Wealth Transfer Taxes

1
Wealth Transfer Taxes

• Chapter 12

2
History

• The U.S. has had an estate tax since 1916 and a
  gift tax since 1932
• In 1976, Congress enacted the unified transfer
  tax system with unified graduated tax rates,
  ranging from 18 to 55
• In 2001, Congress voted to reduce top rates
  gradually until they reach 45 in 2007
• Estate tax will be repealed in 2010, but gift tax
  will be retained (sunset provisions automatically
  reinstate prior law in 2011)

3
Transfer Tax Features

• Tax is assessed on transferor (donor or estate),
  not recipient
• Base for tax is fair market value of property
  transferred
• Gift tax is cumulative over lifetime
• Gifts given in later years are taxed at higher
  marginal tax rates
• Total taxable gifts cause the decedents estate
  to be taxed at higher marginal tax rates

4
Major Exclusions

• Annual gift tax exclusion is 11,000 per donee
  per year
• If all gifts are less than exclusion, no gift tax
  return has to be filed
• Unified credit lifetime transfer tax exclusion
• The 2004 unified credit for an estate is 555,800
  which is equivalent to tax on 1.5 million
  (referred to as exemption equivalent)
• For lifetime gifts the exemption equivalent is 1
  million

5
Transfers Subject to the Gift Tax

• Gifts made directly or in trust and include gifts
  of all types of property whether real, personal,
  tangible, or intangible
• Services are not taxable
• A gift could result from the creation of a trust,
  the forgiveness of debt, or the assignment of
  benefits in a life insurance policy

6
Transfers forInsufficient Consideration

• A transfer is subject to gift tax if the value of
  the property transferred exceeds the value of
  money or other consideration given
• Gift difference between the sales price and the
  FMV on the date of the transfer
• A transfer made in a bona fide business
  transaction with no donative intent is not a gift

7
Joint Property Transfers

• If funds are placed into a joint bank account by
  a donor in the name of the donor and one or more
  other persons, no gift occurs at that time
• A gift occurs when one party withdraws an amount
  in excess of the amount that person deposited
• A gift occurs when an individual adds another
  persons name to the title of real property
• Gift value of other persons interest

8
Life Insurance Transfers

• Naming someone as beneficiary of a life insurance
  policy is not a gift
• When all rights of ownership (right to borrow
  against policy, cash in for cash surrender value,
  and change the beneficiary) are assigned to
  another, a gift equal to the cost of a comparable
  policy is made
• Paying the premium on a policy owned by another
  is a gift

9
Transfers to a Trust

• A trust is a legal arrangement involving three
  parties
• Grantor the one who transfers assets that
  become the corpus or principal of the trust
• Trustee the one who holds legal title to the
  assets and makes investment decisions
• Beneficiary the one who receives the legal
  right to the beneficial enjoyment of income or
  corpus

10
Transfers to a Trust

• Income beneficiary the one who has the right to
  receive income generated by the trust assets
• Remainder interest the one who has the right to
  receive trust assets upon termination of the
  trust
• Parents who want to transfer assets to a minor
  child can use a Uniform Transfers to Minors Act
  (UTMA) account
• Grantor-parent can be trustee and maintain
  control over the property

11
Cessation of Donors Control

• A transfer is not a gift if the donor retains an
  interest in the transferred property for
  example, if the donor retains the right to change
  trust beneficiaries or decide how much
  beneficiaries will receive
• A transfer to a revocable trust is not a gift
  (but actual transfer of income is a gift)
• Transfer of assets into an irrevocable trust is a
  gift
• A trust is irrevocable when the grantor gives up
  all future control

12
Transfers Excluded from Gift Tax

• Transfer of marital property pursuant to a
  divorce
• A transfer to meet support obligations (as
  determined by state law)
• Direct payment of medical or tuition expenses
• Payment must be made directly to the educational
  institution (tuition is excluded, but payment for
  room, board and books is a gift) or the person
  providing medical care
• Contributions to political organizations

13
Valuation of Gift Property

• Gifts are taxed on FMV at the date of the gift
• FMV is price that would be arrived at by a
  willing buyer and willing seller in an arm's
  length agreement when neither is under compulsion
  to buy or sell
• FMV is not a distressed sale price or wholesale
  value
• Stock or securities sold on an established
  securities market are valued at the average of
  the high and low price on the date of the gift

