on the dirt that is fixed a. When a client builds a house you still need the deed to the land. 2. Examples include: home, farm, commercial building, the lot, etc. 3. Also may include mineral interest a. Very hard to value 4. To find the value of real property, get an appraisal done from a professional appraisal a. Take the value on the written appraisal report b. This will need to be attached to the return 5. Value is highest in best use to which the property can be put a. This means it is appraised as to what it can be used for: think expanding farmland in Fayetteville which is constantly trying to build commercial properties. The farming property would be appraised as more because it will be appraised as a high-valued housing development. 6. Partial and temporal property interest a. If you are a co-tenant we would value the property and then include your percent interest. i. If you own 50% of a piece of property that is worth $1 million, we would include $500,00. 7. Life Estate and remainder interest a. When the remainder owner dies the remainder interest would need to be valued by using actuarial tables. b. These tables can be found under § 7520 and its regulations. i. Section says the interest rate that must be used for the purposes of determining the actuarial value is 120% of the applicable federal rate using the midterm rate. (AFR) 8. The IRS can challenge the value of the property. The burden is on the taxpayer to prove the value of the business/property. Interests in Closely Held Businesses 1. The holy grail that you will see in appraisals is seen in Revenue Ruling 59-60 a. Determines what the formal appraisal will be based on. Laying out the valuation of closely held stock.  2. Reg. § 20.2031-2(f)(1) and (2) give us factors to consider: 1. What is the company’s net worth? a. Assets - liabilities of the company = net worth 2. The perspective earning power and dividend paying capacity a. What is their cash flow v. what is their expenses? 3. Goodwill of the business a. Do people recognize that particular brand? 4. Economic outlook in the particular industry a. Look at the difference in the economy in March 2020 v. today. 5. The company’s position in the industry and its management a. If it is a large company it may have a position in the industry, but if it is the dry cleaner down the road they will not. 6. The degree of control of the business represented by the block of stock to be valued a. How much does the donor or the decedent own? Does he own 10% and sit there making no decisions, or does he own 90% and is running the company? 7. The value of stock incorporations engaged in the same or similar lines of business Discounting the value of closing held stock 1. There is no statutory authority for taking a discount from closely held stocks. This is something that estate planning attorneys came up with and was challenged by the IRS for several years until they gave up. 2. The idea of a discount is when you have an entity, whether it is a corporation, partnership, or an LLC, that is bound by bylaws, partnership agreements, operating agreements, you do not have access to the underlying assets. a. If you have taken Business Associations, they will talk about corporate formalities, the partnership agreement will have certain restrictions. b. If you own 100% of a business you can obviously reach into the business funds and takeout. Whereas if you own only a portion, you cannot take out from the business. 3. Think about the friendship example, you own a portion of a company with your friends, you cannot take everything out and spend it. You only own a portion. 4. How this relates to valuation: because you cannot reach into the company and take out what you want, this is not appealing to a buyer who will want to take out or make decisions on behalf of the business. This limitation impacts the value of your interest in the business. If the business is worth $1 million, you do not own $250,000 cash. I own 25% of the stock that owns these assets. That is the basis of the discount.  a. You would have to discount this to find a willing buyer to buy your unmarketable (he would then have to find someone to buy it) share and it is a minority interest. He could not make major decisions. i. Sell at maybe 25% less. ii. If you own less than half: minority discount and a lack of marketability discount 5. Look at each gift separately Estate of Andrews v. United States 1. What was the discount that would be allowed on the value of her ongoing ghostwriters books? 2. Be careful because even though sales after the date of death are not conclusive, if they are third party sales, particularly hard to value assets, the IRS may use that as an indication of value. a. Exp: clients want to sell their business for a lot of money. They get an appraisal for the business and get a good value. They make a separate gift of the business for a certain value and then turn around and sell the business for more than the value that they listed on the gift tax return. 3. Be careful when filling out a gift tax return and listing the property as an appraised value but then you know you're going to sell it for more shortly after Chris Sorensen v. Commissioner of Internal Revenue 1. Firehouse Subs case? 2. Because business appraisals are difficult, the Wandry clause created a formula adjustment clause that provided for fixed dollar amounts of interests in a limited liability company (LLC) to pass to non charitable beneficiaries, with a clause stating that any redetermination of the interests’ value would adjust the number of membership units passing to each beneficiary to conform to the specified dollar amounts. a. A client knows the gift exemption is going to go down so he wants to make a gift that is right under the exemption limit in the form of stock in his company. An appraisal is done on the company, and the client will get a good discount on his gift. The IRS will be mad. You do a formula gift. You will transfer stock equal to the amount right under the exemption, but you don't know the actual value of the share of stock until it is determined for gift tax purposes. The statute of limitations is 3 years from when the return is filed. 3. The IRS disagreed with the Wandry rule and the firehouse subs case is where they give their reasoning for disagreeing with the rule. Estate of O’Keeffe v. Commissioner 1. IRS hates it, but is now accepting of the idea of discounts. They now challenge the value of the discount. Chapter 14 of the IRC 1. Special valuation rules 2. IRC § 2701- SPECIAL VALUATION RULES IN CASE OF TRANSFERS OF CERTAIN INTERESTS IN CORPORATIONS OR PARTNERSHIPS a. Applies when you are transferring certain business interests to family members i. The issue here is that most of the time it is someone trying to transfer the business/property without paying any taxes b. Most commonly deals with preferred stock and common stock i. Preferred stock is stock that is preferred- it gets a preferred payout or dividen ii. Common stock gets the leftovers c. When you have a closely held business where parents own it 50/50 and they want to transfer it to kids without paying taxes, the estate planning attorney will do both types of stocks. Because preferred stocks are so profitable, it means that the entire value of the business is in the preferred stock. This helps the clients because they don't exercise the rights. d. This section of the code says its okay if you transfer to a family member the IRS is going to value the preferred stock at 0 and then put 100% of the value in the common stock. e. Preferred has to have a qualified payment that is cumulative i. If it is not paid in year 1, then in year 2 you are owed year 1 and year 2 ii. The dividen must be paid at a fixed rate iii. The value of the common stock must be at least 10% of the value of the company. f. Need to know: can talk about doing preferred over common, but dont get tripped up by 2701. 