Taxation of Gratuitous Transfers Outline

Taxation of Gratuitous Transfers
Professor Calfee (Fall 2016)
Problems
Transfer of Property is Key to Estate and Gift Tax
Tax Base x Tax Rate = Tax Payable
Estate tax base is “taxable estate.”
Federal estate tax is an excise tax imposed upon the transfer of property at death.
States also impose estate tax via a state tax (excise tax) or inheritance tax.
Difference is that inheritance tax is imposed on the right to receive property, not the right to transfer property. Inheritance tax rate is determined usually by the relationship of the heir to the decedent.
 
Estate Tax
Tax base is the taxable estate defined in § 2051 as gross estate minus deduction.
Gross estate defined in Code in several sections (§ 2033 – § 2045)
Inter vivos transfers are attempt to avoid estate tax, but the gift tax prevents this avoidance.
Gift tax – Tax on transfer of property by completed gift
Exclusions under § 2503(b) – Annual exclusion
Total amount of gift is reduced by deductions is the taxable gifts.
Multiply by § 2502 rate table
Generation skipping transfers are also an attempt to avoid estate tax. Estate or gift tax is imposed when a trust is established where distribution of remainder can result in estate or gift tax to the remaindermen.
Intermediate levels of beneficiaries will escape estate and gift taxation because there is no transfer of property. Result is GST tax – Either a taxable termination or a taxable distribution
 
Problem 1
(1) T, never having made any prior gifts, made taxable gifts of $6M in 2013. T died in current year, leaving a taxable estate of $5M. In 2002, G created a trust, the income to be paid to G’s child T for life, remainder to T’s child R. At T’s death, the remainder of the trust, valued at $4M, K was paid over to R.
(a) Under § 2502 and § 2505, what is T’s gift tax liability for 2013?
1. Determine the Tentative Tax
§ 2501 – Transfer of Property by Gift minus § 2503(b) Annual Exclusion = Total amount of gifts
Annual exclusion is $14,000 in 2016.
§ 2503 – Total amount of gifts – Deductions (§§ 2522, 2523) = Taxable gifts
§ 2503(e) – Any qualified transfer is not treated as a transfer of property by gift (tuition, medical bills / expenses)
§ 2502(a) – Computation of Tax:
§ 2502(a)(1) – Tentative tax on all taxable gifts for current calendar year plus tentative tax on gifts in prior years [current + prior] OVER
§ 2502(a)(2) – Tentative tax on all taxable gifts for prior years [prior] Current taxable gifts ($6M) – Prior taxable gifts ($0M) = $6M
§ 2001(c) – $6M goes into the rate table. The first $1M has a tax of $345,800. The remaining $5M is taxed at 40%, which is $2M. Tentative tax on prior and current gifts under § 2001(c) is $2,345,800.
 
2. Determine the Actual Tax by Accounting for Credit
§ 2505 – Tax credit on the § 2013 gift tax
§ 2505(a) – Credit for § 2501 tax for US citizen or resident equal to applicable credit under § 2010(c) ($5M) reduced by sum of all credits for prior years.
§ 2010 – Plug in the applicable exclusion amount into the § 2001(c) rate table to calculate the tax on the applicable exclusion payment. The basis exclusion is $5M subject to an inflationary adjustment.
§ 2010(c)(2) – Sum of basic exclusion amount plus surviving spouse deceased spouse unused exclusion.
In 2016, $5M adjusted for inflation is $5.45M.
Plug $5M in § 2001(c) rate table. The first $1M is taxed at $345,800. The additional $5M is taxed at 40% (40% x $4M), which is $1.6M. The tax credit will be $1,945,800.
Determine tax under § 2001(c) – Reduce the tentative tax ($2,345,800) by the credit ($1,945,800).
The total tax owed is $400,000.
 