14
Annual Gift Exclusion

• Annual gift tax exclusion (11,000) only allowed
  for gifts of present interest
• Present interest includes
• Outright transfers
• Life estates (right for life)
• Term certain interests (right for specific time)
• Future interests are not eligible
• Remainder interests
• Reversions

15
Gifts to Minors

• Section 2503(c) minors trusts qualify for annual
  gift tax exclusion if
• Trustee may pay out income and/or trust assets
  before beneficiary reaches 21
• Remaining assets and income must be distributed
  to the child when the child reaches age 21 (or to
  the estate if minor dies before age 21)

16
Gifts to Minors

• Crummey trust transfers qualify for annual
  exclusion if the trust has an annual demand
  provision (no distribution required at 21)
• Transfers to Coverdell education savings accounts
  qualify for annual exclusion
• Transfers to qualified tuition programs (Section
  529 plans) eligible for annual exclusion
• Election can be made to spread gift over 5 years
  thus up to 55,000 can be transferred at one time
  with no gift tax consequences (provision can be
  used only once every 5 years)

17
Gift Splitting

• Allows spouses to combine their 11,000
  exclusions so together they can together 22,000
  per donee per year by treating each gift as if
  half made by each spouse
• Requires consent of both spouses
• Applies to all gifts made during that year (or
  during time they are married)
• Requires filing a gift tax return

18
Gift Tax Deductions

• Charitable deduction unlimited gifts to
  qualified charitable organizations (after
  subtracting annual exclusion)
• Marital deduction unlimited gifts to spouse
  (after subtracting annual exclusion)
• Similar deduction allowed for estates thus no
  estate tax owed if entire estate left to spouse

19
Computing Taxable Gifts

• Includible current gifts
• Plus Half of spouses gifts (if gift
  splitting)
• Less Half of taxpayers gifts (if gift
  splitting)
• Less Annual exclusions
• Less Charitable and marital deductions
• Equals Taxable gifts for current period
• Plus Taxable gifts in previous periods
• Equals Cumulative taxable gifts

20
Computing Gift Tax Payable

• Gift tax on cumulative taxable gifts
• Less Gross gift tax on previous taxable
  gifts
• Less Available unified credit
• Equals Gift taxes payable on current periods
  gifts
• Gift tax return due by April 15 of following year
  (eligible for same extension as for individual
  income tax return)

21
Gift Tax Return

• Form 709 gift tax return must be filed if there
  were any of the following transfers
• Transfers of present interests in excess of the
  annual exclusion (11,000)
• Transfers of future interests
• Transfers to charitable organizations in excess
  of annual exclusion
• Transfers with gift splitting elected

22
Tax Consequences for Donees

• Donors adjusted basis (and holding period)
  generally carries over to the donee
• If appreciated property, basis increased by
  proportionate amount of gift tax paid on
  appreciation
• If FMV is less that basis, lower FMV is used to
  determine loss on subsequent disposition

23
Kiddie Tax

• Under the kiddie tax, unearned income (in excess
  of 1,600) of children under age 14 is taxed at
  their parents marginal tax rate
• First 800 covered by standard deduction
• Second 800 (and all earned income) taxed at
  childs tax rates

24
Education Savings Plans

• Earnings are not currently taxed and is never
  subject to tax to the extent income is used for
  qualified education expenses
• Section 529 qualified tuition plan
• No annual limit on contributions
• Can change beneficiary
• Donor can cash out account by paying income tax
  10 penalty

25
Education Savings Plans

• Coverdell education savings accounts
• Annual contribution limit of 2,000 (phased out
  as modified AGI exceeds 95,000 if single or
  190,000 for married couples)
• Donor can contribute to both types of savings
  plans for same child in same year
• Other relatives (grandparents) can also use these
  plans to save for a childs education

26
The Estate Tax

• The estate tax is a tax levied on the right of a
  decedent to transfer of property to beneficiaries
  or heirs upon his or her death
• An estate is created at an individuals death to
  own and manage the decedents property until
  ownership of the property is transferred to the
  beneficiaries or heirs
• Estate taxes are levied on the value of all
  property owned by a decedent and transferred at
  the decedents death
• The estate pays the tax

