The Federal Gift

1
Chapter 17

• The Federal Gift
• and Estate Taxes

2
Transfer Taxes (slide 1 of 2)

• Federal law imposes a tax on the gratuitous
  transfer of property in one of two ways
• Estate tax
• Gift tax

3
Transfer Taxes (slide 2 of 2)

• Estate tax
• Imposed on decedents entire estate
• Tax on the right to pass property at death
• Gift tax
• Tax on inter vivos (lifetime) transfers for less
  than full and adequate consideration
• Payable by the donor

4
Tax Relief Reconciliation Act of 2001

• Made substantial changes to the unified transfer
  tax
• Lowered top tax rates applicable to estates and
  gifts
• Effectively eliminates the estate tax by 2010 but
  retains the gift tax
• For budget reasons, eliminates all changes made
  by the Act after 12/31/2010
• Referred to as a sunset provision

5
Formula for the Federal Gift Tax

• TOTAL GIFTS to which the gift tax might apply
• Gift tax deductions (charitable and marital
  deductions)
• Annual exclusions
• Taxable gifts made this year
• Taxable gifts made in all prior years
• Total taxable gifts
• Tax on total taxable gifts
• Tax paid or deemed paid on past taxable gifts
• Unified transfer tax credit
• Gift tax payable this year

6
Formula for the Federal Estate Tax

• Gross Estate
• Deductions Expenses, indebtedness,
• taxes, losses, charitable bequests, marital
  deduction, state death taxes
• Taxable Estate
• Taxable Gifts Made after 1976
• Taxable base
• Tentative Transfer Tax Consult Rate Schedule
• Gift Taxes On post-1976 gifts
• Tax Credits Including the unified tax credit
• Estate Tax Due On Taxable Estate

7
Unified Tax Credit (slide 1 of 3)

• Allows donors and decedents to transfer modest
  amounts of wealth without being subject to gift
  and estate taxes
• Exemption equivalent is amount that can be
  transferred tax-free through the unified tax
  credit

8
Unified Tax Credit-Applicable Only to Gift Taxes
(slide 2 of 3)

• The Tax Relief Reconciliation Act of 2001 froze
  the unified transfer tax credit applicable to the
  gift tax at 345,800
• This is the exemption equivalent of 1 million
  that can be transferred tax-free

9
Unified Tax Credit-Applicable Only to Estate
Taxes (slide 3 of 3)

• Year Credit Exempt. Equiv
• 2003 345,800 1,000,000
• 2004, 2005 555,800 1,500,000
• 2006, 2007,
• 2008 780,800 2,000,000
• 2009 1,455,800 3,500,000
• 2010 Estate tax repealed

10
Valuation for Estate and Gift Tax Purposes
(slide 1 of 2)

• The value of property on date of transfer
  generally determines the amount subject to gift
  or estate tax
• Under certain conditions, however, an executor
  can elect to value estate assets on the alternate
  valuation date
• Six months after death or
• On the date of disposition if this occurs earlier

11
Valuation for Estate and Gift Tax Purposes
(slide 2 of 2)

• The alternate valuation date election is not
  available unless
• The estate must file a Form 706 (Estate Tax
  Return), and
• The election decreases the value of the gross
  estate and the estate tax liability

12
Key Property Concepts

• When property is transferred by gift or death,
  form of ownership can have a direct bearing on
  transfer tax consequences
• Undivided OwnershipCan fall into any of four
  categories
• Joint tenancy
• Tenancy by the entirety
• Tenancy in common, or
• Community property
• Partial InterestsInterests in assets can be
  divided in terms of rights to income and principal

13
Gift Tax (slide 1 of 3)

• Persons subject to tax
• Citizen or resident of the U.S. on all transfers
  by gift of property wherever located
• Nonresident alien, if the gifted property was
  situated in the U.S.

