Objectives Gain an understanding of gift and estate taxation rules including calculations of tax, definitions of taxability. Gain an understanding of strategies for minimizing gift and estate taxes Lesson TRANSFER TAXES?IN GENERAL GIFT AND ESTATE TAXES Objectives Gain an understanding of gift and estate taxation rules including calculations of tax, definitions of taxability. Gain an understanding of strategies for minimizing gift and estate taxes Lesson TRANSFER TAXESIN GENERAL 1. Excise taxes are imposed upon the transfer of goods and services and based on the value of the property rather than the income derived. 2. Federal tax law imposes excise taxes on the gratuitous transfer of property either by gift or through an estate. Nature of the Taxes 3. Federal gift tax is imposed on the right to transfer property by one person (donor) to another (donee) during life for less than full and adequate consideration. a. b. If the donor fails to pay the tax when due, the donee may be held liable for the tax to the extent of the value of the property received. c. Gift tax is to be determined by using the fair market value of the property as of the date of the gift. d. 4. Tax is payable by the donor. A gift by a corporation is considered made by the individual shareholders. The Federal estate tax is imposed on the right of a decedent to pass all property at death. a. b. 5. The administrator or executor of the estate is obligated to make sure the estate tax due is paid. Federal estate tax is determined by using the fair market value of the property on the date of death (or on the alternate valuation date, if available and if elected). To whom gift and estate taxes apply. a. All citizens or residents of the U.S. The location of the property transferred is immaterial. b. 6. For individuals who are not citizens or residents, the transfer taxes apply to tangible property located within the U.S. Further, estate tax applies to stock of U.S. corporations. Two types of death taxes. a. b. 7. Estate taxes are levied against the estate of a decedent. Inheritance taxes are imposed upon the heirs. Some states and other countries impose an inheritance tax, but it is not part of the Federal tax structure. Formula for the Federal gift tax. a. b. Gift tax is cumulative in nature, thus, prior taxable gifts are taken into account in arriving at the tax base for current taxable gifts. c. 8. Gift tax applies the taxable base, which is the fair value of the gift less the annual exclusion. Credit is allowed against current gift tax for taxes paid on prior gifts included in the tax base. Formula for the Federal estate tax. a. Gross estate is the starting point in arriving at the final tax determination. b. Taxable estate is allowed certain deductions from the gross estate in arriving at the taxable estate. c. Taxable estates are adjusted for any post-1976 taxable gifts. (1) (2) d. 9. Estate tax rates are applied to a tax base which comprises the sum all taxable transfers made after 1976. To avoid double taxation of gifts, a credit is allowed against the estate tax for gift taxes previously paid or deemed paid. Estate tax allows certain credits in arriving at the final tax liability. Unified tax credit (also called exemption equivalent or bypass amount). a. It provides an exclusion amount upon which the taxpayer is exempt from the transfer taxes. It allows most individuals to avoid transfer taxes based on the current exclusion amounts. b. For many years, the unified credit for gifts was frozen at $345,800, which is the tax on $1 million of transfers. In 2014, the credit is $2,081,800 which is the equivalent of a $5,340,000 taxable estate. Valuation for Estate and Gift Tax Purposes ( 2032) 10. Property valuation for transfer taxes is generally on the date of the gift or date of death. Under certain conditions, however, an executor can elect to value all estate assets on the alternate valuation date. a. Alternative valuation date to relieve hardship when assets decline after the date of death. It is the earlier of 6 months after date of death or the distribution date. b. Election for alternative valuation is available only if a Form 706 is required and the valuation decreases both the value of the gross estate and the estate tax liability. c. Income earned by the property after death is not considered in the alternate valuation date determination. Key Property Concepts 11. Form of ownership is important when property is transferred by gift or death. a. Joint tenants and tenants by the entirety provide the right of survivorship. b. Tenants in common or community property ownership is not defeated by death. c. Interests in assets can be divided into rights to income and rights to principal. THE FEDERAL GIFT TAX General Considerations 12. Requirements for a Gift include the following. 13. Donor competent to make a gift. Donee capable of receiving and possessing the property. Intent on behalf of the donor. Actual and constructive delivery of the property to donee or donee's representative. Acceptance of the gift by donee. Incomplete transfers (where the transferor retains rights to the property) are not gifts. An incomplete transfer, however, becomes a gift upon the later occurrence of some event that makes the transfer complete. 