27
The Taxable Estate

• Steps to compute the taxable estate
• Identify and value the assets included in the
  gross estate
• Identify the deductible claims against the gross
  estate and deductible expenses of estate
  administration
• Identify any deductible bequests
• The gross estate includes all property and
  property interests of the decedent

28
Probate

• Probate the process under state law by which a
  will is declared legally valid and decedents
  property is transferred to the beneficiaries
• Probate estate includes only the property
  governed by the will (or the states intestacy
  laws if there is no valid will) and does not
  include property transferred by law
• Gross estate includes property that transfers by
  will and by law

29
Living Trust

• One strategy for avoiding probate costs is to use
  a living trust that holds title to all of the
  individuals assets and specifies how they are
  transferred at death
• The will only needs to designate the treatment of
  any asset not in the trust
• Unlike a will, a living trust is not a public
  document
• Property in a living trust is must be included in
  the gross estate

30
The Gross Estate

• Gross estate includes all property in which the
  decedent had an interest and may include some
  items not actually owned by the decedent at death
• Gifts with strings attached (decedent retained
  right to income or right to designate who may
  enjoy property)
• Transfers in which the decedent possessed the
  right to alter, amend, revoke, or terminate the
  terms of the transfer

31
Life Insurance Proceeds

• Included in the gross estate if
• Decedents estate is the beneficiary or
• Decedent possessed any incident of ownership at
  death (power to change the beneficiary, surrender
  or cancel the policy, assign the policy, revoke
  an assignment, pledge the policy for a loan, or
  obtain a loan from the insurer against the
  surrender value of the policy)
• Insurance is included in the estate if it was
  transferred by gift within 3 years of death

32
Valuation Issues

• The gross estate includes the value of all
  property, regardless of location, as of date of
  death
• Alternative valuation date is 6 months after the
  decedents date of death
• If elected it applies to all assets
• Gross estate and estate tax must both be reduced
  to use the alternate date
• If assets are sold prior to alternate date, they
  are valued at date of sale

33
Valuation Issues

• Market price method used for stocks, bonds, and
  real estate
• Stocks valued at average of their high and low
  selling prices on valuation date
• Actuarial valuation used for annuities, life
  estates, terms certain and remainder interests
• Capitalization of earnings used when valuing
  businesses

34
Estate Deductions

• Any debts of the decedent and claims against
  property included in the gross estate
• Funeral expenses and administrative costs of
  settling the estate
• Casualty and theft losses incurred during the
  administration of the estate
• Bequests to charitable organizations
• Property transferred to surviving spouse
• Qualified terminal interest property (QTIP) trust
  allows the decedent to exclude value of property
  transferred in trust to spouse

35
Computing Estate Tax

• Gross estate
• Less Deductible expenses, debts, taxes,
  losses
• Less Charitable deduction
• Less Marital deduction
• Equals Taxable estate
• Plus Adjusted taxable gifts - prior periods
• Equals Tax base

36
Computing Estate Tax

• Gross estate tax
• Less Gift tax on prior gifts
• Less Unified credit
• Less Other allowable credits
• Equals Net estate tax liability
• Estate tax return, Form 706, due 9 months after
  death (6 month extension possible)

37
GSTT

• Generation skipping transfer tax applies a
  separate flat tax at the highest transfer tax
  rate (48) when a transfer skips a generation
• A direct transfer from grandparent to grandchild
  is a generation skip
• 1,500,000 GSTT exemption is allowed each each
  grantor in 2004

38
Benefits of Planned Giving

• Transfer of investment property (bonds) allows a
  family to shift income to lower-bracket family
  members but offers few transfer tax benefits if
  there are small differences between current and
  future value
• Transfer of equity interest in flow-through
  entity offers both current income tax and future
  transfer tax benefits
• Buy-sell agreement
• Gift-leaseback arrangement

39
Advantages of Lifetime Gifts

• Shield post-gift appreciation from estate taxes
  (taxed on date of gift value)
• Take advantage of annual exclusion and
  gift-splitting
• Nontax advantages of trusts
• Protects property from creditors
• Shields assets from public scrutiny
• Allows ease of management for multiple
  beneficiaries