3. IRC § 2702- SPECIAL VALUATION RULES IN CASE OF TRANSFERS OF INTERESTS IN TRUSTS a. Value income interest at 0. b. Exceptions: i. GRAT: grantor retained annuity ii. GRUT: grantor retained a unitrust. Same as GRAT, but can be either a fixed dollar amount or a fixed percentage 1. Unitrust is revalued every year and must be a percentage iii. QPRT: qualified personal residence trust. It must be your personal residence and you can transfer the property in and the only gift is the actuary value of the remainder interest c. Those above are all for a term of years. For them to work, they have to terminate before the individual/donor dies. 4. IRC § 2703- CERTAIN RIGHTS AND RESTRICTIONS DISREGARDED a. By-sell agreement b. Set one up to purchase someone’s interest in a business when a person dies. c. The survivor can buy it for X d. The IRS gets to disregard the buy-sell agreement and it has to be valued on the estate tax return on its FMV  e. The only way you can use the value of a buy-sell agreement under this rule is if: i. It is a bona fide business arrangement ii. It is not a devise to transfer wealth to other members of the family or less than adequate consideration iii. Its terms are comparable to an arms length transaction 5. IRC § 2704- TREATMENT OF CERTAIN LAPSING RIGHTS AND RESTRICTIONS a. Similar in that they have lapsing rights that are designed to say oh this right that the patriarch had in a business disappear at the triggering event (death) These are very involved rules. Section 2032A: special use valuation 1. This is specifically for farmland 2. When the exemption was $750k you got a special use valuation when you got farmland. You got essentially $1 million of exemption with specific requirements. 3. Currently it is $1.39 million. 4. Very restrictive of what you can or cannot do. Section 2032: alternate valuation date 1. Important- more commonly used 2. In the estate tax realm only 3. You can use the alternate valuation date. That date is 6 months after the date of death. 4. You have to meet: a. There must be a decrease in the decedent's estate value b. There must be a decrease in the decedent’s estate tax. 5. If you elect this and meet the criteria, you have to revalue everything on the alternate valuation date. All assets must be on this, not the date of death. 6. The only time it will usually happen is in a situation like COVID a. Usually you need a lot of publicly traded stock DEFINITION OF A GIFT SECTION 2031 IRC 2501: imposes a tax on transfer of gift IRC 2512: where property is transferred for less than adequate and full consideration in money or money’s worth then the amount by which the property transferred exceeds the value of the property received shall be deemed a gift. 1. What was the value of what the donor gave up and did the donee give the donor anything in consideration for that gift. 2. If they didnt or gave less than FMV then you have a gift. 3. May not be a gift if the FMV is less than what you paid for the property.  a. Paid $300k but it was purchased for $280k 4. The donor pays the gift tax. 5. The gift tax rate is 40%, however there is a lifetime exemption that is equal to 13.61 million dollars a. Make that many gifts without incurring the tax 6. Transfer tax system is united. When you die the estate tax emption is lower. a. 13.61 million dollars - (gifts made during life) - gifts at death 7. A gift occurs when the transferor receives less than adequate and full consideration in money or money’s worth. 8. Part gift/part sale: 9. Safe harbor: business transactions are exempt from taxes a. The transfer was bona fide i. Whether the parties were selling a guinea dispute as opposed to engaging in a collusive attempt to make the transaction appear as something it was not. b. The transfer was transacted at arms length i. Satisfied so long as the taxpayer acts as one would act in the settlement of differences with a stranger c. The transfer was free of donative intent. IRC 2703: a buy-sell agreement will be ignored unless it is (1) a bona fide business arrangement; (2) it is not a device to transfer such property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth; or (3) its terms are comparable to similar arrangements entered into by persons in an arms’ length transaction. 1, 2, and 5 ADEQUATE AND FULL CONSIDERATION 1. Hard to value assets- get appraisal a. Not for stocks, cash bonds, etc. which are easy to value. 2. Closely held business interest- get the asset value level + entity level appraisal 3. A gift is not taxed until the gift is completed- meaning until donor gives up dominion and control over the property 4. Premarital agreement that is conditioned on marriage does not create a gift of income tax consequences. Marriage is not consideration a. Dower rights and other marital property rights are not consideration 5. Issue when the donor requires the donee to pay a gift tax– net gift 6. Net gift: the donor makes a gift subject to the condition that the donee pay the resulting gift tax, the amount of the gift tax is reduced by the amount of the gift tax. a. Formula: tentative tax on full FMV of the property transferred ÷ (1 + rate of tax). DISCHARGE OF SUPPORT OBLIGATIONS 1. Parents have a duty to support children- no tax on transfers between them a. As long as it is clothes, shoes, cars, etc. b. Limited to the necessities and education c. Look into parents financial status d. Cash is arguable 2. Spouses have a duty to support each other a. More lenient in what you can get to support your spouse. 3. Section 2516 (DV): excludes from gift tax transfers made in (1) settlement of marital or property rights or (2) to provide a reasonable allowance for child support a. To qualify there must be: i. A written agreement AND ii. Divorce must occur within the year before the agreement is signed OR two years afterwards. 4. 2503(e): exception to the gift tax: excludes payments of educational and medical expenses. a. Can give an unlimited amount for someone's education or medical expenses and it does not count against exemption or have to qualify for the annual exclusion. In order to use this: i. Must pay the institution directly, cannot run it through someone else. b. Does not cover room and board nor does it cover reimbursement to individuals for expenses they have paid. c. Mainly only tuition or medical expenses d. Applies to anyone, not just family TAXABLE TRANSFERS 1. Lack of consideration does not make it a gift. There must be a transfer of property. a. Joint bank accounts i. $100,000 into a bank account with me and 4 year old daughter. She has not put any money into the account. No gift until she takes money out of the account. Withdraws matter. 2. Below market loans a. 7872: governs both the income tax and the gift tax consequences b. Promissory notes element: amount owed, repayment terms, interest rate, and due date. c. Another name for interest free loan: loan kid 100k and don't charge any interest or charge a lower interest rate. i. Typically in a family context  d. IRS looks at the applicable federal rate (AFR) to determine whether this is a below market loan i. Look at loan terms, short term, mid term, and long term rate- go to IRS website and look at different loans. This will show you the lowest rate you can charge. 1. Three types of rates 2. 0- up to 3 years (short term) 3. 3-9years (mid term) 4. 9+ (long term) ii. Exp: loan daughter $100,000 for a 3 year loan. The AFR is equal to 5% and I charge her 0% interest. 1. The gift would be whatever 5% interest on 100k and then i would have to impute income to me. Report $5,000 on income. Reporting income you didnt actually receive. 2. If charged 3% then the gift would be $2,000 to her and $2,000 income to me. iii. Main Q: are they charging the adequate rate for whatever time period you are dealing with. 1. You can always go over, but not under. e. Gift loans that done exceed 10k- do whatever you want. IRS doesn't track those. DISCLAIMERS 1. 2518: a disclaimer is a post-mortem device that permits a recipient to say they do not want anything and it transfers without any gift tax consequences if certain rules are met. 2. Requirements for the transfer to NOT be taxed: a. Disclaimer must be irrevocable and unqualified b. Disclaimer must be written c. The writing must be received by the transferor, the transferor’s legal representative, or the holder of legal title to the property no later than nine months after the creation of the interest or the date on which the disclaimant turns 21 d. The person disclaiming cannot have accepted the property interest or any of its benefits e. The disclaimed property interest must pass without any direction by the person disclaiming either to the decedent’s spouse or to a person other than the one disclaiming. f. Must abide by state law. g. Page 149, first paragraph 3. One can disclaim an entire interest in the property, an undivided portion of property, a partial interest in property, or survivorship interest passing at the death of a joint tenant. 4. Revocable: the interest is created on date of death  5. Irrevocable: interest is created upon funding of the trust 6. Beneficiary designation on life insurance: interests are not created until the holder dies. No transfer taxes 1. Exp: IRA, dad owns, me and brother are 50% beneficiaries. There is a clause that says if someone is dead it goes to the survivor. When dad dies I have 9 months from the date of his death to disclaim this. When I disclaim this it goes to my brother. I do not determine where it goes. The gift is still made by dad if the rules are met above. 