Federal Estate Tax

1
Federal Estate Tax

• Session 3
• DePaul University CFP Program

2
What Is Federal Estate Tax?

• Federal estate tax (FET)is tax on certain
  transfers of property at death.
• Such property may include
• Cash
• Securities
• Real estate
• Business interests
• The principal of certain trusts
• Other assets
• Whether or not an asset goes through probate does
  not determine FET inclusion

3
Federal Estate Tax

• Federal estate tax (FET) is an excise tax on the
  privilege of giving your property away.
• Federal estate tax is filed using Form 706
• Personal representative must file and pay the tax
  
• Executor or administrator
• Form 706 required when
• Decedents gross estate gt5,120,000 million
  (2012) or
• Decedents gross estate plus adjusted taxable
  gifts gt 5,120,000 million (2012)
• Federal estate taxes are due within nine months
  from the date of the decedent's death
• A 6-month extension for filing (not paying) is
  generally granted

4
Question 3-1

• For which of the following estates would Form 706
  most likely have to be filed?
• Lous because he died owning more than 3 million
  in property. (made no lifetime gifts)
• Stus because he died owning more than 3 million
  in property and had gifted an additional 4
  million to his children.
• Sues because she died owning more than 3
  million in property and had gifted an additional
  4 million to her husband.
• Rues because she died owning more than 3
  million in property and had gifted an additional
  1 million to her grandsons.

5
The Federal Estate Tax Formula

• Federal Estate Tax Formula
• Gross estate
• - Adjustments (debts, expenses, state death
  taxes, casualty loss)
• Tentative taxable estate (aka adjusted gross
  estate)
• - marital and charitable deductions (generally
  unlimited)
• - state death tax
• Taxable estate
• Adjusted taxable gifts (post-1976)
• Tax base
• X tax rate
• Tentative estate tax
• - Credits (applicable credit, prior gift tax,
  other)
• Net estate tax due

6
Estate Tax Property Exemptions Over Time
Year Estate Tax Exemption Top Estate Tax Rate
1997 600,000 55
1998 625,000 55
1999 650,000 55
2000 675,000 55
2001 675,000 55
2002 1,000,000 50
2003 1,000,000 49
2004 1,500,000 48
2005 1,500,000 47
2006 2,000,000 46
2007 2,000,000 45
2008 2,000,000 45
2009 3,500,000 45
2010 5,000,000 or 0 35 or 0
2011 5,000,000 35
2012 5,120,000 35
2013 1,000,000 55
7
35-Percent Rate to Sunset

• The Tax Relief, Unemployment Insurance
  Reauthorization, and Job Creation Act ("TRA
  2010") enacted December 17, 2010.
• Reinstated the estate tax retroactively back to
  January 1, 2010.
• Also set new rules for the estates of decedents
  who die in 2011 and 2012.
• This law, however, is set to sunset on December
  31, 2012.
• Unless new legislation is enacted, in 2013 the
  estate tax laws will revert back to the 2001/2002
  provisions.

8
Fewer Americans Subject to Estate Tax

• Under current law, fewer Americans will be
  subject to federal estate tax than in previous
  years due to
• 2012 federal estate tax exemption at 5,120,000,
  plus
• Portability of the unused exemption to surviving
  spouses,.

9
The Gross Estate

• A decedents gross estate includes all property
  in which the decedent held an interest at death.
• The gross estate is calculated before ANY
  deductions are applied.
• Allowable deductions then reduce the gross estate.

10
Gross Estate Inclusion Examples

• The following are examples of property included
  in a decedents gross estate
• Fee simple property (individually owned)
• Joint tenancy property
• One half included if spousal
• Non-spousal proportion included if consideration
  furnished by survivor can be proven
• Decedents fractional interest of TIC property
• Revocable trust property

11
Gross Estate Inclusion Examples

• continued
• Property in some tainted irrevocable trusts
• Life insurance
• Owned by decedent
• Transferred within three years of death
• Reversionary Interests
• Survivor annuities
• .more

12
Question 3-2

• Which of the following assets would not be
  included in Marks gross estate?
• A. His municipal bond portfolio
• B. His IRA naming his wife, Anne as beneficiary.
• C. A right to receive income until death from his
  grandmothers trust
• D. His jeep

13
Life Insurance Policies Included in Gross Estate

• A policy of life insurance that insures the life
  of another and owned by the decedent at death is
  included in the gross estate.
• Generally, value of policy is replacement value
  but type of policy may determine valuation
  method
• Newly issued policies, the value premiums paid.
• Paid up one-time, single premium policies,
  value carriers current cost for identical
  policy.
• Policies in force for some time on which
  additional premiums are due, value interpolated
  terminal reserve amount plus unearned premiums

14
Life Insurance Proceeds Generally Included in
Gross Estate

• The proceeds of a life insurance insuring the
  decedents life is included in the gross estate
  if the decedent held incidents of ownership at
  death.
• Incidents of ownership include
• Right to name/change beneficiary
• Right to assign ownership
• Right to make policy loans
• .more
• Proceeds are included in the gross estate for FET
  purposes regardless of who actually receives them.