14. Setting (business or personal) for the transfer often determines whether a gift occurs. a. b. 15. If full and adequate consideration is involved no gift occurs even if the transfer occurs in a personal setting. Valuable consideration does not include love, affection or promise to marriage. Depending on the circumstances, loans in a personal setting may be treated as a gift either when the loan is made or when it is forgiven. Transfers excluded from the application of the Federal gift tax include the following. Transfers to political organizations. Direct payment of another's tuition or medical care. Beneficiary need not be a dependent of (or even related to) the taxpayer. IRS has ruled that grandparents' payments of tuition at a private school on behalf of a grandchild are covered by this exclusion. No gift results. Satisfaction of an obligation of support does not constitute a gift and what constitutes the obligation of support is determined by state law. If a father pays for his 21-year old daughter's apartment rent while she attends college. No gift results. If a father makes a $40,000 down payment on a residence purchased by his 30-year old daughter and her husband. A gift results. Adult children may have an obligation of support to their indigent parents. 16. Lifetime gifts (intervivos) and death (testamentary) transfers have different treatment and thus must be distinguished. a. Payable on death arrangements are used for investments and are very similar in effect to a revocable trust. b. No gift tax is due when investment is made because transfer occurs at death. Transfers Subject to the Gift Tax 17. Gift loans are any below-market loans where the forgone interest is considered a gift. a. For gift loans not exceeding $100,000, the interest element may not exceed the borrower's net investment income. b. If net investment income is less than $1,000, it is treated as zero and the interest element is disregarded. 18. Property settlements of marital rights (divorce) are not subject to the Federal gift tax if made within 3 years of final divorce decree. 19. Disclaimer is a refusal to accept property passed to the person from another. The effect of a disclaimer is to pass the property to someone else. a. To be effective in avoiding gift taxes, the following condition must be met. b. Refusal must be in writing. Issued within 9 months after the right to the property arose. Person making the refusal has not previously accepted the interest or its benefits. Interest passes to another without any direction from person issuing the disclaimer. For uniform application, Federal rules override state law. Annual Exclusion 20. Transfers by gift have an annual exclusion of $14,000 per donor per donee. This exclusion is indexed for inflation. a. An annual exclusion applies to gifts of a present interest (the unrestricted right to the immediate use, possession, or enjoyment of the property or the income currently) and not to gifts of a future interest (the right that comes into existence at some future date). b. Accumulating the income in a trust rather than paying it out currently makes the transfer a gift of a future interest. c. Code provides an exception to the future interest rule when transfers are to a minor (under age 21) and certain conditions are met. Both property and its income may be expended for the benefit of the minor. Any portion of the property or income not expended by time the beneficiary reaches 21 passes to the beneficiary at that time. If the beneficiary dies before reaching 21, the property and income is part of the minor's estate. 21. Qualified tuition plans, ( 529 plans) enjoy the best of all possible tax worlds. a. Although plan contributions are not deductible when made, income accumulates tax free and distributions are not subject to income tax (if used for education purposes). Some states allow deductions for contributions to their own plans. b. Grantor can claim up to 5 years of annual exclusions per donee for contributions. c. No estate tax results if the grantor dies during the existence of the plan. Deductions 22. In determining taxable gifts, a charitable deduction is allowed for transfers to qualified organizations and a marital deduction is allowed for transfers between spouses. Computing the Federal Gift Tax 23. a. Basing gift tax computations on all current and past taxable gifts pushes the tax-payer into higher marginal brackets because the unified tax rates are progressive. b. To mitigate double taxation, the donor is allowed a credit for gift taxes previously paid or deemed paid. (1) \"Deemed paid\" adjustment is necessary for pre-1977 taxable gifts and is sometimes difficult to grasp. Basically, it is the amount of tax that would have been paid if the unified tax rates would have been in effect prior to 1977. (2) 24. Post-1977 gifts are also subject to deemed paid adjustments since the same rates have not been