Chapter 14 – Wealth Transfer Txation and Tax Planning
Gift tax – inter vivos gifts which are transfers that lack consideration. Each donor is entitled to make annual gifts up to a set amount to each individual donee before creating fit tax implications.
In 2002 the annual gift tax exclusion is now $11,000 per year per donee.
Estate Tax – at death transfers that lack consideration. The tax is imposed on the decedent’s taxable estate at time of death. The tax is levied on the total amount transferred (the gross estate) less certain deductions (charitable devises, debts, loans and mortgages).
Gross estate – deductions = taxable estate.
Inheritance tax – unlike an estate tax, an inheritance tax is imposed on the amount a recipient receives, not on the decedent. The amount depends on the amount the person receives and the closeness of the relationship (closer relationship the lower the tax). No federal inheritance tax, but state inheritance.
Unified gift and estate tax scheme – has the effect of permitting an individual to pass up to a set amount of property at death (or during life) free from any estate or gift tax.
Ex- You have 10 million dollars (10,000,000) under today’s law you have a problem. The estate tax exemption in 2008 is 2 million dollars.
i. Adjusted taxable gift – if you give five million away in 2009 and you die in 2029 and the law is the same the five million comes back into your estate when you die.
ii. Estate tax is tax inclusive it is levied on the decedent’s assets which includes the amount that ill be transferred to uncle Sam as estate taxes. Gift tax is exclusive the person receiving the gift pays tax on the amount that the gift was for.
1. Ex of Gift Tax – O aims to transfer 1, 000,000 to her daughter A and that this transfer is subject to a 50% rate. For A to receive by gift 1 million subject to a tax of 500,000 O must part with a total of 1.5 million. The tax rate on the amount parted is really 33½ %.
2. Ex of estate tax – For O to transfer 1 million to A at death, O must part with 2 million subject to a 50% rate to get 1 million in the hands of A.
Stock – if you buy stock worth 10,000 in 1979 and immediately give it away and now it is worth 10 million. The amount that you pay taxes on is what you originally bought the stock for the 10,000.
i. Ex P. 851 – If in 2006 W gives 261,000 to her daughter D. W is entitled to an 11,000 annual exclusion so 250,000 is the taxable gift for 2006. You look at the chart on P 850 & the tentative gift tax is 70,800 so you have used 70,800 unified gift tax credit so far. So you don’t pay any gift tax. If in 2007 W gives D 261,000. W is entitled to the 11,000 annual exclusion so 250,000 then add the 250,000 from the previous year making the cumulative taxable gits 500,000 and the tax from the chart on P. 150 is 155,800 – the 70,800 tax on the 2006 gift gives you 85,000. So you have used 8500 of your unified gift tax credit.
II. The federal Gift Tax
Taxable gift – 2 variables need analyzing when calculating whether an inter vivos gift triggers gift tax consequences
Whether the transfer is a gift
Whether the amount exceeds the annual gift tax exclusion.
i. The annual exclusion is 11,000 per year per donee. Husband and wife can split the gift and give 22,000 per year per donee.
Gift – A gift is one where the transferor has not received adequate consideration in money and when the transferor has abandoned sufficient dominion and control over the property being transferred to put it beyond recall or the right to demand the beneficial enjoyment of the property.
Retained powers – if the transferor retains the power to revoke, appoint, or change the owner, the transferor has not abandoned sufficient dominion and control over the property so not a gift and the transforer is taxed.
Retained Interests – where the transferor retains an interest in the property, for example, where the settlor is also a beneficiary, the issue is whether the interest is mandatory or discretionary.
Mandatory – where the settlor grants himself a mandatory interest in the property, there is no gift.
Discretionary – where the settlor grants himself a discretionary interest (settlor has delegated nearly complete or limited discretion to the trustee to decide when and how much income or property is distributed to the beneficiary) in the property in trust, the issue is how discretionary the trustee’s discretion is:
i. Ascertainable standard: where the trustee’s discretion is governed by an express ascertainable standard, no gfit has been made for tax purposes
ii. Unfettered discretion majority view – when the trustee has an unfettered discretion it isstill not a gif for tax purposes b/c the creditors of e settlor can force the trustee to exercise his discretion in favor of the creditors.
iii. Holz v. Comissioner – Settlor created an inter vivos trust and retained a life estate. The trustee had a mandatory duty to pay the income to the settlor for life and the trust gave the trustee the discretion to invade the principal for the settlor’s benefit for welfare, comfort, emergency needs. Not a complete gift because the inclusion of the standard of guidance for the trustee meant that the standard was not truly discretionary.
1. ex – O transfers property in trust to pay the income to her son A for life and on A’s death to pay the principal to A’s daughter B. O retains the power to revoke the trust. B/c O retains the power to revoke the trust during O’s life the income from the trust property is taxed to O whether the income is paid to O or to A.
2. If the donor can revoke a transfer only with the consent of an adverse party, a taxable gift has been made. Ex – O transfer property in trust to pa the income to A for life and on A’s death to distribute to the principle to B. O retain e power to revoke or amend the trust with the consent of A so a taxable gift has been made.
3. Disclaimer – the party disclaiming is not treated as having made a gift as long as the disclaimer is valid: need to be in writing, is executed within 9 months of the party receiving the property interest, the disclaiment accepted no interest in the disclaimed property prior to disclaiming it and the disclaimant doesn’t designate to whom the disclaimed property is to go to.