2. GST know for potential bonus points COMPLETION SECTION 2501 SECTION 2512 SECTION 2703 SECTION 2518 Completion- 2nd element of a gift 1. Generally, a transfer of property will not be taxed until the transfer is complete. a. A gift is complete when 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. i. Focus on the donor's loss of control over the property. ii. Has to be irrevocable 2. Gift is complete when the contract becomes enforceable. a. Look to see when a party fulfills his part of the contract, then the gift is complete. 3. Gift by check is not enforceable until the check is deposited. Revocable Trusts and Retained Interests 1. Where the donor reserves power over the disposition of property, the transfer may be wholly incomplete or only partially incomplete. a. If you create a revocable trust, when you fund it there is no gift. i. The person who created it reserves the power to amend it prior to death. b. The grantor reserved the power to reserve the power, when he released the power, he departed with control over the asset. c. Where the donor retains control and power over the asset, the gift has not been completed.  2. Transfer was made, but not complete because the person who made the transfer retained some sort of power over it. Until they can no longer alter the benefit, it is not a completed gift. 3. A grantor is deemed to have a power over the trust property even if they can exercise the power in conjunction with another person. a. Exp: I created a trust and I am a trustee with my brother and my brother is also a beneficiary of the trust. I have the ability to make decisions, therefore the gift is not complete until I relinquished power. i. See example 5-6 on pages 168-169 4. The grantor may retain control over trust property as long as that control is a fiduciary power and is limited by a fixed or ascertainable standard. a. Ascertainable standard: health, education, maintenance, or support (HEMS) b. Where this is present the donor is NOT taxed for income tax purposes. Installment Sales and Loan 1. Whether the consideration paid is adequate and full and is in money or money’s worth. 2. You sell something and it is an adequate price. 3. Where things are being forgiven- implied agreement that does not apply to exclusion a. Gift of the entire thing when the note is created. 4. Forgiving every once in a while is okay. 5. Just a note on its face is not enough to escape the gift tax. 6. Factors to consider: page 177 a. Was there an actual real expectation that whoever the beneficiary under the loan (kids) would repay the loan? i. Can they afford what they are buying? b. Did the taxpayer intend to enforce the note? c. Was security given for the loan? d. Was there discussion of terms of the note- repayment date? e. Whether there is a signed promissory note f. Whether interest is charge g. Whether there is a demand for repayment h. Whether there were payments made i. Look at lenders health- deathbed is a gift 7. What would a third party lender allow? 1. ANNUAL EXCLUSION  SECTION 2503 CHAPTER 6: THE ANNUAL EXCLUSION A. Section 2503: an individual can give $18,000 to as many people as they want to. a. Don't give someone more than $18k in a single calendar year. B. Taxpayer does not have to report gifts that fall under the exclusion. Gift Splitting 1. 2513: allows the taxpayer to treat gifts as if made one-half by their spouse as long as the spouse consents. a. One spouse can make the gift, the other can claim a split b. Must file a gift tax return to get gift splitting. 2. If you split as to one gift during the year, you have to split all gifts. 3. REQUIREMENTS a. Both spouses must be citizens or residents of the United States b. The donor must not give the spouse a general power of appointment over the property c. The donor must be married to the spouse at the time of the gift and not remarry during the calendar year if they divorce or one dies d. Both spouses must consent to split all gifts made during the calendar year. 4. Once the gift tax return is filed, both spouses become jointly and severally liable for the tax. 5. This is separate from the lifetime exemption. Here we are dealing with an annual exclusion. Present Interest Requirement 1. The annual exclusion is only available for gifts of present interest- those that give the recipient the “unrestricted right to the immediate use, possession, or enjoyment of the property or the income from the property.” 2. Gift of corporate stock may be present interest because the recipient has the right to a full and immediate enjoyment even if the corporation is a small, family-held corporation that never pays dividends. a. Still potential for income. b. Make sure there is some kind of income being produced. 3. The gift of a partnership, and the give of a limited partnership interest are all present interests. 4. Still a gift, even if it doesn't have any present interest. Present interest just allows it to fall under the exception and not eat into exemption 5. Trust- must be payments on basis, must product income, beneficiary must be Gifts to Minor 1. Custodial Account- can be used for any benefit for a child. a. Terminates at 21 2. 529 plan- an educational plan. You can change beneficiaries on it, but it can only be used for educational expenses. If you use it for any other purpose, there is a 10% penalty. You can front load with up to 5 years of contribution. a. Insert from echo. 3. Crummey trust- See below 4. All of the above qualify for annual exclusion. Crummey Trusts 2. People didn't like the above listed gifts, so Crummey trusts were created to give the grantor more control. a. You have to have a mandatory income interest and present interest. 3. What is it: the beneficiary, whether an adult or a minor, has an ability to withdraw the lesser of the contribution of the trust in the year or the annual exclusion amount. a. Must give them notice that a gift has been made to the trust. b. There must be a 30 days term for them to withdraw. c. Applies whether this is a minor (sent to legal guardian) or an adult. d. Trust must have sufficient liquid assets to be able to satisfy either demand. e. You can put a lot of people in there to meet your exclusion amount. i. Must have other interests in the trust. 4. The point of this is that you can have a trust that says whatever you want, as long as you have the Crummey powers, you can make the annual exclusion. 5. Common in life insurance trust “GROSS ESTATE” PROPERTY OWNED AT DEATH SECTION 2033 IRC 2033- The value of 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. 1. Mainly probate estate assets. General 1. Includes assets that are included in someone's probate estate or would have been but for a property transfer by beneficiary designation. a. Not talking about retirement accounts or life insurance  b. Talking about the bank account has a POD or a beneficiary deed for the real estate. 2. Just because it is included under 2033, does not mean it will not be included under some other code section. Property Rights 1. State law determines property rights. a. If in a fight with the IRS over whether a piece of property will be included in the estate, the tax court will look to state law. Guardians or Fiduciary Capacity 2. If you are a guardian or trustee, 2033 is not going to include it with one exception a. If you are the custodian of a UTMA (uniform transfer to minor act) you are deemed the owner for IRS purposes, but are not the legal owner. You are the legal owner until the minor turns 18 or 21 b. Look at the moment of death to determine if the owner has an interest in the property. Types of Ownership under 2033 1. Sole owner of real property- own your house and die, included under 2033 2. Partial interest in real estate- if I am a tenant in common (default in AR- you would include your interest) 3. If you have successive interest- vested remainder- INCLUDED a. You have the power to pass that remainder at death Life Estates- NOT INCLUDED 1. Life estates are not included under 2033. a. Terminates at death so not included Tangible Personal Property- INCLUDED 2. Tangible personal property is included under 2033. Checking/Savings Accounts- INCLUDED 3. Checking accounts and savings accounts and brokerage accounts that are not retirement accounts are included under 2033. Cash- INCLUDED 4. Cash is included under 2033 Income items, salary due at