14
Gift Tax (slide 2 of 3)

• Requirements for a gift
• The donor is competent to make the gift and the
  donee is capable of receiving and holding the
  property
• Donative intent of the donor
• Actual or constructive delivery of property to
  donee or donees representative and acceptance of
  gift by the donee

15
Gift Tax (slide 3 of 3)

• A transfer is not a gift if the transfer is
  incomplete
• e.g., Funds may be transferred to a trust
• If terms of the trust allow the transfer to be
  revoked for any reason, the transfer is not a gift

16
Excluded Transfers

• Federal gift tax does not apply to
• Transfers to political organizations
• Tuition payments made to an educational
  organization on anothers behalf
• Amounts paid on anothers behalf for medical care

17
Annual Exclusion

• The first 12,000 of gifts made to any person
  during any calendar year is excluded in
  determining the total amount of gifts for the
  year
• Applies to all gifts of a present interest
• Spouses may elect to split gifts
• e.g., Allows one spouse to give 24,000 to each
  donee during a year, even if the assets were only
  owned by one spouse. Allows gift to be treated
  as being made 1/2 by each spouse eliminating any
  transfer tax on the gift

18
Gift Tax Example(slide 1 of 4)

• During the current year, Jane and Harry, a
  married couple, make the following transfers in
  2007
• 22,000 cash to son Hal
• 20,000 tuition for daughter Beth
• 60,000 to the American Diabetes Foundation, a
  qualified charity
• 10,000 to the Young for Governor campaign
• 200,000 to a revocable trust for the benefit of
  their two children
• 30,000 for medical care and medical insurance
  for Janes mother
• 60,000 car to Harrys brother, subject to a
  liability of 30,000

19
Gift Tax Example (slide 2 of 4)

• Which of these transfers are treated as gifts for
  gift tax purposes?
• What is the amount of taxable gifts for the year
  if Jane and Harry elect to split gifts?

20
Gift Tax Example (slide 3 of 4)

• Several of these transfers are not included in
  gross gifts
• The 20,000 tuition payment, 30,000 medical care
  and 10,000 political contribution are not gifts
  by definition
• The 200,000 transfer to the trust is not a
  completed gift since the trust is revocable
• The car transferred to Harrys brother is 50 a
  sale for 30,000 (amount of liability) and 50 a
  gift of 30,000. Harry may have taxable gain
  (for income tax purposes) on the 30,000 sale

21
Gift Tax Example(slide 4 of 4)

• Taxable Gifts calculation
• Cash to Charity 60,000
• Cash to Hal 22,000
• Car to Harry's brother 30,000
• Total gross gifts 112,000
• Less charitable deduction (60,000)
• Less annual exclusion (12,000 each for
• Harry and Jane, for each donee (Harry's
• brother and their son Hal)) (48,000)
• Taxable gifts 4,000

22
Gift Tax Example 2 (slide 1 of 5)

• Mel (an unmarried individual) made the following
  transfers during 2007
• Child support payment for son Marvin 25,000
• Qualified transfer in trust for Marvin, age 12
• (Marvin has no access to the funds until he
  is 21, but funds may be used on his
  behalf) 450,000
• Transfer of stocks to an irrevocable trust. Mel
• retains the income for his life. His mother
  will
• receive the principal on Mels death. Assume
• the income interest value is 140,000 and the
• remainder value is 60,000. 200,000

23
Gift Tax Example 2 (slide 2 of 5)

• Mel made prior taxable gifts of 750,000 and paid
  55,500 tax
• What is Mels 2007 gift tax liability?

24
Gift Tax Example 2 (slide 3 of 5)

• Taxable gifts in 2007
• Transfer in trust for Marvin 450,000
• Transfer in trust for mother 60,000
• Total current taxable transfers 510,000
• Less annual exclusion 12,000
• Current taxable gifts 498,000
• Prior taxable gifts 750,000
• Total taxable gifts 1,248,000
• Tax Liability
• Tax on taxable gifts 447,480 Less Prior
  gift tax paid 55,500 Less Unified credit
  345,800
• Net Tax Due in 2006 46,180

25
Gift Tax Example 2 (slide 4 of 5)

• Comments regarding gift tax calculation
• Child support payments are not a gift for gift
  tax purposes in most cases
• The transfer in trust for Marvin qualifies as a
  present interest under 2503
• The 12,000 annual exclusion is available for
  this transfer

26
Gift Tax Example 2 (slide 5 of 5)

• The transfer in trust for Mels mother is a
  completed transfer since the trust is irrevocable
• Only the remainder interest is a gift since Mel
  keeps the income interest for his life
• This is a gift of a future interest
• The 12,000 annual exclusion is not available

27
Gross Estate (slide 1 of 3)

• The Gross Estate includes all property owned by
  the decedent subject to the Federal estate tax,
  valued at FMV, including the following
• Personal effects, jewelry, furniture
• Stocks, bonds and other investments
• Rights to receive dividends or interest (if
  accrued at the date of death), and
• The value of businesses owned by the decedent