15
When Life Insurance Is Not Included In The Gross
Estate

• Proceeds of life insurance on the decedents life
  will not be included in the gross estate when
• The decedent gives away the policy more than 3
  years prior to death retaining no incidents of
  ownership
• This includes the transfer to an irrevocable life
  insurance trust (ILIT)
• Life insurance where decedent held no incidents
  of ownership in the policy at death and
  decedents estate is not named beneficiary

16
Question 3-3

• Six weeks after transferring his life insurance
  to an irrevocable trust, Rick was hit by a bus.
  What happens in terms of his gross estate?
• The insurance is not in his gross estate because
  it was held in trust.
• The insurance is not in his gross estate because
  insurance is not a financial asset.
• The insurance is not in his gross estate because
  Ricks death, although within three years of the
  transfer was accidental.
• The insurance is in his gross estate because Rick
  held incidents of ownership within three years of
  his death.

17
Other Assets Not Included in aDecedents Gross
Estate

• The following assets are not generally included
  in a decedents gross estate
• Gifted property over which decedent retained no
  powers of control/enjoyment at death
• Property over which decedent held only a
  non-general power of appointment

18
Property in the Gross Estate

• Property in a decedents gross estate includes
• Individually owned property
• Ones fractional interest in TIC property
• 50 of spousal JTWROS property
• 50 of community property
• 100 of non-spousal JTWROS property unless estate
  can prove survivors contribution

19
Property in the Gross Estate

• Property in a decedents gross estate includes
• Proceeds of life insurance with incidents of
  ownership
• Proceeds of life insurance transferred within 3
  years of death
• Retained interest property
• Reversionary interest property
• Personal effects

20
The Three-Year Rule

• Certain transfers made within 3 years of death
  are included in the gross estate including
• Gift tax actually paid by the decedent
• Only the tax paid, not the amount of the gift
• To discourage reduction of the estate by the
  tax-exclusive nature of the gift tax
• Known as grossing up the estate
• Severance of a retained interest less than 3
  years prior to death
• Life insurance transferred by the insured to
  anyone, including a spouse or trust

21
Valuation of Assets for Federal Estate Tax
Purposes

• In determining the gross estate, assets are
  generally reported at fair market value (FMV)
• Decedents full or proportional interest shown
• Certain discounts may apply
• Lack of marketability discount
• Lack of control discount (minority discount)
• Key person discount
• Co-ownership discount
• Blockage discount

22
The Alternate Valuation Date (AVD)

• Some estates may elect to value the gross estate
  as of the date 6 moths after the date of death
  (AVD).
• To use the alternative valuation date, all three
  requirements must be met
• Electing the AVD must decrease the value of the
  GE
• Electing the AVD must decrease the amount of FET
  actually due
• The PR who files the 706 must make the proper
  election on the return.
• This election must be made within 1 year after
  the due date of the federal estate tax return
  (including extensions).

23
Using the AVD

• If the alternate valuation date value is elected
  it applies to all assets in the gross estate,
  except
• Assets sold between death and the AVD are valued
  at sales price
• Assets that diminish in value over time by their
  nature, e.g., annuities, royalties and MOG
  interests subject to depletion
• Possible disadvantage use of AVD will reduce
  the basis in the assets received by distributees

24
AVD Example

• Butch dies on January 1, 2012, owning 100 shares
  of Technotawk Inc, common stock having a date of
  death value _at_75 per share. On July 1, 2012 that
  stock has a FMV of 50 per share.
• If Butchs PR elects the AVD the stock is
  valuated at 5,000 in Butchs estate
• If Butchs Will gives that stock to his daughter,
  her basis for capital gains purposes is 5,000

25
Question 3-4

• Which of the following assets would possibly not
  qualify for AVD treatment on the Form 706?
• An IRA owned by Fred, who died at age 77.
• A municipal bond portfolio owned by Marilyn.
• Ritas house
• Arthurs mutual funds

26
Lack of Marketability and Minority Discounts

• The value of business interests transferred to
  family members may be reduced by lack of
  marketability and/or minority discounts.
• A lack of marketability discount is a reduction
  in the value of the property due to the
  difficulty or inability of the owner to sell the
  property to a third person.
• A minority discount is a reduction in the value
  of the property since the interest does not
  provide for control of the entity.