death, bonuses- INCLUDED  1. The decedent has an enforceable right Rent and Interest accrued at the dated of death- INCLUDED 5. Rent which has accrued and due at the date of death 6. Interest which has accrued and due at the date of death Dividends- INCLUDED 7. Dividends if the decedent is living on the record date a. Record date is the date on which it is marked that says the shareholder will receive the dividends Insurance Proceeds- INCLUDED under 2033 in two situations, otherwise INCLUDED under 2042 8. Insurance proceeds are generally included under 2042 a. Two times when it is included under 2033 i. You own life insurance and the beneficiary of the life insurance is your estate ii. When you own life insurance on someone else Social Security- NOT INCLUDABLE 9. Social security benefits are NOT includable Wrongful Death- NOT INCLUDABLE 10. Wrongful death recoveries are NOT included because that is not an asset that the decedent had a right to. a. If there is a wrongful death and negligence claim combined, anything the decedent would be entitled to had they lived is includable. (pain and suffering, medical bills, etc.) Outstanding Loans and Notes- INCLUDABLE 11. Loans and notes that are outstanding at the time of death, my asset is a promissory note and it is includable. Business Interest- INCLUDABLE 12. Any business interest you may have. JOINT OWNERSHIP SECTION 2040 Three ways to have co-tenant ownership In Arkansas tenancy in common, joint tenants, or tenants by the entirety  1. Tenants in common is default a. Caveat: if you are married the default is tenants by entirety. SURVIVORSHIP PROPERTY UNDER 2040 1. Only looking at joint tents and tenants by the entirety Joint Tenancy- GIFT and INCLUDED IN ESTATE If a joint tenancy is created it is a gift 1. This will also be included in their estate at death 2. A joint tenant can unilaterally sever the joint tenancy either turning it to tenancy in common or forcing a sale/particial, tenants by the entirety, you are joined pursuant to state law and the laws of property a. Can't sell it b. Creditors against one spouse cannot come and attach, although they can put a lien on it, they cannot force you to sell it. 3. Exp: father and daughter go in as joint tenants. The father pays $200,000 for the deed that lists both father and daughter as owners in the property. Father and daughter have ½ interest each. Father has made a gift to daughter for $100,000 minus the annual exclusion because it is a present interest right. Presumption 2040(a) 4. Section 2040(a) creates a presumption that when the first joint tenant dies, that joint tenant provided 100% of the consideration. a. This matters because 2040(a) says you have to include the entire amount of the property if you paid all of the consideration. b. In the above example, if dad dies and paid $200,000 and made a $100,000 gift to me. If the property is worth $300,000, he has to include $300,000 in his gross estate. i. If daughter’s estate can prove that she did not contribute any part of the consideration, then she does not have to include any part in her estate. Exceptions to the Presumption 1. Three exceptions to this: a. Exception #1: The consideration is furnished- if dad and daughter go in as joint tenants, and dad pays $100,000 and she pays $100,000 of own money. Father only has to include 50% (his interest) i. If he made a $150,000 contribution and she paid $50,000, then he made a $50,000 gift to daughter because she has a $100,000 interest. When he died and property was worth $300,000, figure out the initial contribution  was $150,000 over the total value of $200,000 (¾) and multiply it by $300,000 (FMV on date of death). He would have to include $250,000. 1. I think this is the example from the book where you take the FMV and then multiply it by his fraction of contribution. ii. The amount that is excluded from the decedent’s estate is the survivor's contribution divided by the entire consideration paid multiplied by the value of the property at death. iii. What is considered consideration: money, but also the value of services and other non-monetary contributions. 1. If you use gifted money to contribute to the purchase price, it is as if he paid for it himself. a. Exception: if whatever the gifted property is, has generated income, and you use the income to contribute, then that is the daughter once the gifted asset comes to her. Example 8-4 page 228 b. Exception: if he gifted property as joining tenants that we then sell and buy a new piece of property and there is gain, I get to take as my own money, not gifted, the amount subject to income tax. Example 8-6, page 228 i. How to calculate contribution amount when there is income or gain: (sale price - the contribution to the original property) / the new purchase price multiplied by the value at date of death. ii. Exp: dad buys property by $20,000 and sells it as joint tenants for $25,000. Now they go and buy more assets and contribute $50,000. That is (25-20)/50, that second asset that they bought is worth $75,000. The amount that is excluded is the $7,500 or 10% of the $75,000. iii. Dad gave $20,000 and she went and did something with it and sold it and made $5,000. Now she has $25,000. She takes $25,000 and he takes $25,000 and they jointly purchase property. When determining at his death, what that joint tenancy asset, how much is included in his estate, to determine her contribution. He gave her $20,000 and she gained $5,000. Since the $20,000 seed money was a gift from him, that continues to bear its origin and would be treated as a contribution from him. The $25,000 - $20,000 is giving you how  much appreciation is her contribution. Look at what the appreciation is in whatever her asset was. Divide that by the total contribution. That will tell you how much consideration she is deemed to have continued. 5,000/10,000 (1/10) of the contribution. 2. Exception #2: If cotenants receive property from inheritance or gift a. Father decided to give daughter and 3 sons as joint tenants with rights of survivorship. In that instance, daughter just has to prove the common source was a gft. 3. Exception #3: spouses a. If property is owned by husband and wife under 2040(b) you include ½ no matter what, no matter who gave the consideration i. Sarah buys $200,000 and labels it as joint tenancy, piece or property with husband. Each owns ½ even though she has made a 50% gift to him. ii. She gets a marital deduction. iii. One spouse includes 50% but after death the other spouse has 100% iv. Exception 2056(d)(1)(B): if the surivivng spouse is not a U.S. citizen, you go under 2040(a) as if they are not married. v. Has no bearing on property law rights. If the husband is not a U.S. citizen, if the wife dies, it is all included on her estate because he is not a U.S. citizen. vi. Look at citizenship, not residence. Overview: 1. How it passes: Under 2033, property owned by the decedent passes pursuant to intestate law or will. 2. How much is included: Under 2040, all we are looking at is how much has to be included on the estate tax return. We know where it is going, it will be owned by the surviving tenant, but we need to know how much to put on the estate tax return at death. a. Father contributes $100,000, she contributes nothing. He died. He includes everything. Daughter is still the 100% ownership. If she dies, she contributed nothing and includes nothing and he still owns $100,000. When the survivor dies she will include 100%. 3. What is the basis: Under 1014- you get a stepped up basis to the extent of such to the estate tax. If 100% is included for estate tax purposes you get a 100% stepped up basis. Distinction between 2033 and 2040 for property ownership 4. Property ownership, the distinction 2033 is an asset owned by you that you can give away at you. Tenants in common- always 2033. 2040 is only dealing with survivorship. a. EXAM TIP: If you see tenants in common it is 2033. If you see tenants by the entirety or joint tenants you are looking at 2040. RETAINED INTEREST SECTION 2036 SECTION 2038 SECTION 2037 SECTION 2035 SECTION 2036- RETAINED LIFE ESTATE Retaining Beneficial Enjoyment Section 2036: “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 for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death— (1)the possession or enjoyment of, or the right to the income from, the property, 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.” Exam Tip: if decedent did not make a transfer, 2036 will NOT apply. Exception to General Rule 1. there is an exception set out for a sale of adequate and full consideration. Even if the decedent makes a transfer, if the decedent gets equivalent value back from the transferee then 2036 will not apply. 