Estate Planning Outline
Johanson Spring 2008
The Estate Tax (Ch 12)
I. Overview of what is includable in the gross estate
a. §2033 – property owned at death
b. + §2035 – certain transfers within 3 years of death (ie life insurance policies)
c. + §2036 – transfers with a retained life estate or retained control
d. + §2037 – transfer taking effect at death
e. + §2038 – revocable transfers
f. + §2039 – annuities and employee death benefits
g. + §2040 – property passing by right of survivorship
h. + §2041 – general powers of appointment
i. + §2042 – life insurance
j. + §2043 – transfer for a partial consideration
k. + §2044 – QTIP transfer for which marital deduction was previously allowed
l. = Gross estate
II. General Issues
a. Marital property (property acquired from the earning of either spouse during marriage)
i. In common law states only the decedent’s property gets a step up in basis
ii. In community property states, the entire estate gets a step up in basis
III. Property Passing by Right of Survivorship (ROS) – §2040
a. Survivorship estates between persons other than spouses (§2040(a))
i. Gift Tax: look at how interest is created. If A purchases a house but then takes title as “A and B, joint tenants” then A has made a gift of ½ of the purchase price to B
ii. Estate Tax: Consideration furnished test – all property passing by ROS is includible in the gross estate to the extent that the decedent furnished the consideration for the property’s acquisition.
1. Burden of proof on executor to show that any of the amount on deposit was someone else’s money
2. Basis – be careful! Only fraction attributable to decedent gets a stepped-up basis at death
a. With lifetime gifts, there is a carryover basis. Donee gets donor’s basis in the gift (§1015)
b. TIP: hold substantially appreciated assets ‘til death so that increase in value will be wiped out when you transfer it
b. Survivorship Estates between spouses
i. Gift Tax: no gift tax concerns here if gifted when married
ii. Estate Tax: ½ the value of the property is includible in the estate of the first spouse to die, regardless of which spouse furnished the consideration when it is a qualified joint interest between spouses*
1. Qualified joint interest is a tenancy by the entirety or a joint tenancy w/ ROS, but only if the decedent and the spouse are the only joint tenants (§2040(b)(2))
2. *Note: consideration furnished test applies to survivorship estates b/w spouses that were created pre-1976
iii. Security interests with a note that still has a balance (mortgage)
1. Only ½ of the loan balance is deductible in decedent’s estate under §2053
iv. Basis – §1014 dictates
1. Common law states – decedent’s ½ interest gets a stepped-up basis, SS’s basis stays the same
a. TIP: W can gift ½ interest to H and H can give it back to her in his will (since he gives it back at death, property gets a stepped up basis) – as long as H doesn’t die within the year
2. Community property states[1]- the entire interest gets a step up in basis under §1014(b)(6) even though only ½ is includible in gross estate for FET
3. Basis in property given to decedent within 1 year of death
a. If H dies w/in 1 year of the transfer, there is no step up in basis since the gift goes back to donor or donor’s spouse – §1014(e)
i. If he lives one year and one day, step up!
b. SO H should leave it to someone besides his W (ex. daughter) – then step up in basis!