Additional Questions
Who pays the gift tax?
§ 2502(c) – Donor pays the tax (Use Form 709 to pay the gift tax. It is filed annually).
What if the donor does not pay the gift tax?
§ 6324(b) – If gift tax is unpaid, there is a lien on the gift made during the period for which the return was filed for 10 years from the date the gift was made.
If the gift is not paid, the donee of any gift is personally liable to the extent of the value of the gift. IRS can come after a donee whose gift was not subject to tax (annual exclusion gifts) for the gift taxes owed on another gift.
It does not matter whether the donee’s gift was taxable. They will still be liable for the unpaid gift tax.
§ 6019 – Gift tax return is due when a transfer described in the section is made.
If gift is less than the annual exclusion ($14,000 to as many people under § 2503), no return is required.
If the gift is to a spouse (§ 2523 marital deduction), no return is required.
If the gift is to a charity (§ 2522 charitable deduction), no return is generally required.
When to file the tax return?
§ 6075(b) – Time for filing gift tax returns under § 6019 must be filed on or before April 15th following the close of the calendar year.
(b)(2) Exception – If TP is granted an extension for filing income tax return, the extension extends to the gift tax return, and there is automatic extension to file income tax return (6 months).
(b)(3) – Need to coordinate gift tax return with estate tax return (706 is due 9 months after date of decedent’s death). If due date of estate tax return before normal due date for gift tax, the gift tax return is accelerated.
Decedent dies 1/1/2016 à Due 10/1/16
Gift made 1/1/2016 à Normally due 4/15/17, but it is accelerated to 10/1/16
§ 6081 – If need extension for gift tax but not income tax, secretary may grant a reasonable extension of time for filing any return (must not be more than 6 months). No form is needed and must write a letter to where you file return.
§ 6161 – Extension of time to pay tax à Secretary may extend time to pay for a reasonable period not to exceed 6 months. The extension to file does not include an extension of time to pay. TP will be required to pay interest for the extension.
Basis in gift (§ 1015) – Donee receives a carryover basis from the donor unless there is a built in loss (if BIL, FMV basis)
§ 1015(d) – Increase in basis up to the amount of FMV for the amount of gift tax paid
If property appreciates from 3M to 6M, there is an increased basis for gift tax paid.
3M (1015a) + gift tax (1015(d)) of 400,000
 
Problem – $1M FMV and $400,000 tax paid
§ 1015(d)(6) – Gifts made after 12/31/76 get increase in basis of the amount of the gift that is attributed to the unrealized appreciation. The increase in basis with respect to any gift for the gift tax paid shall be an amount which bears the same ratio to the amount of tax so paid as net appreciation in value of gift bears to amount of tax.
If 3M worth of unrealized appreciation, the tax is (1/2), which is limited to 200,000 under § 1015(d)(6).
$400,000 x $5M/$6M = $332,000 à Basis = $1M + $332,000 = $1,332,000
§ 1015(d)(6)(B) – Net appreciation is amount by which the FMV of the property exceeds the basis in the property.
 
Problem – $6M where AB is $12M
Basis is FMV for purposes of determining loss (6M) even though the AB is 12M.
 
(b) Determine estate tax payable on T’s death in current year, using § 2001 computation and § 2010 credit amount.
Taxable estate is $5M
§ 2001(b) – Amount of estate tax equals the excess of tentative tax computed under (c) on the sum of the amount of the taxable estate and the adjusted taxable gifts over the aggregate amount of tax paid with respect to the gifts.
Taxable Estate + Adjusted taxable gifts ((b)(2) flush language – Total taxable gifts made after 12/31/76 that are not included in gross estate) = 5M + 6M
§ 2001(c) rate table – In current year, the maximum rate is 40%.
For the $11M, the tentative tax on first $1M = $345,800 and 10M at 40% = 4M = 4,345,800
Total ($2,345,800 + excess of $11,000,000 over $6,000,000 x 40% = $4,345,800)
Tentative estate tax – $4,345,800
§ 2001(b)(2) – Subtract from the tentative estate tax the gift tax which would have been payable under the § 2001(c) rates (keeps the rate reductions from being retroactive and only allows credit for current rate gift tax).
Use rates in effect when the person died, not the rates paid when the gift was made.
Use the unified credit in effect at the time the gift was made, not the unified credit at the time of death
§ 2001(b)(2) = $400,000
$4,345,800 – $400,000 = $3,945,800 tentative tax
§ 2010 credit amount (unified credit) – § 2010(c) sets amount of the applicable exclusion (5M).
Take the applicable exclusion and use it to compute the unified credit.
The exclusion amount for current year is $5,000,000 – Multiply by § 2001(c) rates to get $1,945,800 for the applicable credit amount. This is the unified credit and gives an estate tax of $2,000,000 ($3,945,800 – $1,945,800).
 