2. Generally 2036 applies to life estates and trusts. In either of these where the decedent has obtained a life interest, section 2702 (gift tax provision) provides that the gift will of the entire value of the transfer, notwithstanding the fact that the decedent will have retained a value, the equivalent of his life estate, if the remainder interest is being paid to an ancestor, a descendant, a sibling, or the spouse of any of those people. a. Exp: if I create a trust for the remainder of by life, for my benefit, and transfer the remainder to my son, and put $1 million into it, there is a property value to my  life interest and to my son’s interest, but because of 2702, the value of the gift is $1million, I value my life estate at $0. Requirement #1: there is a transfer by the decedent. There are two types of transfers: direct and indirect Direct Transfer- I made a transfer and I retained an interest. Indirect Transfer- the benefit is imputed to the decedent. 1. This is seen where a trust terminates and the beneficiary elects to leave the trust intact in which case the beneficiary is treated as transfering the property a. Exp: I transfer into a trust for my lifetime remainder to my child. WHen I die my child says I will just leave it in the trust and let the trustee continue to administer it. (usually happens when a child turns 21 and influences around him encourage him to leave the funds in the trust.) Here he is deemed to have pulled it out and transferred it back. b. Exp: “reciprocal trust doctrine”: you have two trusts, two transferors, typically spouses, but not always. I create a trust for the benefit of my husband for life, remainder to my child. Transfer $1 million to it. He creates a trust for the benefit of me for my lifetime, remainder to my child. I am in the same economic position as I would have been if I had created a trust for my own benefit. The reciprocal trust doctrine says essentially if you create two trusts at the same time with the same provisions, then we are going to switch the grantors for purposes of analysis of 2036. That would treat me as the transferor for the trust for my benefit and my husband for the trust for his benefit. i. Why? When 2036 came out and people learned they can't create a trust for their lives, they can just have their husbands do it and do the same for the wife. They will get $2 million out of their estate 1. Get around 2036. 2. Comes up often. Financial advisors recommend this to your client and you have to be able to say it is a poor decision. 3. How to get around it? No specific way to tell you what is a reciprocal and what is not. Look at the circumstances. If you create one at the same time with the same benefit, it is a reciprocal trust. Same doc, same situation. a. If 6 months or a year apart, it is not necessarily a reciprocal trust. 4. Make them separate and distinguishable to ensure they are not reciprocal. a. The further apart, the better. The closer they are created in time, the more different they need to be. Requirement #2: The transferor must have obtained something. 1. (a)(1): Possession or enjoyment or right to the income 2. (a)(2): they have obtained the right to designate the person who shall possess or enjoy the property or the income. 3. If I transfer my residence to my child and retain a life estate, that is classic 2031. a. I have made a transfer b. I have retained possession 4. If I make the transfer and don't retain the life estate, but I am a squatter a. The lack of an enforceable right is not enough to pull you out of 2036. b. This would be fine if you are not subject to an estate tax. Include this in your estate under 2036 and take a stepped up basis. If the client is trying to move assets out of their estate, but continue to live there, they cannot do that. Whether they have a legal right by obtaining a life estate, or they have an implied right because they are actually still living there. They can pay rent. If they pay fair rental value, that falls under the exception of the code- a bonafide sale for adequate consideration of money or money’s worth. It's not actually a sale, but it is payment for what you are keeping- the right to live there. 5. Look for both a legal right (clear pet retention) or implied right (still living there). a. Same applies for a painting. My father gives me his $10,000,000 painting, but says he is going to keep it until he dies. He has made a completed gift, but he is retaining enjoyment of the property. Requirement #3: the period for which the interest must be retained 1. Period 1: retain for life a. Life estate 2. Period 2: retain for any period not ascertainable without reference to death a. I create a trust and I say I get the income quarterly except for the quarter that includes my death. In which case I die during that quarter (say October 1) it's the beginning of the 4th quarter, I get no income for this quarter. It actually ended on September 30th, not October 1. I did not have it for life, but I had it for a period that was not ascertained without reference to my death. You never know when the trust will terminate without knowing when I will die. 3. Period 3: retain for any period which does not end before death a. This trust will last for 10 years and I die in year 8. My estate is still entitled to receive income through the 10th year. It did not end, I did not have the right for life, nor did you need to know when I die to ascertain the end, but it did not end, in fact, before my death.  b. Exception: 2702- both from the gift perspective and from the death perspective, if you have a QPRT (qualified personal residence trust) or a GRAT (grantor retained annuity trust) or a GRUT (grantor retained unitrust), if you follow the requirements of 2702, whether it is in regard to a QPRT or dollar amount and you give that to a trust, then by meeting the requirements of 2702 which is either the right to live in the personal residence for a period of time or the right to receive an annuity or unitrust amount not income, but rather a fixed unity or unitrust amount, then you only have to include the remainder value as the gift. To keep it out of the estate for estate tax purposes you have to survive the term of the trust. c. For a QPRT (qualified residence), I create a trust, I transfer my home into the trust, for 10 years I live in the home, in year 11 I die. If I have moved out when I move out at year 10 when the trust terminates, we are done. If I squatted at the end of the trust and stayed there, it is included in my estate under 2036. If I paid fair rental value when the trust ended then it won't be included under 2036. i. If you are using a QPRT it is usually a multi-million dollar home, rent won't be $1,500. Requirement #4: the nature of the interest retained 1. 2036(a)(1): prohibits the retention of a beneficial interest (I get some benefit from it after I transfer it). 2. 2036(a)(2): prohibits the retention of control over the interest of others. 3. Beneficial interest- I stay in the house or keep the painting and get the income. 4. Indirect retention: where you create a trust for a dependent (minor child usually) because you have a legal duty in Arkansas to support you minor child, there are certain circumstances where a trust created for a minor child will be included as a beneficial interest under 2036(a)(1). a. In Arkansas a minor is under 18. Once you are 18, you are on your own, no legal responsibility b. In Arkansas, you have no legal obligation to support your spouse (doctrine of necessities) 5. If you have a client that comes in and wants to create a trust to support their children and the children are 3 and 2. a. Client cannot be the trustee b. The trustee must have complete discretion over distributions to the minor child. 6. Generally create a trust, name a third party who is independent, and say “distribute what you want to them” 7. If the decedent can either be the trustee or puts parameters that includes support (what are you legally obligated to do, food, clothing, shelter, etc. not buy cell phones, computers, etc.)  8. How she recommends to get around these things is to not (the parents not) be the donor or transferor. The parents are the only ones with the obligation to provide support. 9. 2036(a)(2): control over other interests. 10. Another part says that either alone or in conjunction with another person. 11. Does not require that the decedent have retained a benefit, but rather that the decedent retain control. If you have adult children and the decedent creates a trust, serves as trustee, the trustee has complete control to make distributions. The decedent as trustee retrains the right to dictate who enjoys the property. 