in effect for all gifts for this period. The deemed paid may be less than the actual amount paid for these gifts. For the split gifts election, individuals must be legally married when the gift is made. It thus, doubles the annual exclusion to $28,000 rather than $14,000. Procedural Matters 25. Form 709 must be filed whenever gifts for a calendar year exceed the annual exclusion per donor per donee or if a future interest is given. a. Filing is necessary if spouses want to elect to split gifts as discussed in 25 above. b. Return due date is April 15 of the year following the year of the gift regardless of the taxpayer's income tax year-end. THE FEDERAL ESTATE TAX 26. The key components in the formula are the gross estate, the taxable estate, the tax base, and the credits allowed against the tentative tax. Gross Estate 27. Gross estate includes all property subject to Federal estate tax and generally includes all property in which the decedent had an interest. Probate estate is all of the decedent's property passed to heirs under a will or law of intestacy (when there is no will). a. b. 28. Probate estate is generally smaller than the gross estate. Probate estate is controlled by state law and states provide an order of distribution in the event that someone dies intestate (without a will) Code 2033 (Property in Which the Decedent had an Interest) delineates what property is included in a decedent's gross estate. a. Encompasses real, personal, tangible, and intangible assets wherever located. b. Does not include the surviving spouse's share of the community property. c. Examples of inclusions are the following. d. Personal effects (including jewelry) and household goods (including antique furniture). Retirement plans. Investments (e.g., stocks, bonds). Collectibles (e.g., works of art, coin collections). Interests in a business (sole proprietorships, partnerships). Real estate holdings. Present value of future royalty rights (e.g., patents, copyrights, mineral interests). One important inclusion that is often overlooked when planning for a survivor's estate is the tax effect of a prior QTIP election. See Code 2044. Example. Andrew died ten years ago leaving a trust worth $2 million, life estate to June (his surviving spouse), remainder to their children. June dies in 2011 when the value of the trust is $8 million. If Andrew's executor made the QTIP election ten years ago, June's estate must include the $8 million value of the trust. If not, June's estate includes nothing for trust [ 2036 does not apply to June's life estate since she was not the grantor]. 29. Dower and curtesy interests developed under common (nonstatutory) law (dower for surviving wife and curtesy for surviving husband). State statutes have replaced them and give the surviving spouse a statutory share of the deceased spouse's estate. 30. Gifts made within 3 years of death are not included in the gross estate of the donor except in the following situations 31. Any gift tax paid on gifts within 3 years of death. Called the gross-up approach, the procedure prevents the amount of the gift tax from escaping the estate tax. Certain property transfers that would be included in the gross estate such as transfers of retained life estate, transfers taking effect at death, revocable transfers, and proceeds of life insurance. Estate tax can be avoided on lifetime transfers only if the donor retains no degree of control over the property, that is, the gift is complete. Incomplete gifts are included in the estate. a. b. 32. Transfers with a retained life estate are incomplete transfers. Revocable transfers are incomplete transfers. Retaining the power to alter, amend, revoke, or terminate a transfer as well as changing beneficiaries will cause the transfer to be incomplete. Classic example is a revocable trust. Annuity may be commercial and noncommercial and have different types of contracts (straight-life, joint and survivor, self and survivor) that can be issued. a. b. 33. While a straight-life causes nothing to be included in the gross estate (nothing is transferred to an heir) a survivorship annuity triggers estate consequences at the death of the first annuitant. Amount included in estate is cost of a comparable annuity covering the survivor adjusted for contribution by survivor to the annuity. In employment-related annuities, the employer's contributions to the plan are treated as having been made by the employee annuitant. Joint Interests include tenancies in common, community property, joint tenancies, and tenancies by the entirety. a. With joint tenants and tenancies by entirety, upon death, the property passes to the surviving tenant but with tenancies in common and community property, death does not defeat ownership. Part of the property is included in the deceased estate. b. In the non-spousal situation, the full value of the property is included in the gross estate of the first tenant to die unless the surviving tenant proves contributions to the cost of the property. c. 34. In the spousal situation, there is an automatic inclusion rule; regardless