CH 12 The scope of the estate tax Sec 2033

Section 2033
· Gross estate: Value of the property to extend of interest at time of death
Section A
· estate tax is excise tax: “tax included on the property”
· Tax base must include the value of the property that most obviously is transferred (FUNCTION OF 2033)
· Section 2033 includes (GROSS ESTATE) o Decedent’s securities o Bank deposits o Real state o Income earned before death are collectible by the estate
§ Rent
§ Interest
§ Dividends
§ Partnership profits
§ Refunds
§ Vested rights
§ Promissory notes (matured or not)
§ Insurance policies
§ Saleable (commercial) leasehold interest
§ Interest in rented property
· By either tenants in common or one-half community.
§ Federal and State bonds are includable despite their exemption from other taxation either by their express terms or by law
· REG 20.2033 o Descendant hold only legal title (trustee) under enforceable oral or written does not possess an interest taxable under section 2033.
§ Ex: agent o ONLY DIRECTLY OWNED PROPERTY
· Principal reliance on judicial and administrative interpretation of Sec 2033’s simple language potentially would yield over inclusions “many” o There are not many limits o Limits must be established o Congress explicit responded what property interest that are to be taxed, eventhough they lied beyond the reach of 2033.
§ 2033- Base line
§ Section 2041
· in contrast to other specific inclusion provisions in particular with Sect 2041 relating to powers of appointment. o Giving someone the power to designate the power of designate the beneficiaries of property, taking into considerations limits given by the donor.
§ Property law sees a power as an agency.
· Agent holds the power to dispose.
§ Includes within the donee’s gross estate property subject at death to a general power of appointment o 2033 has not been interpreted to reach that kind of power o Helvering v. Safe Deposit & Trust Co.
Section B “Interest Airing at Death”
· Wrongful death Proceed o Treasury Department has issued 3 revenue rulings concerning the inclusion of wrongful death proceeds
§ Proceeds are not part of the gross estate
· Proceeds (Life Insurance, etc)
· Wrongful Death Statutes o What is wrongful death? When a person dies or is killed due to the negligence or misconduct of another, including murder, the surviving members of the victim's family may sue for "wrongful death." Most wrongful death lawsuits follow in the wake of criminal trials, using similar evidence but with a lower standard of proof. Regardless, someone found liable for wrongful death may or may not be convicted of a crime associated with that death. o Section C “Property vs Expectancy” o Estate of Barr V Commissioner o Wage Dividend death benefit
A. VESTED RIGHTS TO BENEFITS
1. Employer’s Policy
2. Contracts for payments of death benefits
3. Benefits Paid from funded trust
B . EFFECT OF ABILITY TO DESIGNATE BENEFICIARIES
C. PAYMENTS IN THE NATURE OF DEFERRED COMPENSATION
D. EFFECT OF OTHER SECTIONS
Section D “Bank Deposits, Checks, and Notes”
A. Checks
B. Notes
Section E “Right to Accrued payments”
A. Includibility of right to future payments
a. Statutory structure
B. EFFECT OF CHARACTERIZATIONS AS INCOME IN RESPECT OF A DECENDENT
C. REFORM PROPOSALS

CHAPTER 15

* irrevocable trust cannot be touched. * Cannot be amended * Once assets are transfer it’s a completed transfer. * not included on gross estate

Why create a trust 1. taxes 2. estate planning 3. asset protection 1. against litigation

Section 2036, 2037, 2038
· Include in the gross estate lifetime transfers which the transferor has retained certain power or rights with respect to the transferred property o Ex: Irrevocable transfer of stocks where the dividends will still be received by the person transferring the stocks. o This requires to include the full value of the stock at death.

2036a
IRC § 2036(a), which provides that the value of the gross estate includes the value of all property to the extent the decedent has made a transfer but has retained * (i) the possession or enjoyment of, or the right to income from, the property, or * (ii) 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