28
Gross Estate (slide 2 of 3)

• The Gross Estate includes the proportionate value
  of any asset owned by a decedent and another
  person, if both parties paid
• e.g., A decedent jointly owns a boat with his
  son. Both parties paid one-half the initial
  purchase price.
• Only one-half the value of the boat is included
  in the Gross Estate

29
Gross Estate (slide 3 of 3)

• Asset values are determined at
• The date of death, or
• The alternate valuation date (AVD), 6 months
  later, if elected by the executor
• AVD must reduce gross estate and estate tax
  liability if used

30
Adjustments for Gifts Within 3 Years of
Death2035 (slide 1 of 2)

• The Gross Estate includes any gift tax paid on
  gifts made within three years of death
• Called the gross-up procedure
• Prevents the gift tax amount from escaping the
  estate tax

31
Gifts Made Within Three Years of Death 2035

• Gifts made within three years of death no longer
  are included in the gross estate of the donor.
  They are, instead, treated the same way as any
  other post-1976 taxable gift
• It continues to apply to gifts of interests that
  otherwise would be covered by  2036 (transfers
  with a retained life estate),  2037 (transfers
  taking effect at death), 2038 (revocable
  transfers), and 2042 (proceeds from life
  insurance)  2035(a)(2).

32
Adjusted for Gifts Within 3 Years of Death2035
(slide 2 of 2)

• The Gross Estate also includes the following
  property interests
• Transfers with a retained life estate
• Transfers taking effect at death
• Revocable transfers
• Proceeds of life insurance

33
What Is a Trust?

• Not defined in Code
• Usually refers to an arrangement created by a
  will or by inter vivos (lifetime) declaration
• Trustee takes title to property for purpose of
  protecting or conserving it for beneficiary
• Used to achieve various financial and other goals

34
Structure of Typical Trust
35
Powers of Appointment

• A power to determine who shall own or enjoy,
  presently or in the future, the property subject
  to the power.
• Typically, property will be transferred to a
  trust, giving an individual a life estate, and
  someone is given the power to appoint the
  remainder interest during his or her life or
  through a will.

36
Powers of Appointment

• General powers of appointment allow the holders
  the right to appoint the property to themselves
  without restriction.
• Special power of appointment limits the holder to
  a specified group of appointees none of which
  includes himself or herself

37
General Power

• Its tantamount to actual ownership (especially
  when couple with a life estate)
• If the holder appoints another person, it is
  treated like a taxable gift.
• But, if a decedent holds a general power over
  property at his or her death, the value of the
  property must be included in the gross estate.

38
Section 2036 Retained Life Estate

• The value of property given away by the decedent,
  but to which the decedent retained the propertys
  income or the right to designate who may possess
  or enjoy the property, shall be included in the
  decedents gross estate.

39

• Example. Jean creates a trust, life estate to
  Betty and Al, and remainder to Alice. Jean,
  however, retains the right to determine how the
  income from the trust will be allocated between
  Betty and Al.
• Example. Jean creates a trust, life estate to
  Betty and Al, and remainder to Alice. Jean,
  however, reserves the right to decide whether the
  income is to be distributed to Betty and Al or
  accumulated and added to corpus (for the benefit
  of Alice).
• In both of these examples, the trust is included
  in Jeans gross estate upon death. Under
   2036(a)(2), Jean possesses the right, either
  alone or in conjunction with any person, to
  designate the persons who shall enjoy the
  property or the income there from.

40
Life Insurance Gift Tax

• The rules involved are summarized below.
• a. Olga purchases a policy on her life and
  designates Norman as the beneficiary thereof. No
  gift takes place.
• b. Under a. above, Olga dies and the proceeds of
  the policy are paid to Norman. No gift occurs as
  the proceeds pass to Norman by testamentary
  transfer.
• c. Under a. above, Olga gives the policy to
  Norman. A gift occurs. See Example 57 in the
  text. (The measure of the amount given is
  discussed in Chapter 18.)
• d. Under c., Olga continues to pay the premiums
  on the policy. Each premium payment is a gift
  (Example 57).
• Olga owns an insurance policy on the life of
  Norman with Tom as the designated beneficiary.
  Upon Normans death, the proceeds of the policy
  are paid to Tom. Olga makes a gift to Tom
  (Example 58).