12. It is most common that the right to determine who enjoys the property is to be as trustee. a. Could be that the grantor specifically put in there that he/she will retain the right to determine who enjoys it. 13. Exception: where the decedent has made a transfer and says this trust is the benefit for my adult children and I’m going to serve as trustee. When the client says draft the trust so that I can make these gifts and it will not be included in my estate for estate tax purposes. In that scenario, I am going to say you can serve as trustee, but you must have an ascertainable standard. If the trust has an ascertainable standard for distribution purposes, then we can probably pull it out of 2036(a)(2). a. Before we even get to an ascertainable standard, if it is a “vanilla” trust that says I create a trust for the benefit of my child for his lifetime, the remainder to my grandchildren. Child gets all of the income. At death the remainder passes to grandchildren. There is very little effort on the part of the trustee aside from traditional duties like making the distribution, filing income tax returns, etc. If that is the case then we don't have to get to an ascertainable standard because the trust doc tells the trustee what he can and cannot do. The fact that the trustee exercises his or her powers as trustee in a fiduciary capacity for managing and administering the trust, that is not going to pull it in under 2036. It is where you come across a trust where you have multiple beneficiaries nad you want to have multiple flexibilities and you want to be able to let the trustee make decisions as circumstances change. i. She prefers not to draft where the income has to be distributed (given to someone who is in jail) but we will draft ascertainable standards. 1. Ascertainable standard may be as specific as you want. a. EXP: between 18-25 educational expenses only. That will include tuition, books, transportation expenses, etc. Once 25, can have $50,000 to buy a house or get married. 2. Definition of an ascertainable standard: it is something a beneficiary can enforce. Ascertainable Standards 1. Ascertainable (HEMS) standard: health, education, maintenance, and support a. Very broad  b. Doesn't mean much more than giving the trustee the ability to make distributions based on his discretion. 2. Why are we talking about an ascertainable standard? Because the trustee has created a trust for a beneficiary or beneficiaries. The trustee has discretion to make distributions to those beneficiaries which means he affects the enjoyment of the property. But if the trust has an ascertainable standard, then it will pull it out of 2036(a)(2). When a grantor can serve as a Trustee 1. In general, the only time the grantor will be able to serve as a trustee is if there is an ascertainable standard and the beneficiaries are not the minor children or the grantor himself. 2. Ascertainable standard- either be specific or use the HEMS standard. Don't use happiness, welfare, or in conjunction with the HEMS standard (maybe). It is a state law question. 3. The other part of this section says that if the decedent transferor has the right either alone or in conjunction with another person (even if it is permission from 50 other people) you are going to be under 2036(a)(2). Recap/Overview 1. 2036(a)- have to have a transfer, there has to be some kind of enjoyment retained, for a prohibited period, and that enjoyment must be either the right to possession or income to the grantor, or the right to control the beneficial enjoyment. Transfer of Stock 2036(b): where the decedent transfers stock. 1. Closely held businesses a. If decedent transfers the business but wants to retain the voting rights, and as the trustee has the legal right to vote those shares or partnership/llc units. 2. This section says if you transfer an interest controlled corporation and the transferor retains the right to vote the stock, then that is treated as a 2036(a)(1) situation where you have retained the right to the possession and enjoyment of the property. 3. What is a controlled corporation? a. 318- if the decedent owns, directly or indirectly, at least 20% of the voting power of the stock b. 318 are the attribution rules to determine who owns 20%. Decedent will be treated as owning stock if it is owned by the decedent's parents, children, grandchildren, or spouse. 4. The purpose of 2036(b) is to say that if you are going to transfer it, you have to actually give it up.  5. If we meet the def. Of a controlled corporation, then the decedent either says by virtue of the transfer I’m going to continue to have the right to vote or the decedent is the trustee and thus has the right to vote. Next Step after 2036 Applies- What is Included? Once you have jumped through all the hoops and have determined that 2036 applies, you next have to determine what you will include on the estate tax return. 1. General rule: include 100% of the value of the trust or the property if a life estate on the date of death. a. Exception: if you create a trust where you get all the income for life, remainder to child, and you transfer $1 million into it, and then your parents transfer $1 million into it. You are only the transferor for 50% of the trust. Therefore only 50% of the trust would be included in your estate. b. Exception: if I create a trust for the benefit of my husband for his life and then for the benefit of me for my life, then to my child, then I get to for my estate tax when I die, I get to subtract out the value of my husband’s life estate. i. This is rate, but it would come up if you had a piece of property in only your name and not your husband and you transfer the property to your child, grant you husband life estate, and retain a life estate for yourself. 1. If you die first the value of the property would be included in your estate less the value of his life estate 2. If he dies first then we are definitely in 2036 because you have a life estate and when you die it passes to your child. SECTION 2038 - REVOCABLE TRANSFERS The Power to Change the Enjoyment Section 2038- The value of the gross estate shall include the value of all property— (1) 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, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3 year period ending on the date of the decedent’s death. Choosing Between 2036(a)(2) and 2038(a)(1) 2036(a)(2) is almost always the same as 2038(a)(1). When they are not the same, but both would require some inclusion then you pick the section that causes the most inclusion. Exception to 2038 1. the same exception as 2036: bonafide sale for adequate consideration for money or monies worth. Requirements of 2038: 1. A transfer a. Same as 2036- if the decedent has not actually been the one who actually transferred the property in the first place we are not in 2038. 2. The power must be at death a. Decedent must have an actual power at the decedent’s death. Different from 2036(a)(2). i. One exception- 2038(b) which says that the power will be treated as existing at death even though the exercise of the power is subject to a precedent giving of notice OR even though the amendment, revocation, or termination takes effect only upon the expiration of a stated period after the exercise of power. b. In general the rule is that you must have the power at death. Exception is if there is a precedent giving of notice (to exercise the power you have to give notice) and/or that the exercise is delayed by a period of time once exercised that will still be treated as existing at death. i. Exp: decedent cannot exercise the power to revoke until 30 days after giving notice of his intent to revoke. If he has not given that notice at death he technically does not have the power to revoke. 2038(b) says he does. c. If there are other contingencies over which the decedent did not have control (life, death, etc.) then 2038 will not apply. i. Exp: Trust income payable to wife for life. At her death to his children as he directs. When he dies his wife is still alive. He does not have the power at death as required by 2038. He does have a power that would trigger 2036-to change the beneficial enjoyment. 3. The decedent must have the ability to make a change a. The interest in the property and the enjoyment thereof is subject to any change. b. Reg. 20.2038-1(a) simply provides that if the time or the manner of enjoyment of an interest may be altered, that is a change within 2038. c. Revoke or to change are the harshest changes. Just the ability to invade the trust (the decedent says to pull the money out and give it to someone) is enough. 