of which spouse furnished the consideration, one half of the value of the property is included in the gross estate of the first spouse to die. However, the effect of marital deduction neutralizes automatic inclusion rule. Whether a gift results when property is transferred into joint ownership depends on the consideration furnished by each party for the ownership interest they acquire. a. b. 35. Exceptions to this rule occur with the creation of a joint bank account and with the purchase of U.S. savings bonds. In these situations, a gift occurs only when one owner withdraws more than their contributed share. Due to the application of the unlimited marital deduction, no gift tax results upon the creation of spousal joint tenancies and tenancies by the entirety. Proceeds from the decedent's life insurance are included in the gross estate in the following situations. It is receivable by the estate. It is receivable by another for the benefit of the estate. Decedent possessed incident of ownership in the policy (can change beneficiary). Only of the proceeds are includable if the insurance is community property. 36. Life insurance on another's life that is owned by a decedent is included in the gross estate. The amount includible is the replacement value of the policy. 37. Gift tax ramifications of life insurance are summarized in the following examples. Olga purchases a policy on her life and designates Norman as the beneficiary. No gift takes place. When Olga dies, the proceeds of the policy are paid to Norman. No gift occurs as the proceeds pass to Norman by testamentary transfer. Olga gives the policy to Norman. A gift occurs. Olga pays the premiums on the policy. Each premium payment is a gift. Olga owns an insurance policy on the life of Norman with Tom as the designated beneficiary. Upon Norman's death, the proceeds of the policy are paid to Tom. Olga makes a gift to Tom. Taxable Estate 38. Taxable estate is gross estate less allowable deductions which include the following. Funeral expenses. Administrative costs. For community property, costs are deductible only in proportion to the deceased spouse's interest in the community property. Claims against the estate (indebtedness). Taxes. Losses. Charitable transfers. Marital deduction. 39. Casualty & theft (C & T) losses are allowed under 2054, if they occur while the estate holds the property. C & T can be claimed on either the estate income tax return fiduciary return or as an estate tax deduction but not on both returns. 40. Charitable bequests must be provided for in the will and must be mandatory. Charitable deductions for estate purposes include transfers to the following. 41. U.S. or any political subdivision. Entities operated exclusively for religious, charitable, scientific, literary, or educational purposes. Veterans' organizations. Foreign charities. Marital deduction. a. b. 42. Because Congress regards a husband and wife as one economic unit, the law contains no monetary limit on the amount of the marital deduction allowed. Marital deduction is available only on property included in the gross estate of the deceased spouse and that passes to the surviving spouse. Terminable interest limitation to the marital deduction. a. Terminal interest occurs when the interest in the property fails by the passage of time or other event. The property is not included in the recipient's estate. b. Terminal interests given to the surviving spouse will not qualify for the marital deduction. This is to ensure that the property not taxed to the deceased spouse (due to the marital deduction) is subject to either gift or estate tax upon the disposition by the surviving spouse. c. By giving the spouse a general power of appointment, the interest will qualify for the marital deduction. With a general power of appointment, the surviving spouse cannot avoid a transfer tax upon the disposition of the property. The exercise, release, or lapse of a general power of appointment is a transfer subject to tax. d. Qualified terminal interest property (QTIP) is an alternative means for obtaining the marital deduction. The transferee spouse is subject to a transfer tax when there is a disposition of the QTIP. A QTIP must meet the following conditions. Spouse is entitled all of the income from the property for life. No person (including the spouse) has the power to appoint any part of the property to anyone other than the surviving spouse during her/his life. 43. A Federal estate tax deduction for state death taxes. There is no longer a credit for state death taxes ( 2011). 44. Post-1976 taxable gifts are added to the taxable estate. Using the unified transfer tax rates, the tentative tax on the estate is determined. All available credits are subtracted from the tentative estate tax. Estate Tax Credits 45. Unified credit ( 2010) amount depends on the year of the transfer. 46. Successive deaths of family members over a short span of time may generate a significant amount of estate tax liability. Therefore, to mitigate this possibility a credit for prior estate taxes is available. a. Maximum amount of the credit is limited to the lesser of the following amounts. b. Maximum credit is further limited by time between deaths of the transferor and the transferee. See Table 27.2. 