41
Life Insurance Estate Tax

• Gross estate includes the proceeds of life
  insurance if
• They are receivable by the estate
• They are receivable by another for the benefit of
  the estate
• The decedent possessed an incident of ownership
  in the policy

42
Joint Interests

• Tenancies in common and community property
• Taxes the portion included in the estate
• Example. At the time of his death, Errol has a
  one-fourth interest as a tenant in common in real
  estate worth 400,000. Presuming the alternate
  valuation date is not elected, 2033 causes
  inclusion in Errols gross estate of 100,000.

43
Joint Interests- joint tenancies and tenancies by
the entirety.

• Nonspousal
• Full value of the property is included in the
  gross estate of the first tenant to die (but see
  below).
• If the surviving tenant proves that he or she
  contributed to the cost of the property, a pro
  rata portion of the value is not included in the
  gross estate of the deceased tenant. For this
  purpose, however, the use of funds received as a
  gift from the deceased tenant does not constitute
  a contribution. Example 43
• If property is received by gift or inheritance by
  a third party, each tenant is deemed to have
  contributed an equal share of the cost of the
  property (Example 44).

44
Joint Interests- joint tenancies and tenancies by
the entirety

• Spousal
• 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.
• Effect of marital deduction neutralizes this
  automatic inclusion rule

45
Joint Interests

• Whether or not a gift results when property is
  transferred into some form of joint ownership
  depends on the consideration furnished by each of
  the contributing parties for the ownership
  interest acquired.
• Two exceptions to this rule established are as
  follows.
• (1) Creation of a joint bank account.
• (2) Purchase of U.S. savings bonds.
• In these situations, a gift does not result from
  the creation of the joint tenancy. A gift
  materializes only when one owner withdraws more
  than he or she contributed (Examples 50 to 52).

46
Joint Interests

• Spousal joint tenancies and tenancies by the
  entirety have been substantially simplified. Due
  to the application of the unlimited marital
  deduction ( 2523), no gift tax results upon the
  creation of such tenancies.

47
Marital Deduction 2056 and 2523

• Because Congress chose to regard husband and wife
  as one economic unit, the law contains no
  monetary limit on the amount of the marital
  deduction allowed.
• Under prior law, the estate tax marital deduction
  was limited to 50 of the adjusted gross estate.
  The adjusted gross estate was the gross estate
  less 2053-2054 expenses. For gift tax
  purposes, the marital deduction was 50 of
  whatever qualifying interest passed to the donee
  spouse.

48
Marital Deduction

• Most estate plans choose between either
  equalization or deferral approaches with regards
  to the marital deduction.
• Generally, the deferral approach is preferred
  because of the time value of estate taxes lost as
  a result of the death of the first spouse.
• Equalization approach is advisable when any of
  the following conditions exist.
• (1) Both spouses are of advanced age and/or in
  poor health.
• (2) Neither spouse is expected to survive the
  other for a prolonged period of time.
• (3) The spouse that is expected to survive has
  considerable separate assets.
• d. In any event, effective use of by-pass amount
  is desirable The by-pass amount for 2007 is the
  exclusion amount of 780,800, or 2,000,000 in
  asset value.
• (See examples 43 44 in Chapter 18.)

49
Marital Deduction

• When a surviving spouse is involved, the
  decedents will should be properly structured to
  combine the marital deduction and bypass amount
  for maximum effect.

50
Minimizing Gift Taxes

• One key to minimizing Federal gift taxes, is
  making effective use of the annual exclusion.
• a. Since each year allows annual exclusions per
  donee (12,000 in 2007), programs of lifetime
  giving should be entered into as soon as possible
  
• b. For married donors, the election to split
  gifts can double the number of annual exclusions
  and make available the unified transfer tax
  credit of the nonowner spouse.
• One problem frequently encountered with programs
  of lifetime giving is limiting the gift to the
  amount of the annual exclusion. The problem can
  be resolved by making gifts of partial interests
  in property. (such as, tenants in common)

51
Minimizing Estate Taxes

• Factors to be considered in gift planning that
  reduce estate taxes are summarized below.
• a. Give assets that are expected to appreciate in
  value. In this regard, life insurance policies
  are particularly attractive.
• b. Except in a few states, lifetime transfers
  avoid any state gift tax.
• c. Federal gift taxes paid on lifetime transfers
  have both positive and negative ramifications.
• (1) Positive. Gift tax paid is not subject to the
  estate tax. An exception to this rule concerns
  any gift tax paid within 3 years of death.
• (2) Negative. Donor loses the use of the cash
  used to pay any gift tax paid.