4. That power must be the right to alter, amend, revoke, or terminate the trust a. Alter and amend are basically the same thing. i. Includes things like adding new beneficiaries, being able to change the beneficial interest among a group of people, the grantor having a power of appointment at his death even if it can only be exercised by his will. 1. Exp: grantor creates a trust for the benefit of his children that is to terminate at his death, but he retains the power to appoint the assets pursuant to his will to any number of people or simply among his descendants, that will be a 2038 power to alter or amend. ii. Other powers are administrative power. In regard to trustees, if the decedent was serving as trustee and his power to alter or amend was a result of his administrative or managerial powers, his fiduciary powers, those will NOT trigger 2038. 1. The reason that argument is made is that a trustee has the ability to determine how to invest in assets. Some things like land do not produce income, by determining what you invest in you are determining the income that is coming into the trust. 2. As a fiduciary you have an obligation to all of your beneficiaries a. Administrative and managerial powers that are fiduciary powers are not one to trigger 2038 as long as it is subject to judicial review. Colony case. i. A court cannot come in and force you to diversify b. Revoke and terminate- while not synonymous, they are close enough. i. Probate proceedings- typically people do revocable trusts designed primarily to avoid the probate proceedings. Created while living, they are typically the beneficiary and they have the ability to revoke the trust. Anything in that trust will be included in their estate under 2038. A revocable trust does nothing to remove an asset from an individuals estate. 1. Be carefully with the power of revocation- it does not have to be specifically retained. No retention requirement like 2036. Only look to see whether they have a power at death. a. CL used to say if a trust is not explicitly revocable, it is irrevocable. The Trust Code (Ark. Code. Sec____602(a)) says that a trust is now revocable unless it states otherwise. i. State whether it is revocable or not and how it is revocable just to be safe. The power is also in whatever capacity exercisable by the decedent- just like with 2036 it can be a power that the decedent retains in a trust document or it can be in their capacity as trustee. 1. If the decedent created a trust and named a third party as trustee with discretionary income distributions, no standard, and the decedent retains the right to remove and replace the trustee, and to appoint himself, then the powers of the trustee will be imputed to the decedent even if the is not serving. a. Sometimes the decedent cant serve, like Estate of Wall b. Rev. Ruling 95-98 acquiesced but said that they will agree to the Estate of Wall but only if the power to appoint a successor is an independent trustee under section 672- can't be a related or subordinate party (spouse, kid, parent, sibling, employee, etc.) i. They acquiesced only in part. Only if the ability to replace a trustee is not a related or subordinate party (independent trustee). ii. Arguably you could still get away with naming someone who did not qualify as an independent trustee and then fight the IRS on it, but the IRS said as long as it is an independent trustee we will not fight it. c. If trustee has power to alter or amend because they have complete discretion on distribution or power to amend trust or terminate trust, as long as the grantor/transferor/decedent, did not have ht empower to serve as trustee or appoint a related or subordinate party as trustee, then that power will not be applied to the decedent and 2038 will not apply. d. Also like 2036- an ascertainable standard will pull us out of a lot of problems. i. If the decedent’s discretion in how to exercise the power is subject to an ascertainable standard, (as trustee, so if the grantor is serving as trustee has the ability to make distributions to ABC pursuant to an ascertainable standard) then that will NOT be treated as the power to alter or amend. 1. Health, Education, Maintenance, or Support- use this to give the trustee as much discretion as they can possibly have. ii. IRS has also said emergency, custom standard of living, welfare in conjunction with other blessed words, etc. But there is no need to get fancy, use HEMS to get by. You can be more specific, but as to the HEMS standard. 1. EXP: You can distribute the income and principal to the beneficiary for their maintenance, support, or education as long as they are enrolled at Bowen and maintain a 3.0 GPA a. Can't say you can distribute income to beneficiaries while at bowen law school if it is proper or if it makes them happy.  i. Best interest and welfare is also shot down. e. As with 2036- if the power is exercisable only with another, we do not care. i. It does not matter if the decedent has to have the consent of another person or persons as long as they had the power it will be included under 2038. 1. This would apply if the grantor had the power to revoke the trust if children agree. 2038 will still catch it. Also applies if you have the ability as a co-trustee to distribute income or principal to a beneficiary with no ascertainable standard. a. Exception: treasury reg 20.2038-1(a)(2) which says that if the power can only be exercised with the consent of all persons who have an interest in the trust, and local law allows the alteration, you wont be under 2038 even though you are doing exactly what 2038 says. 2. 2038 HAS NO RETENTION REQUIREMENT UNLIKE 3026 3. Once you have gone through the analysis that 2038 applies, the amount to be included is the value over the amount which the decedent had the power to make the change. a. If only have power to terminate or revoke ½ the trust, only include ½ the trust. If only power to change income, only include the amount of income. Similarities between 2036 and 2038: 1. Both require a transfer 2. Both have full and adequate consideration exception 3. Both have an exception if the decedent’s power is limited by an ascertainable standard a. Under 2036 if it is the decedent’s minor children, an ascertainable standard is not going to pull us out of 2036 4. Both if the decedent can serve as the trustee, or by appointing himself as trustee, then the trustee’s powers will be imputed to the decedent. 5. Both sections will apply whether the decedent’s power is held alone or in conjunction with another person. Differences between 2036 and 2038: 1. Often the amount to be included. If the decedent retains a power to designate who receives the income and otherwise meets the requirements of 2036 a. 2036- entire value of the trust will be included b. 2038- only the value of income will be included. 2. 2038 does not have a retention requirement. a. If you have the power at death, we will tag you under 2038.  3. If the decedent has power which is subject to a contingency which is beyond the decedent;’s control and that contingency has not occurred at the time of the decedent's death, then 2038 will NOT be triggered. SECTION 2037 - GIVING UP YOUR RIGHT OF REVERSION NOT ON THE EXAM Section 2037: A decedent's gross estate includes under section 2037 the value of any interest in property transferred by the decedent after September 7, 1916, whether in trust or otherwise, except to the extent that the transfer was for an adequate and full consideration in money or money's worth (see § 20.2043-1), if— (1) Possession or enjoyment of the property could, through ownership of the interest, have been obtained only by surviving the decedent, (2) The decedent had retained a possibility (referred to in this section as a “reversionary interest”) that the property, other than the income alone, would return to the decedent or his estate or would be subject to a power of disposition by him, and (3) The value of the reversionary interest immediately before the decedent's death exceeded 5 percent of the value of the entire property. Requirements 1. Requirement: a. Transfer of property b. The property can only be obtained by surviving the decedent who is the transferor c. The retention of an interest by the decedent/transferor of a reversionary interest > greater than 5% of the value of the property of the date of death d. Reversionary interest would be that either the property would return to the decedent or his estate or that property will be subject to a power of disposition by him. 2. Three exceptions: a. If an individual holds a general power of appointment over the property b. If only the income will revert or could revert to the decedent c. A transfer for full and adequate consideration Requirement #1: Transfer 1. Same as the requirements of 2036 and 2038- the decedent had to have transferred the property Requirement #2: Survivorship 1. Main component of 2037 2. Primary test- an individual can only get possession or enjoyment by outliving the decedent 3. If possession or enjoyment comes in any other way then we are out of 2037 4. Exp: if the decedent creates a trust with income to A for life, remainder to B if B is living, if B is not living then to Decedent if living or if not then to R. a. A gets a life estate remainder to B if living b. A and B don't have to survive the Decedent to get a benefit, but R has to survive the Decedent to get a benefit. 