Incentives encourage wealthy Donors to make inter vivos transfers
· Retain economic benefit
· Tax Exclusivity of the gift tax, exclusion of the gift tax from the gross estate o Ex: an Older parent gives a gift to their son while alive using a technique that reduces the gift tax payable in connection to the transfer. It’s a variation on a traditional gift, since it requires the donee to assume liability for the gift, but also for the contingent estate tax liability if the donor dies within 3 years of making the gift 2035b. 3. o Section 2503b
§ Section 2503(b)(1) provides, generally, that in the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $14,000 of such gifts to such person shall not be included in the total amount of gifts made during such year. The $14,000 annual exclusion is only available for gifts of present interests in property. o 2036, 2037, 2038 POLICY OBJECTIVES
1. The donor retains economic benefit until death
2. Estate tax imposed upon transfer, and must be included in the testament.
3. An estate tax is imposed upon property transferred during life, when transferor reservers significant power over the possession or enjoyment
Transfers are subject to 3 forms of analysis
1. Transfers subject to estate tax only
2. Transfers subject to gift tax only
3. Transfers subject to both the estate tax and the gift tax
SECTION B 204
· Section 2036 includes in the gross estate o The value of all property as to which the donor has retain certain powers or rights. o 2036a requires the inclusion of property in the gross estate where the donor has transfer the property but:
§ Retain right to income
§ Procession or enjoyment
§ Designated the person of who process or enjoy
· EXPEPTIONS 1. Transfer for adequate and full consideration in money or money’s worth. 2. transfer before March 4, 1931
******
Retained interest: * ex: A father transfer a house to her kid, the father is later given a key and has a room * not taxable if not implied agreement

Amount Includible (2 types) 1. default - at day of death 2. Alternate valuation - 6 months after the death of the decedent.

Transfers made within 3 years of death * Are included in the estate

Discretion over income and principal * Decide what to do with the income generated and the principal included in the gross estate * EXEPTION: Ascertainable standard * Healthcare * Education * Maintenance * Support

Pg 217
ASPECTS OF THE RECIPROCAL TRUST DOCTRINE
1. Trust must be organized
2. Mutual value must leave the settlors in approximately the same economic position as if the had each created his or her own trust.
The doctrine states that if a husband creates a trust for his wife, and the wife creates a nearly identical trust for the husband, then the two trusts may be “un-crossed” and treated for tax purposes as if each spouse had created a trust for himself or herself.
244
SECTION 2038(a)(2)
CHAPTER 16
SECTION H – ESTATE PLANNING AND THE REVOCABLE TRUST
· Revocable living trust subject to inclusion in estate
· ADVANTAGES of retaining power to alter, amend or revoke

1. Establish of managerial commitment: In the event that grantor is not longer capable he assign a committee to manage his affairs after death.
§ the best way to ensure that your property remains available to be used for your benefit,
2. Avoidance of publicity:
Not everybody needs to know about the value of the property

3. Avoidance of attacks on probate
§ Because probate can be costly and time consuming, the avoidance of probate is often cited as one of the primary benefits of a revocable trust.

4. Choice of governing state law
§ Grantor has the option of selecting particular jurisdiction under the laws he wants the revocable trust to be interpreted. Which means the grantor can choose which state laws interpret the trust.

5. Costs
It’s less expensive to have a revocable trust that a irrevocable trust. The property included in the trust is not included in the grantor’s probate estate.

6. Alternative to power of attorney designate someone to act as an agent in the event the grantor is not longer capable either by competence to handle it’s own case.
The

7. Increase charitable dispositions
Some states does not allow to allow to give property by will after certain value on the property. Having a revocable trust it allows to distribute the property as charity beyond the limits.

8. Receptable for non-trust assets:

9. Flexibility: * Grantor does not lose control of the property until death. * grantor can design the trust to accommodate desires and needs * decide who will receive the income of the property * Modify the trust if needed

* Transfer to a revocable living trust will not be subject to gift taxes * The trust is included in the grantor’s gross estate

Chapter 23 * Life insurance * Tax free benefit (normally from employers) * It’s attractive to high income individuals since it helps to accumulate earnings * Insurance proceeds can help to pay estate debts * Taxes * Avoiding having to sell other assets * Purchaser makes premium payments to a life insurance * Life insurance represents a promise to pay a certain amount to the designated beneficiary upon death of person

Advantages: 1. Replaces income of the person who dies 2. Income tax free for beneficiary 1. taxed on over premium payments 1. Investment vehicle to accumulate income 2. Provides liquidity so that assets can be distributed. 3. Avoid selling assets since it can pay estate debts such as taxes.