Income Tax – if O buys land for 50,000 and sells it for 75,000 the gain of 25,000 is subject to income taxation.
i. Ex P. 857 – O purchases 100 shares of IBM common stock for $50 per share. Over the years the stocks value increases to 150/share.
1. If O sells the stock for 150 per share what are the income consequences – have to pay $100/100 shares
2. If O gives the stock to his son A and the A sells the stock for 150/share then A has to pay the tax on 100/100 shares.
3. If O dies leaving a will that bequeaths the stock to A and then A sells the stock for 150/share then A gets a stepped up basis which is the date of death value.
Gift tax annual exclusion
Each donor can give up to 11,000 a year to a donee before the gift is considered a taxable gift.
i. Tuition and medical bills – unlimited exclusion for money paid towards these by one individual on behalf of another. These must be paid directly to the providers.
ii. Gifts made to charity and spouses are generally deducted in computing taxable gifts.
iii. Future interests – where a donor makes a gift of a future interest, no part of the gift qualifies for the annual gift exclusion. The present value of the future interest is subject to the gift tax analysis.
iv. Gift to a minor – the gift to a minor does not constitute a gift of a future interest and therefore qualifies for the annual gift exclusion as long as the property is given to the minor despite his age, the property is given to the guardian for the minor or the property is used for the minors current benefit.
v. Right or power to receive trust property – when a trust beneficiary is not receiving at least trust income presently, there is no present interest and therefore, no annula exclusion.
1. However, if the trust contains a provision that allows the beneficiary to immediately demand at time of contribution to the trust, a certain dollar amount (annual exclusion amount) then for gift tax purpose this is deemed to be a present interest and therefore qualifies for the annual exclusion to the donor.
2. It does not matter if the beneficiary actually exercises his or her right of withdrawal but rather that he or she has the right to do so.
3. Estate of Crisofani v. Comissioner – The grandchildren have no right to immediate possession of the property and therefore they would not qualify under 2503.
a. However, every time a contribution was made the children and the grandchildren were allowed to withdrawal up to the principal amount of the annual gift tax exclusion which is 11,000 for fifteen days after the contribution. The grandchildren got notice of their right to withdrawal so they had a present interest and would qualify as a 11,000 gift exclusion. Didn’t matter that the grandkids were too young to withdrawal.
i. They had a presently exercisable right of withdrawal which constituted a present interest in the property which qualified for the annual gift tax exclusion.
III. Federal Estate Tax
3 steps to calculating the estate tax
the trustees. The trust provided that 80% of the income was payable to the son but the trustees had absolute discretion to increase the amount of income in case of changed circumstances etc. Gave trustees unusually broad investment powers. The settlors retained power over the property in trust warranted including it in the settlors gross estate.
a. Giving broad administrative powers to the trustee is a problem if the settlor is a trustee or could be a trustee.
Revocable transfers – if the transforer retains the power to revoke, appoint or modify who has the right to enjoy the property or when a party has the right to enjoy the property, the property is includible in the transferors gross estate.
i. If the transferor retained such power but released it within 3 years of the transferors death the property is still includible in the transfers gross estate.
ii. If the power to revoke or modify is given to a third party, friendly or adverse the property is not includable in the transferors gross estate
iii. P. 888 Problem 1 – O transfers property to first national bank in trust to pay the income to O’s daughter, A for life and on A’s death to pay the trust principle to O’s granddaughter B. The trust is irrevocable. O retains the power to invade the corpus for the benefit of B. It is part of O’s gross estate b/c he has the ability to go in and not give anything to A.
1. Problem 2 – O has no power to invade corpus but retains the power to direct that all or a portion of trust income be accumulated and added to corpus. Whole trust goes into the gross estate of O.
Powers relinquished and transfers made within three years of death – when an individual retained a power to revoke, alter, amend, retained for life to enjoy trust income or determine who gets the trust income or certain retained versionary interests, relinquishes these powers and dies within 3 years, it treats it as though they did not relinquish these powers and includes the property in their gross estate.
i. Problems P. 891
1. your client a 72 year old widow with a 5 million dollar estate has been diagnosed as having terminal cancer. Her present will leaves her entire estate to her two children in equal shares. The client has a daughter, a son, two in law and five grandchildren what advice do you give?
a. Could tell her to give it to charity. So give 3 million to charity and then avhe to pay estate tax on 2 million but have the 2 million estate tax deduction.
2. same clients will includes a bequest of 50,000 to her alma mater. Is there any advantage in the clients making the 50,000 gift to the alma mater during her life in lieu of the testamentary gift?
a. If she makes it during life she will get an income tax deduction for that year as well.
3. A enters the airport preparing to take a trip on an airplane. At a machine selling insurance A busy a life insurance policy for the trip payable to B. Should have B as the owner of the life insurance.
Powers of appointment – if the decedent held a general power of appointment (gives the beneficiary the ability to appoint who will receive the property) when he died testamentary or inter vivos, that was created by another, the property subject to the power is included in the decedent’s gross estate. If he held a special power of appointment, (gives a more specified group of people that the property should go to such as descendants) the property is not included in the donee’s gross estate even if the donee exercises that power
1. Ex – H’s will creates a testamentary trust providing for the payment of trust income to H’s wife W for life and on her death to pay the trust principal to such person’s as W appoints by her will. On W’s death the value of the trust corpus is includable in her gross estate b/c she had a general power
Ex – H’s will creates a testamentary trust providing for the