52
Procedural

• Filing requirement is correlated to the unified
  tax credit exemption equivalent.
• a. This explains why the amount of the gross
  estate has to be reduced by post-1976 taxable
  gifts in determining whether or not a Form 706
  has to be filed (Example 70).
• b. An adjustment is necessary if the decedent
  made use of the 30,000 specific exemption on
  gifts made after September 8, 1976, and before
  January 1, 1977.
• Estate tax return (Form 706) is due nine months
  after the decedents death.
• a. Noncompliance leads to imposition of failure
  to file penalty (See Chapter 16).
• 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 discussed in
  Chapter 18.
• d. In any event, interest on any unpaid estate
  tax liability accrues from the due date of the
  return.

53
Gross Estate Example(slide 1 of 5)

• 1. Marcia owned a 100,000 life insurance policy
  on her son Georges life. The cash surrender
  value (CSV) of the policy was 25,000 when Marcia
  died this year.
• 2. George purchased and owned a 100,000 life
  insurance policy on Marcias life (his mother),
  which he collected when Marcia died

54
Gross Estate Example(slide 2 of 5)

• 3. For 30,000, Marcia purchased 100,000 of
  insurance on her life. She gave this policy to
  her husband Milford four years before she died.
• 4. For 35,000, Marcia purchased an additional
  100,000 of insurance on her life. She gave this
  policy to son George one year before she died,
  and paid gift tax of 5,000 on the transfer.

55
Gross Estate Example(slide 3 of 5)

• 5. Marcia and son George jointly owned real
  estate valued at 600,000. Marcia paid 45,000 of
  the original cost and George paid 15,000.
• 6. Marcia and husband Milford jointly own
  additional real estate valued at 1,200,000.
  Milford paid the entire 680,000 purchase price.
  (Assume this is not community property).

56
Gross Estate Example(slide 4 of 5)

• 7. Marcia established a revocable trust with son
  George as remainder beneficiary. The value of
  assets was 60,000 when the trust was created and
  200,000 when Marcia died.
• 8. Marcia owned a vacation residence and
  transferred title to George six years ago, but
  she (and Milford) continued to use the property
  valued at 500,000 each summer. (No one else
  uses the property.)

57
Gross Estate Example(slide 5 of 5)

• 9. Marcia and Milford jointly own cash, stocks,
  personal effects and other real estate valued at
  2,000,000.
• 10. Marcia has a life estate in a trust created
  by her fathers will. Son George is the
  remainder beneficiary. The value of trust assets
  is 1,250,000. Marcia has an income interest and
  can use trust assets for her support, health,
  education, or maintenance.

58
Marcias Gross Estate(slide 1 of 5)

• 1. 25,000 CSV is included. This is insurance
  on another persons life, and is not matured, so
  its only value is the replacement cost, or the
  cash into which the policy can be converted.
  (George is still alive, so Marcias estate does
  not have access to 100,000, it can only receive
  25,000 if it cashes in the policy on George.)
• 2. -0- is included, since George bought and
  owned the policy.

59
Marcias Gross Estate (slide 2 of 5)

• 3. -0- is included, since this policy was
  gifted more than three years prior to Marcias
  death (also, marital deduction would apply if
  included).
• 4. 105,000 is included the value of the life
  insurance plus the 5,000 gift tax since the
  transfers were less than 3 years before death.
  (The estate will get credit for the 5,000 gift
  tax paid.)

60
Marcias Gross Estate (slide 3 of 5)

• 5. 450,000 is included since Marcia originally
  paid 75 of the cost. Note that Marcia made a
  15,000 gift when they bought the property.
  Assume gift splitting was used and no tax was
  paid at that time.
• 6. 600,000 is included. One-half the value of
  property held jointly by spouses is included
  regardless of who purchased the property.

61
Marcias Gross Estate (slide 4 of 5)

• 7. 200,000 is included. The trust was revocable
  so it is Marcias property.
• 8. 500,000 is included since she retained the
  right to use the property.
• 9. 1,000,000, or one-half the value of these
  jointly held assets, is included in Marcias
  gross estate.

62
Marcias Gross Estate (slide 5 of 5)

• 10. -0- is included since Marcia does not have
  a general power of appointment over these assets.
  Her rights to the income of the trust terminate
  at Marcias death. Note if the trust has
  accrued income which is rightfully Marcias at
  her death, that amount should be distributed to
  her estate and included in the gross estate.
• Total Gross Estate 2,880,000