* Types of insurance * “term insurance” * * estimating when person will die and if dies during that period pays the total amount assigned, if does die insurance company will keep the premium * “Whole life insurance” * increase in premium periodically * whole life insurance * More expensive at the beginning (contrary to term life insurance) * less costly in later years. * 378 * excess premium payments are invested by the insurance provided and help to defray the cost in later years. * Policy owner does not pay income taxes on the investment income * if cancel the policy is entitle to receive the “cash surrender value”- * the owner will normally recognize taxable income only to the extent that net surrender value is greater than amount of premium paid * Section 101 * allows the policy owner (beneficiary) to receive insurance proceeds and investment income upon death of the insured free of income tax. * Section 2042 * Include in gross estate the proceeds of life insurance * proceeds are receivable by executor * in a trust * if proceeds are receivable by other beneficiaries * executor has the benefit of changing the beneficiary * are creditors beneficaries * * applies to insurance under policies on the life of the decedent. * Issues * definition of insurance * standards determining whether the insurance proceeds are “receivable by the executor” * Decendent has possessed any of the incidents of ownership. http://www.buckley-law.com/the-estate-taxation-of-life-insurance-and-how-using-irrevocable-life-insurance-trusts-can-help-avoid-having-to-pay-these-taxes/ * “b. When Life Insurance is subject to Estate Tax. Section 2042 of the Code provides that the proceeds of any life insurance policy under which you are insured will be “included” in gross estate (and thus potentially subject to estate taxes) if either * (1) the proceeds are paid to your estate, or * (2) you own the policy or, if you do not own the policy outright, have retained certain “incidents of ownership” at the time of your death. These incidents of ownership include the right to change or add beneficiaries, the right to borrow against the policy’s cash value, or to cancel or surrender the policy. * c. How do you avoid Section 2042? * The first prong of Section 2042 is easily avoided. The estate should not be named as a beneficiary, and make sure that you have a current beneficiary designation on file with the insurance company. Your estate may be the default beneficiary under the policy if you fail to name a beneficiary or if your beneficiary predeceases you and there is no contingent beneficiary.
The second prong is tougher to avoid. In most cases, the insured person under a life insurance policy is also the owner. No one questions whether this ownership is appropriate until the insured is terminally ill or already deceased. Because of the “three year rule” (discussed below), it becomes exceedingly difficult to avoid estate taxation of life insurance if the owner/insured is already at death’s door.

1. Insurance Under policies on the life of the decedent * 379 * Life insurance there must be 1. Shifting of the risk of a premature death from the insured to the insurance provider. 2. Spreading of that risk by the insurance provider among several insureds

B. The statutory Definition of Insurance * Deferral or avoidance of income tax on investment income generated by insurance policies under SEC 101 Encourage insurance providers to market policies called “Flexible premium” or “Universal life” these are policies that provided only nominal life insurance protection but substantial tax deferred investment income. * due to the above congress responded with section 7702 which defines the term “life insurance contract” for purposes of internal revenue code. * Provision is to differentiate between investment rather than protection oriented. * 380 * Section 2042 * if a contract fails to meet the definition of 7702, even if it is consider an insurance contract, the excess amount paid under the contract over the net surrender value will be treated as “life insurance”. * Remaining will be included in gross estate under section 2033
C. Payments by insurance company on account of liability insurance policies:

2. Proceeds “Receivable by the executor” * Section 2042 * Requires inclusion of * amount receivable by the executor as insurance under policies on the life of the decedent whether or not she possessed any incidents of ownership at death.

3. Proceeds receivable by beneficiaries other than executor of the decedent 381 * Incidents of ownership possessed by a decedent * Where insurance proceeds are payable to someone other than decedent estate, the proceeds may still be included in the decedent's estate if she possessed “any incidents of ownership” Section 2042(2)
Chapter 26
The gift tax annual exclusion: Resolution of Administrative problems of taxing small transfers

* Section 2501(a) 446 * impose tax on the transfer of property by gift * Section 2503(b)(1) * excludes from taxable gifts the first 14,000 of gits (OTHER THAN GIFTS OF FUTURE INTEREST) made to any one person during the calendar year * Section 2513 447 * the effect of gift splitting is to double the value of the exclusion * A gift made by one spouse to any person other than his spouse shall, for the purposes of this chapter, be considered as made one-half by him and one-half by his spouse * 448 * Section A. Present interest vs Future interest * PRESENT INTEREST Section 2503(b)(1) provides, generally, that in the case of gifts (other than gifts of future interests in property) made to any person by the donor during the calendar year, the first $14,000 of such gifts to such person shall not be included in the total amount of gifts made during such year. The $14,000 annual exclusion is only available for gifts of present interests in property. * FUTURE INTEREST: * Lifetime gifts of future interest do not qualify for the $14,000 annual gift tax exclusion. Future interest gifts include gifts of * remainder interests, * reversions and * other interests that will commence in use, possession, or enjoyment at some future date. * Certain interests created in Trust and a life estate interest in Real Property are examples of future interest gifts. * The person receiving the gift does not have use or enjoyment of the asset until some future date.