4. For depreciated assets: if the carry-over basis is greater than the FMV, then for purposes of determining basis for a loss, basis equal the asset’s FMV at the time of gift §1015(a)
c. Tenancy by the entirety
i. Non-servable (unlike JTWROS)
ii. Only exists between spouses
d. Federal Gift Tax – Difference b/w real estate and a bank account
i. When purchase real estate, gift is complete
ii. When have money in joint account, gift not complete b/c the donor can still withdraw
e. Federal Estate Tax – Difference between joint tenancies and tenants in common (if one T bought it)
i. Joint tenants
1. EX: C buys 40K in stock, taking title as C&D, joint tenants
a. After Annual Exclusion (20K – 12K), taxable gift of 8K to D
b. C dies, stock worth 60K
i. All 60K incl in C’s GE b/c of consideration furnished test
ii. No adjusted taxable gifts inclusion b/c trumped by FET
ii. Tenants in common
1. EX: A buys 40K in stock, taking title as A&B, Tenants in common
a. After AE, taxable gift of 8K to B
b. A dies, worth 60K
i. Although A furnished all consideration, made a taxable gift so only ½ is hers
ii. 30K incl in A’s GE, 8K ATG comes back in
IV. Transfers within 3 years of death – §2035
a. Transfers of life insurance
i. If decedent owned life insurance and gifted it within 3 years of death, entire amount of proceeds includable in his GE
ii. Taxable gift of cash surrender value
1. But if transferor dies within 3 yrs, this amount is not included in ATG b/c otherwise included in GE under §2035
iii. But even if T dies w/in 3 years, Silverman gambit applies. (*Silverman only an issue if D dies w/in 3 yrs)
1. Transfers of life insurance policy in which the beneficiary makes payments of premiums are entitled to pro rata reduction in the gross estate inclusion
a. If policy was owned for 10 years, 7 by decedent and 3 by daughter then only 7/10 of the policy is includible in decedent’s GE
2. Effective even if transfer w/in the 3 year period
3. The younger the policy the better b/c greater pro rata reduction per premium payment
iv. *If annually renewable term life insurance that is guaranteed renewable and guaranteed convertible, consider converting to a cash value policy before the assignment since the assignee will then pay higher premiums and increase the pro rata portion of premiums paid after the assignment.
b. Gift Tax
i. Gross up rule – gift taxes paid on gifts within 3 years of death are brought back into the estate
ii. Designed to eliminate the DuPont effect. If gift of 10M, had to pay 15M including taxes so able to deplete estate of 15M w/ a 10M taxable gift. Also removes appreciation from estate.
V. Lifetime transfers with Retained Interests or Controls (§2036 and §2038)
a. “Retained”- retained for life, or any period not ascertainable without reference to his death or for any period which does not in fact before death
b. Note: interaction between §2036(a)(2) and §2038
i. Control over beneficial enjoyment- §2036(a)(2)
1. Where transferor retains right to designate persons who get income or property from trust then the entire trust is includable
ii. Revocable transfers- §2038
1. Where grantor retains discretion as to corpus – in this case only the amount to which discretion is retained is includable
iii. Ex: Grantor is required to distribute income (no discretion), but has discretion as to corpus to specified B
1. No §2036 inclusion b/c no discretion as to persons
2. BUT there is a §2038 inclusion for corpus (w/o income) b/c §2038 hooks the “discretion as to B”
c. §2036(a)(1)- Transfers in which grantor retains right to income or enjoyment
i. What kind of lifetime gifts can be given to beneficiaries to avoid this provision? Possible solutions below.
ii. Deed of personal residence but continue to live there?- NO, 2036 still applies
1. Court will find an implied retention of a life estate
a. Linderme – D transferred home to 3 sons, it was recorded, but he continued to live there alone until a few months before he died w/o paying rent – included in §2036
i. Court said “if there is an agreement, implied in fact or law [that D will have right to enjoyment], then will look at the facts of the situation, not the paperwork” (substance over form)
2. Grantor lives with grantee after the transfer
a. Married persons (H deeds his ½ of the home to W)
i. Union Planters – court found transfer was not within §2036 b/c even though H continued to live there, it was consistent w/ his role in the relationship
1. If can relate to “a natural incident to the marital relationship” then can make gift w/o GE inclusion.
b. Grantee child and family move in and grantor continues to live there with them
i. Diehl- elderly parent living with adult child – normal for families to live together
ii. BUT Rev Rul 70-155 said government will not follow Diehl and will continue to challenge this as an implied agreement under Linderme
3. BUT even if any of these work under 2036, there will be basis problems
a. Carry-over basis for lifetime transfers so if home given to children and they ever want to sell it there would be a lot of capital gain
i. XX: §121 – exclusion of gain on the sale of a principal residence up to $250K or $500K for married
b. If home is given by bequest, new basis at death
4. Of all of the gifting alternatives, deeding personal residence and continuing to live there is the least attractive
iii. Tenancy in common – RISKY, may only work under specific facts
1. How it would work
a. Deed house to child in fractional share (say $700K house and 1/10 shares)
b. Take fractional discount on each gift (around 20%) so gift will be 56K. With AE, this will be 44K
2. Pros
a. Okay if grantor occupies b/c they are TiC and each TiC has an equal right to occupy
b. If grantor dies owning undivided 9/10 (or whatever fraction) will get a fractional share discount for her estate.