5. If a person has a power of appointment- power to direct the distribution of the property, then that will pull us out of 2037. Requirement #3: Reversionary Interest Retained 1. That retention can either be expressed (prior exp) or it can arise by operation of law. 2. 2037 is based on the possibility of a reverter. It also includes the possibility that the property becomes subject to the power of disposition by the decedent. That will be in the event a trust fails. In which case it would have been passed pursuant to Decedent’s intestate estate or his will. Almost every trust can fail. Requirement #4: Retention is Greater than 5% of the value of the property on date of death 1. Reversionary interest, the value of reversionary interest, must be more than 5% on the date of death. 2. Insert from echo a. The next question is with that reversion, allocable to the decedent, does that exceed 5%? This is acturarily valued. Example of how this plays out: 1. Exp: if A transfers property in trust to B for life, if B dies before A then back to A. If A dies then to C. a. If A is 90 and B is 30, you can tell statistically that the likelihood of a reversion is less than 5% because it is based on life expectancy. If they are both 50, the odds and percent value of the likelihood of the reversion is more than 5%. 2. Exp: I create a trust for grandpa. He creates the trust for the benefit of his child. The child is deceased, to the child’s descendants. If the child has no descendants, then to the grantor’s living descendants. This trust has potential to fail and revert back because he could have no descendants. How much is included? Once you go through the entire analysis of 2037 and meet all requirements, then you value for estate tax purposes. Value the interest that would pass to the individual who must survive the decedent. Different valuation from the 5% valuation based on life expectancy. 1. Exp: if the decedent creates a trust with income to A for life, remainder to B if B is living, if B is not living then to Decedent if living or if not then to R. a. Here, include R’s contingent interest. Distinguishing between 2033 and 2037 Under 2037 sometimes it is difficult to distinguish between 2033 and 2037. If the decedent’s reversionary interest does not terminate by decedent’s death, it is 2033- even if it is contingent. If the reversionary interest terminates and passes to someone else, it is 2037. SECTION 2035 - ADJUSTMENTS FOR CERTAIN GIFTS MADE WITHIN 3 YEARS OF DECEDENT’S DEATH “THE THREE YEAR RULE” Section 2035: If you did any of the following acts within 3 years of the date of death, then we are going to consider it under 2035 as if you did not actually do those acts. When it Applies 1. 2035 ONLY APPLIES TO CIRCUMSTANCES WHERE 2036, 2037, 2038, OR 2042 WOULD HAVE APPLIED. a. 2024 deals with life insurance When it does NOT Apply 1. If there would be inclusion for any under rule, under 2040 or 2033, and that is transferred within 3 years of death, 2035 is not applicable. a. Exp: Father writes me a check for $1million on Dec. 31, it clears, he dies 3 days later. He made a gift of $1million on Dec. 31. 2035. 2035 is not applicable because the gift would have been included in the estate under 2036, 2037, 2038, or 2042 and would have instead been included under 2033. b. Exp: Father transfers property but retains a life estate, but then relinquishes the life estate. If he dies within 3 years of relinquishing the life estate, it will be included under 2035 because it would have been included under 2036 had he not relinquished the life estate. How to Answer this on the Exam:  1. First ask: would it have been included but for his actions under 2036, 2037, 2038, or 2042? a. 2036 (a)(1) you giving up possession or enjoyment or income interest b. 2036 (a)(2) giving up ability to affect beneficial enjoyment c. 2038- giving up the power to alter, amend, or terminate d. 2037- giving up your right of reversion e. 2042- giving up your incident to ownership in life insurance. i. 2035 really has an impact on life insurance. If you make a gift of life insurance the value is FMV. Interpolated Terminal Reserve (ITR)- what could you cash it out for. We don't care about its face value. 2. Second ask:were his actions taken within 3 years? What is Included? 1. Gift is cash value a. If you have actually owned it at death then the proceeds at death (face value) is what is included in the estate. Exception 1. Exception #1- full and adequate consideration 2. Exception #2: 2035(e)- making a gift from a revocable trust. if you have got a trust that would be treated as owned by the grantor under section 676 (income trust) it is a revocable trust that is being used only for estate planning purposes, then 2035 will not apply with regard to transfers from the revocable trust, so we don't have the three year rule. Stepped Up Basis 1. If any asset is included on an individual's estate tax return then the basis is the amount recorded on the estate tax return. a. Farm/relinquishment of property and dies two years later, because it is included in his estate I will get a stepped up basis to the amount included on the estate tax return. Gift Tax Gross Up Section 2035(b) 1. Gift tax is tax exclusive. The estate tax is tax inclusive. a. This means the estate tax- you pay tax on the whole including the amount of tax. i. If you have a taxable estate of $1 million and you apply a 40% tax to the $1 million, we know that $400,000 will be going to the federal government and $600,000 will go to the beneficiaries.  b. The gift tax is tax exclusive- say an individual comes to you and says they want to give $600,000. I want to make a gift, but go ahead and give my beneficiary $600,000. It is going to cost you the $600,000 and then 40% of the $600,000 so that is $800,000 out of pocket. 2. If you pay gift tax within 3 years of date of death, then we dont necessarily bring the value of the property back in, but we will bring in the gift tax that has been paid because had you died with both the value of the estate.. Both would be.. because it will be tax inclusive at this point. a. If you want to do dollars to dollars- if the donor said I have $1 million, I can die with it and pay tax or i can pay the gift tax and give the amount to my beneficiary now. What would you recommend? i. Assuming you live 3 years, then the math is the value of the gift divided by 1.4. ii. This applies to people who have went over the exclusion and the gift is now taxable. ANNUITIES AND EMPLOYEE DEATH BENEFITS SECTION 2041 Section 2039- retirement plans, annuities, and employee death benefits Requirements For this to apply there must be: 1. A K or agreement that isn't life insurance 2. Beneficiary who will receive annuity or payment by reason of surviving decedent 3. The decedent must be receiving annuity or other payments at time of their death or have and enforceable right to payment 4. Decedents' right to the payment must arise from the same K or agreement as the beneficiaries payment and they must continue for the decedent’s life for a period not ascertainable to the decedent’s referenced death or for a period that did not in fact end before the decedent's death. a. Same language from 2036 and 2038 What is an Annuity? Annuity is broad- one or more payments spread out over time 1. Never look the same 2. Can be equal, unequal, etc. 3. Single payment can be sufficient. What is a K or Agreement? 1. Includes any agreement, arrangement plan, understanding, etc. Payments to Beneficiary Payments to decedent beneficiaries must arise from same K or agreement 1. Whether purchased directly by the decedent or provided by the employer the decedent or beneficiary receives the sam