1. 453 2. A Present Interest in non-income producing property 1. Present interest exclusion may be denied upon the transfer of property because: * The type of property transferred and/or powers of the trustee over the trust indicates NO PRESENT BENEFIT was intended * even if present interest in nominally created, the characteristic of the property transferred when combined with the trustee’s power, render the interest incapable valuation.. 1. Ex: Husband and wife gave 16% voting and non voting interest in a LLC to their sons, wives of their son, grand childers that does not constitute to gifts of present interest because they did not render economic benefit presently reachable by the donnes. 2. Three-part test to decide whether rights to income satisfy present interest under 2503(b) 1. Trust will receive income (be able to produce it) 2. some income will steadily flow to the beneficiary 3. some portion of the income flowing out to the beneficiary can be ascertained. 1. assure how much income is going to be payable to the beneficiary. 1. Trustee Administrative Powers 456 * even though present interest exists, interests may be rendered incapable of valuation because of the existence of powers in the trustee which render uncertain the actual receipt by the beneficiary of an ascertainable present benefit from the trust. 2. Trustee’s power to invade principal * If Daniel creates a trust to pay the income to Patricia and Daniela (trustee) manages the trust and I have access to the trust to benefit patricia is it’s present interest. * if the trustee gives the beneficiary proceeds, would be considered present interest * if the trustee decides to give the proceeds to another person other than the beneficiary, it would be considered future interest

D. Gifts to class including after-born children 457 * If settlor creates a trust with income to a class of beneficiaries consist of settlors children and grandchildren after born members of each share income D. effects of spendthrift clause * impose limitations on distributions or conditions before distributions are made. * beneficiary is not able to assign income to a third party * creditor cannot after a trust with spendthrift clause * created mainly to protect assets

F. Remainder interest 458 * future interests F. Contractual rights to future payments * F. Gifts to Corporations F. Power to demand all or a portion of annual transfers 459 F. Leveraging the annual exclusion. F. Section 529 Plans * take up to 5 years of annual exclusion (70,000 = 14,000 x 5) 1. once in a lifetime 2. For college savings plan *

Section B. Gift to Minors 1. Section 2503(b)(1) 1. Non-trust gifts to minors

Chapter 27
Estate tax deductions necessary to define the net transfer * Decuctions under 2053(a) * Funeral Expenses * Administration expenses * claims agains the estate * unpaid mortgage or any indebtedness in respect of * property where the value of the decedent's interest therein * undiminished by such mortgage or indebtedness (INCLUDED IN THE ESTATE) * included in the value of the estate * Section 2053(b) allows as a deduction from the gross estate amounts representing expenses incurred in administering “property not subject to claims” which is included in the gross estate. * Section 2054 * Allows deduction for losses incurred during the settlement of estates arising from * fires * storms

Obama proposal

1. Trust fund loophole * suppose an individual leaves stock worth $500,000 (stepped up basis)to an heir. When purchased, it cost $100,000. That means $400,000 of gain currently goes untaxed, because the capital gains tax doesn’t apply on this transfer, and the law allows the heir to sell it and figure any gain based on the stock’s stepped-up basis of $500,000. * creating a tax liability

* Increase in capital gains (dividends) * from 20% (23.% on some investments) to 28% *

* Eliminating stepped up basis. Calling it “the single largest capital gains tax loophole” (again, I’m not sure that the President understands that word), the President proposes to eliminate stepped up basis at death. With stepped up basis, heirs may use the date of death value of capital assets rather than a decedent’s actual basis for capital gains purposes. This allows those assets – stocks, bonds, houses and companies – which have appreciated to be transferred at death without paying capital gains tax. The tax policy behind stepped-up basis is tied to the federal estate tax: since heirs pay the estate tax, they get a pass on capital gains. That’s why, for example, in 2010, when there was no federal estate tax, there was no stepped up basis. Under the President’s proposal, no capital gains tax would be due until the death of the second spouse for married couples and capital gains of up to $200,000 per couple ($100,000 per individual) would be exempt; the exemption would be automatically portable between spouses as it is for the federal estate tax. An additional$500,000 exemption ($250,000 per individual) would apply to personal residences – this is the same exemption amount that applies to the sale of personal residences during lifetime. Tangible personal property (generally, things you can touch like furniture and clothing) other than expensive art and similar collectibles would also be exempt. * And, because you know the argument is coming, the proposal would also exempt inherited small, family-owned businesses from capital gains tax at death unless and until the business was sold. Any closely-held business subject to capital gains tax would have the option pay out over 15 years.

* The President claims that this move, together with raising the rates on high-income taxpayers (see below), would impact only those at the top and would “address a basic unfairness in the tax system.” *

Chapter 32

Section 2523 * Where a donor transfers during the calendar year by gift an interest in property to a donee who at the time of the gift is the donor’s spouse, there shall be allowed as a deduction in computing taxable gifts for the calendar year an amount with respect to such interest equal to its value.