47. Federal estate tax attributable to the transferred property paid by the transferor's estate. Federal estate tax attributable to transferred property paid by the transferee's estate. If death within the first 2 years - 100% of maximum credit. If within 3rd or 4th year - 80% of maximum credit. If within 5th or 6th year - 60% of maximum credit. If within 7th or 8th year - 40% of maximum credit. If within 9th or 10th year - 20% of maximum credit. Credit for foreign death taxes is allowed because a double tax effect might arise when a U.S. citizen or resident owns real estate situated in a foreign country dies. Procedural Matters 48. Estate tax return (Form 706) is due 9th months after the decedent's death. a. Noncompliance leads to imposition of failure to file penalty (Chapter 26). b. Upon timely application, the IRS will extend the filing date for an estate. c. Extension for filing does not, by itself, exonerate an estate from the failure to pay penalty. But see 6161 and 6166. d. In any event, interest on any unpaid estate tax liability accrues from the due date of the return. GENERATION-SKIPPING TRANSFER TAX 49. Congress enacted the generation-skipping transfer tax (GSTT) to preclude avoidance of either the estate or gift tax on each generation by making transfers that bypass the next younger generation. a. GSTT is triggered when any of these events occur: a taxable termination occurs, a taxable distribution takes place, or there is a direct skip. b. In determining when a generation is skipped. (1) Spouses, regardless of age disparity, are of the same generation. (2) A generation is not skipped if the skip-person's parent (direct or collateral descendent) is dead. Question 1 Not yet answered Points out of 1 Flag question Question text The gift and the estate tax are connected by the unified wealth transfer tax credit and common tax rates in such a way that it makes no difference whether wealth is transferred during life or at death. Select one: True False Question 2 Not yet answered Points out of 1 Flag question Question text For purposes of calculating the federal estate tax, the value of the asset can be determined at Select one: The date of the distribution The date of death A date six months after the date of death all of the above b and c Question 3 Not yet answered Points out of 1 Flag question Question text If a taxpayer is a US citizen or resident, property located outside the United States is exempt from US estate tax. Select one: True False Question 4 Not yet answered Points out of 1 Flag question Question text If property is held as community property, at the death of one spouse the amount includible in the gross estate is Select one: None 50% of the value 100% of the value None of the above Question 5 Not yet answered Points out of 1 Flag question Question text A no interest rate loan by a parent to an adult child is a good way to avoid gift tax. Select one: True False Question 6 Not yet answered Points out of 1 Flag question Question text The annual gift tax exclusion does not apply to gifts of future interests in property. Select one: True False Question 7 Not yet answered Points out of 1 Flag question Question text For both gift and estate tax puposes, gifts to spouses are "tax free". Select one: True False Question 8 Answer saved Points out of 1 Flag question Question text In which, if any, of the following independent situations has Jean made a gift? Select one: a. Jean gives her 19-year old son $20,000 to be used by him for his college expenses. b. Jean buys her grandfather a new $120,000 RV for his birthday. c. Jean sends $14,000 to Temple University to cover her nephew's tuition. The nephew does not qualify as Jean's dependent. d. Jean contributes $10,000 to her Congressman's reelection campaign. e. None of the above. Question 9 Answer saved Points out of 1 Flag question Question text Prior to his death in 2011, Alma made the following gifts. Year 2007 2009 2010 Asset Marketable securities Term life insurance policy Unimproved land Fair Market Value Date of Gift $400,000 -0- 900,000 Date of Death $900,000 100,000 950,000 As a result of the 2010 transfer, Alma paid a gift tax of $70,000. As to these transactions, Alma's gross estate includes: Select one: a. $0. b. $70,000. c. $100,000. d. $170,000. e. $1,120,000 Question 10 Answer saved Points out of 1 Flag question Question text Tom and Jean are husband and wife and live in California. In 1991, they use $400,000 of community funds to purchase an annuity from an insurance company. Under the terms of the contract, Tom is to receive $40,000 per year for life once he reaches age 65. If Jean outlives Tom, she is to receive $30,000 per year for life. Tom dies first in 2011 (and before reaching age 65). At this time, the value of Jean's interest is $500,000. As to this contract, Tom's gross estate includes: Select one: a. $0. b. $200,000. c. $250,000. d. $500,000