i. Discounts are the game to play right now
3. Cons
a. Grantor will probably pay property taxes and other incidents of ownership.
i. But G has a right to collect from ot
b. Amend
c. Revoke
d. Or Terminate
i. The power to remove trustee and appoint self as trustee triggers this rule
2. OR where any such power is relinquished during the 3 year period ending on the date of decedent’s death
3. Note: even if D had to give some notice before exercising, still held power at date of death so includable
g. Reciprocal Transfers
i. Applies to economic benefits in trust- Grace test examines relative economic status of parties before and after the transaction
ii. Reciprocal trust powers (in §2503(c) trusts)
1. Ex: W creates 2503(c) trust for kids and names H as trustee, and H creates one and names W as trustee
2. Estate of Green is only case we have, and says this is not okay
3. Just name someone else as trustee!
iii. May not apply if transfers that are not identical – but risky so don’t do it!
1. Levy- case dealt with Green reciprocal trust transfers, not Grace reciprocal economic benefits
a. If the transfers are not identical transfers, they may not be held to be reciprocal transfers
iv. No concerns if reciprocal trusts when trusts are not reciprocal at the outset
v. Bottom line: there is no bright line test, but if the parties get around something they couldn’t otherwise do (ie create a GRIT for a member of the family) through reciprocal transfers for nieces then it is not allowed
vi. §2503(c) trusts- includable under §2038 via required terms of 2503(c) if settlor is trustee
1. If settlor is trustee than the has retained power to terminate via the power required by 2503(c) to distribute all principal so is includable
2. Trustee who is not settlor can be given power to distribute all or a portion of the trust without tax consequences- but if transferor has right to remove trustee with this power is includable in power to terminate
VI. Valuation Rules
a. GR: Valuation is the date of death value (willing buyer/willing seller) of the property in the decedent’s estate!
i. If Dad has $1,000 shares of ABC Corp and split between his 3 kids, the shares are valued at their FMV in his GE (although kids may claim minority discounts later when they pass away and shares in their GEs)
b. Alternate Valuation (very rare)
i. GR: Value is normally date of death value (willing buyer/willing seller), BUT
ii. §2032 allows a decedent’s personal representative a 6 month window from the time of death to elect for the valuation either 6 months after death, date of death, or date of sale or distribution (within the 6 months allowed) values can be used
1. Implemented to avoid hardship in rapidly depreciating value estates
iii. BUT §2032 election only allowed only if will reduce value of GE and the amount of FETAND election must be made for ALL assets (no partial elections)
c. Special Use Valuation of Farm and Business Real Property
i. §2032(a) value linked to land’s actual use (not its optimal, highest, or market value)
ii. To qualify:
1. Market value of land + related personal property (equipment and machinery) > 50% of gross estate
2. At least 25% of adjusted value of the GE is qualified farm or closely held business real property
3. Real property must pass to “qualified heir”- member of decedent’s family
4. RP was owned by decedent or a member of the decedent’s family and used or held for use as a farm or closely-held business for 5 of 8 years immediately preceding D’s death
5. There was “material participation” in the operation of the farm of business by decedent or a member of the decedent’s family during 5 yr period
d. Fractional Interest And Minority Interest Discounts
i. Fractional interest – created by giving undivided interests
1. Whitehead – court gave discount half way between what TP was proposing and government was proposing. This is usually how it works
ii. Minority interests – based on “willing buyer, willing seller” test, selling an interest that does not confer control
a. [1] 9 community property states
i. Texas*, California, Idaho*, Washington, Louisiana*, Arizona, New Mexico, Wisconsin, Nevada
1. * Income from separate property is community property