Section 2513 * A gift made by one spouse to any person other than his spouse shall, for the purposes of this chapter, * be considered as made one-half by him and one-half by his spouse, but only if at the time of the gift each spouse is a citizen or resident of the United States. * ex: Father giving to his sun 106,000 ( half and half is consider $53,000 - $14,000 Exclution)
Marital deduction and Split gifts * Reduce tax cost of transferring wealth

SECTION B
The estate tax Marital deduction * Interest in property * passed * Passed to surviving spouse *

Section 2056
Section 2056 (ESTATE MARITAL DEDUCTION) * permits a deduction from the gross estate of an amount equal to the value of the property passing from the decedent to the surviving spouse * To the extent that this property is included in determining the value of the gross estate. * INTEREST IN PROPERTY * Terminable interests. A “terminable interest” in property * is an interest which will terminate or fail on the lapse of time or on the occurrence or the failure to occur of some contingency. * Life estates, * terms for years, * annuities, * patents, and * copyrights are therefore terminable interests. However, a bond, note, or similar contractual obligation, the discharge of which would not have the effect of an annuity or a term for years, is not a terminable interest.

* Nondeductible terminable interests. (2056)(B)(1)

* (1) A property interest which constitutes a terminable interest, as defined in paragraph (b) of this section, is nondeductible if— * (i) Another interest in the same property passed from the decedent to some other person for less than an adequate and full consideration OTHER THAN THE SURVIVING SPUSE in money or money's worth, and * (ii) By reason of its passing, the other person or his heirs or assigns may possess or enjoy any part of the property after the termination or failure of the spouse's interest.

* (2) Even though a property interest which constitutes a terminable interest is not nondeductible by reason of the rules stated in subparagraph (1) of this paragraph, such an interest is nondeductible if— * (i) The decedent has directed his executor or a trustee to acquire such an interest for the decedent's surviving spouse (see further paragraph (f) of this section), or * (ii) Such an interest passing to the decedent's surviving spouse may be satisfied out of a group of assets which includes a nondeductible interest (see further § 20.2056(b)-2. In this case, however, full nondeductibility may not result.

why terminable interest rule? * assure deduction is allowerd only for the property which if not taxable to the estate of the first spouse to die, will be subject to tranfer tax if disposed of inter vivos or at death by the surviving spouse. The marital deduction is perhaps the best-known estate tax reducer. It also is among the most misused planning devices. While powerful, the mari-tal deduction also can trigger higher taxes or other headaches.The marital deduction is straightforward. The estate executor totals the value of all assets owned by the deceased to arrive at the gross estate. From this is subtracted the value of all property left to the surviving spouse. The marital deduction and the charitable contri-bution deduction are the major deductions in determining the taxable estate. | |
There is no limit to the amount of the marital deduction. A married person easily can eliminate estate taxes by leaving the entire estate to his or her surviving spouse. Many people do just that, and it can be a mistake.
In addition to the deductions, every person has a lifetime credit, also called the estate tax exemption equivalent. The credit allows an individual in 2006-2008 to avoid estate taxes on up to $2 million of property left to non-spouses. The amount rises to $3.5 million for 2009.
The marital deduction only defers taxes, it does not eliminate them. All the property that was transferred to the surviving spouse is taxed at that spouse's death if it remains in his or her estate. http://www.retirementwatch.com/EstateSample4.cfm 1. Status as Surviving “Spouse” 1. Turns validity of the decedent's marriage at the date of death 2. Conflicts of previous divorces can cause problems juridiction over the administration of a decedent's estate when problems occur
Problems proving common law marriage B. Statu as “Surviving” Spouse 1. When there is no will as of what to do with the property presumption is established by law or decedent’s will that his spouse survived will be recognized as property passing under the will that is includable in the gross estate.
Now it’s more common to include in the will presumptions as to orders at death. 1. Reason to do this is to take advantage of the Marital deduction
When no inclusion of death clause 2. administered in a Jurisdiction that has adopted the UNIFORM SIMULTANEOUS DEATH ACT (USDA) 1. EACH SPOUSE IS PRESUMED TO SURVIVE THE OTHER SPOUSE B. Any “Interest” in property which “passes or has passed from the decedent to his surviving spouse” b. EX: buying from the probate inventory that is worth $50 and is purchased for $60, cannot be included in Marital deduction since is it’s not a transfer of property it’s a purchase
“passing requirement” 1.