40
Disadvantages of Lifetime Gifts

• Carryover basis on gift property
• If donor had retained property until death, basis
  would have been stepped up to FMV
• Early payment of transfer taxes
• Estate tax exemption increases to 2 million for
  2006-2008 and 3.5 million in 2009 while lifetime
  gift exemption remains at 1 million

41
Fiduciary Income Tax Issues

• The decedents final income tax return extends
  from date of the last tax return to the date of
  death
• Income in respect of decedent (IRD) income
  earned by cash-basis decedent but not received
  prior to death is taxed to whoever receives it
• Examples unpaid salary, interest, dividends,
  retirement plan income
• Decedents basis carries over and character of
  income also carries over

42
Fiduciary Income Tax Issues

• Deductions in respect of decedent (DRD)
  expenses or liabilities incurred by cash-basis
  decedent but not paid prior to death are
  deductible by party legally required to pay them
  (usually estate)
• Examples property and state income taxes

43
Basis Issues

• Basis of inherited property is its fair market
  value as of the valuation date used for estate
  tax purposes
• The basis rules will change in 2010 (if estate
  taxes are repealed) to a modified carryover basis
  rule
• 1.3 million of basis can be added to certain
  assets
• 3 million of basis can be added to assets
  transferred to a surviving spouse
• Basis increase cannot increase property to more
  than FMV

44
Income Taxation of Trusts and Estates

• Fiduciaries (estates and trusts) are taxed
  following a modified conduit approach that taxes
  the fiduciary only on income it retains, not on
  income that it distributes to the beneficiaries
• Beneficiaries are taxed on income distributed to
  them
• Character of income is determined at fiduciary
  level and retains this character when distributed
  to beneficiaries

45
Trusts

• Grantor trust grantor retains some incident of
  ownership (such as reversionary interest) and
  income is taxed to the grantor
• Simple trust must distribute all of its
  accounting income annually to its beneficiaries
  cannot make charitable contributions
• Complex trust any trust that is not a simple
  trust (estates are considered complex trusts)

46
Fiduciary Income Taxation

• Fiduciary gross income is computed using rules
  similar to individual income taxation
• Deductions allowed for expenses of producing
  taxable income, depreciation, administrative
  expenses, and charitable contributions
• Simple trusts allowed 300 exemption
• Complex trusts allowed 100 exemption
• Estates allowed 600 exemption

47
DNI

• Distributable net income (DNI) is the current
  increase in value available for distribution to
  income beneficiaries
• DNI determines the fiduciarys maximum
  distribution deduction
• DNI determines beneficiarys maximum taxable
  income
• Character is retained so beneficiaries do not pay
  tax on tax-exempt income

48
Fiduciary Income Tax Rates

• 2004 Rates
• 15 on 0 - 1,950
• 25 on 1,951 - 4,600
• 28 on 4,601 - 7,000
• 33 on 7,001 - 9,550
• 35 over 9,550
• Because beneficiaries are usually in lower
  marginal tax brackets, distributing the income
  annually to beneficiaries usually results in
  lower taxes overall

49
Fiduciary Income Taxation

• A trust is required to file a Form 1041 by April
  15 of the following calendar year if it has gross
  income of 600 or more
• Any estate with gross income of 600 or more is
  required to file a Form 1041 by the 15th day of
  the 4th month following the close of its tax year
• Beneficiaries report their share of income based
  on the fiduciarys tax year that ends within the
  beneficiarys tax year

50
Distributions to Beneficiaries

• When property is distributed to trust
  beneficiary, generally no gain or loss is
  recognized by the trust for difference between
  FMV and basis
• Beneficiaries use trusts adjusted basis
• If property satisfies a required income
  distribution, distribution deduction limited to
  lesser of propertys basis or its FMV
  (beneficiaries still use basis)

51
Distributions to Beneficiaries

• Trustee can elect to recognize gain on
  distribution of appreciated property
• Beneficiarys basis is FMV
• If trust has unused capital losses, it can net
  these losses against any capital gains resulting
  from the election

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The End