27
Question 3-5

• The minority interest discount is most likely to
  be available for valuating transfers of
• Real property
• Publicly traded securities
• Stock in a closely held business
• Bonds

28
Lack of Marketability and Minority Discounts
Example

• Example, if Stus estate transfers an interest in
  his closely-held business valued at 18,000, the
  estate may use lack of marketability and minority
  interest discounts and perhaps reduce the value
  of the gift for estate tax purposes from 18,000
  to 12,000.

29
Key Person Discount

• The key person discount is an amount or
  percentage deducted from the value of an
  ownership interest to reflect the reduction in
  value resulting from the actual or potential loss
  of a key person, often the founder, in a business
  enterprise.
• Factors used to evaluate whether to apply a
  key-person discount include the
• Companys relationships with customers and
  suppliers,
• Nature of the business,
• Key persons actual duties and activities, and
• Quality and depth of the companys management
  team.

30
Co-Ownership Discount

• The co-ownership discount reflects a transferee
  receiving a fractional interest in real property.
• This reflects that all current owners may not
  have similar objectives.
• Example Your late mother left you her ½ interest
  in a building she owned with her sister (your
  aunt). Your aunt has no wish to sell the
  building and it may be difficult to find a buyer
  to co-own property with your aunt.
• Discount reflects lower probability of turning
  the asset into immediate cash.

31
Blockage Discount

• A blockage discount is a deduction from the price
  of a publicly traded stock. The discount may be
  available when the block of stock to be valued is
  so large (relative to the volume of actual sales
  on the existing market) that the block could not
  be quickly liquidated without depressing the
  market price.
• Value of gross estate is a snapshot on the date
  of death. Bill Gates 460MM shares of MSFT (10X
  daily volume is a different picture than someone
  elses 400 shares.

32
Vaulating Publicly Traded Stocks

• Publicly traded stocks are valuated at the
  average/mean of the high and low prices on the
  date of death multiplied by the number of shares
  the decedent owned.
• Not the settlement price
• Note If the death occurs on a day when the stock
  market is closed, then the average prices for the
  stock on the trading days immediately before and
  after the date of death are used

33
Stock Valuation Example

• The closing price is not used. If a stock's price
  fluctuated between ten and twelve dollars on the
  date of death, the average of 11.00 per share is
  used for determining the value of the stock.
• If the death occurred on a weekend or holiday
  when the market is closed, the high and low
  values for the trading date prior to the death
  and those of the next trading date are
  "re-averaged."

34
Question 3-6

• For transfer tax valuation purposes, publicly
  traded stock is most likely to be valuated at
  its
• FMV
• Settlement price
• Closing tick
• Mean price

35
Valuating Mutual Fund Shares

• For mutual funds, the gross estate includes the
  "bid" value, or public redemption price, of the
  fund as of the date of death.
• If the death occurs on a weekend or holiday, the
  fund is valued based on the public redemption or
  bid value as of the trading date preceding the
  date of death.

36
Valuating Bonds

• Bonds must include accrued interest when their
  value is determined. Since bonds typically pay
  interest twice a year, unless the owner dies on
  the date of payment, the interest from the date
  of the last payment through the date of death
  must be computed and included.
• If there is no high and low value for a bond on
  the date of the death, the average of the closing
  price on the date of death and the closing price
  on the trading day preceding the date of death is
  used.

37
Valuating US Savings Bonds

• United States Series E, EE, H, and HH, Savings
  Bonds are valued at the price for which they
  could be redeemed during the month of death.
• The redemption value of such bonds, which depends
  on both the month and year of purchase as well as
  the redemption date, is available on a website
  published by the federal government.

38
Single Life Annuties

• Single(pure) life annuities are not included in
  the gross estate for FET purposes.
• Why?
• Because payments stop on the death of the (one)
  annuitant.
• Thus, nothing can be transferred to another
  party.
• Also, nothing to include in probate estate.