 
 
Additional Notes
Who pays the estate tax?
§ 2002 – The executor is liable for paying the estate tax.
§ 2203 – An executor is the executor or administrator of the decedent OR if no executor or administrator appointed, then any person in actual or constructive possession of any property of the decedent (no formal appointment necessary, but “executor” is required to pay the tax).
§ 6161 – Extension of time to pay the estate tax, but must pay interest on the amount.
 
Who bears the burden of the estate tax? Not going to be tested.
§ 2205-§ 2207A – Liability for estate taxes (apportionment) where each starts with “where not otherwise provided by will.”
In many cases, the residue of the decedent’s estate bears the burden. Every state has state apportionment (733.817), and federal apportionment statutes (§ 2206).
§ 2206 – If insurance person does not want to pay taxes, you should have decedent provide for it in the will.
§ 2207 “Liability of recipient of property over which decedent had power of appointment”
§ 2207A “Marital Deduction Property” –
 
When are we required to file a federal estate tax return? Not going to be tested.
§ 6018 “Estate tax returns” – When gross estate at death of a citizen or resident exceeds the basic exclusion amount under § 2010(c) for the calendar year which includes the date of death, the executor must file a return.
When estate tax return must be filed and if in doubt, file a return to start the statute of limitations.
If gross estate of $5.4M, you do not need to file a return, but can filing start the SoL?
§ 6075 – Must file estate tax return within 9 months of the date of decedent’s death.
§ 6081 – Extension of time to file taxes
§ 6161 – Extension of time to pay but have to pay § 6621 tax rate
§ 6166 – Extension of time for payment of estate tax where estate consists largely of closely held business interest
10-year installment plan if interest in closely held business exceeds 35% of the gross estate, which can be deferred for 5 years (total of 14 years).
§ 6166(a)(3) – First payment is made on or before 5 years from the date of death
§ 6601(j) – 2% rate on estate tax extended under § 6161
2% plus interest on amount exceeding 2% portion shall be paid at a rate equal to 45% of annual rate.
Part of deferred liability has interest computed at 2% (first $1M computed after application of exclusion amount) and rest of deferred liability has interest computed at 45% of the § 6601(a) rate.
$1,480,000 is the inflation adjustment under the Rev. Proc à Multiply by 40% = $592,000
§ 6601(a) rate is the federal short term rate under § 6621 + 3%
 
(c) Are the taxable gifts being taxed twice?
No, the aggregation of gifts causes the estate to be taxed at a higher rate, but the gifts are not taxed twice because they are removed from the computation when computing the estate tax.
In year of death, if estate tax return is due before income tax return, it will accelerate the due date of the income tax return.
 
(d) Proper computations in (a) and (b) make use of applicable credit amount. Is credit allowed twice?
No, you are NOT getting credit twice because pay estate tax (2M) and gift tax (400,000), so that is a total of 2.4M in tax. If 11M (estate) and take off 5M (excluded), which gives 6M subject to tax = 6M x 40% = 2.4M
Only got it once because it was $400,000 that you got credit for (§ 2001(b)(1)(B), not total amount of tax.
 
(e) Using an inclusion ratio equal to one and a taxable amount equal to the value of the remainder interest, what is the amount of tax imposed on the taxable termination GST that occurs upon T’s death?
§ 2602 – Amount of the tax imposed by § 2601 is the Taxable Amount ($4M) x Applicable Rate.
§ 2641 – Applicable rate is maximum federal estate tax rate (40%) x inclusion ratio (1)
$4,000,000 x 40% = $1,600,000
§ 2631 – Exclusion amount equal to the applicable exclusion amount for federal estate tax purposes
If $5M taxable estate, there is AB in hands of decedent (3M) with FMV (5M) at death.
§ 1014 basis of property acquired from decedent is FMV of property at date of death, so donee will have $5M basis (extinguishes the built in gain). If $10M AB and $5M FMV, there is a lurking loss that would be lost at disposition.
 
 
 
 
§ 1014 Basis
(a)(1) FMV of property at the date of decedent’s death
(a)(2) In case of § 2032, its value at the applicable valuation date.
(a)(3) In case of § 2032A, its value determined under such section.
(a)(4) To the extent of applicability of exclusion in § 2031(c), the basis in the hands of decedent
 
(c) § 1014(a) does not apply to property which constitutes a right to receive an item of income (IRA) in respect of a decedent under § 691.
 
(e) If appreciated property was acquired by the decedent by gift during the 1-year period ending on the date of the decedent’s de