39
Question 3-7

• How is a single life annuity valued for Federal
  Estate Tax purposes?
• A. At FMV
• B. At its intrinsic value
• C. At its alternate valuation day value
• D. At zero

40
Survivor Annuities

• The present value of a survivors interest in an
  annuity having a survivorship feature is included
  in the (transferors) decedents gross estate.
• Contracts include
• Joint and survivor annuities
• Refund annuities
• Term certain annuities before term completed
• If there is no survivorship feature, no amount is
  included in the decedents gross estate because
  no value is transferred by the decedent

41
Valuating Real Estate

• The value of real property is determined by
  written appraisal.
• For a single family residence, the appraisal can
  be made by a local real estate broker or agent.
• The appraisal should describe the property, its
  value, and how that value was determined.
• Similar agents or brokers, using the same
  procedures and submitting the written appraisal
  as mentioned, can value unimproved property
  valued at 250,000 or less.

42
Valuating Commercial Real Estate

• Commercial property, including office buildings,
  apartment complexes and farms need to be
  appraised by a qualified appraiser.
• Costs that would result from a sale, including
  future brokerage commissions, etc. are normally
  excluded from determining the value of real
  property.
• If the property includes or consists of a farm or
  ranch, any farm equipment, livestock, stored
  seeds and fertilizers as well as growing or
  harvested crops are valued separately.

43
Valuating Farm and Business Real Property

• If a farm or real property used in a closely held
  business is part of the gross estate, and the
  requirements are met, the executor may elect to
  value the property at its special use value,
  rather than its fair market value.
• If a farm or real property used in a closely held
  business is part of the gross estate, the
  executor may elect to value the property at its
  special use value, rather than its fair market
  value.
• The real property is then valued at its
  discounted business use value, not its fair
  market value at its highest and best use.

44
Valuating Autos, Planes, and Boats

• The value of all vehicles is determined
  individually using the sale price as of the date
  of death. The value of automobiles may be
  determined by consulting the "Kelley Blue Book"
  or similar publications, and RVs, motorcycles,
  mobile homes, boats, or planes have similar
  publications that can be used to determine their
  value.

45
Valuating Fine Art

• Art objects, including paintings, sculptures,
  tapestries, silverware, and other artifacts, are
  subject to the general valuation rules for estate
  tax purposes. Documentation required depends on
  the value of the articles.
• An art object valued at no more than 100 may be
  grouped with other articles on a room-by-room
  appraisal, with a separate value given for each
  item named. An executor is also allowed to submit
  an aggregate value as appraised by a competent
  appraiser or dealer.

46
Valuating Fine Art

• Continued
• For articles with artistic or intrinsic value of
  more than 3,000 or a collection of similar
  articles valued at more than 10,000, the
  appraisal must be made under oath by an expert
  who must also attach a statement of
  qualifications.
• When an art object has a value in excess of
  20,000, the valuation is automatically reviewed
  by the Art Valuation Group (National Office) of
  the Engineering and Valuation Branch of the IRS
  for possible audit. When the value is greater
  than 50,000 and substantiated valuation is
  desired, the IRS provides a procedure for
  obtaining this secure art value.

47
Valuating Foreign Currency

• Foreign currency is valued at the commercial or
  retail exchange rate as of the date of death. If
  death occurs on a weekend or bank holiday, the
  average exchange rate on the date prior to the
  death and that following is averaged.
• Coins and bills having a value exceeding their
  face value, such as silver certificates or items
  in a coin or similar collection, are valued at
  their potential sales value instead of their face
  value.

48
Retained Life Estates

• If a decedent gave property away but retained the
  right to income from, or use of, the transferred
  property, such property must be included in the
  decedents gross estate at the date of death FMV.
• Mere right to determine who will enjoy property
  constitutes a retained interest
• Known as the beneficial enjoyment rule

49
Retained Life Estate Example

• Charles establishes a trust naming himself as
  trustee. The trust provides that the trustee has
  discretion as to which of his children, all named
  as beneficiaries, receive distributions at
  specific times.
• The trust property must be included in Charles
  gross estate

50
Question 3-8

• If Evan does not want his stock portfolio to be
  part of his gross estate he should
• Transfer it to an irrevocable trust with his
  brother as trustee.
• Own it individually
• Transfer it to an irrevocable trust naming
  himself as trustee.
• Own it individually, but leave it to his wife
  under his Will.

51
Typical Beneficial Enjoyment Exposures

• Transferors may control beneficial enjoyment of
  their transferred property under various
  arrangements
• Examples
• Transferor dies while serving as custodian before
  UGMA and UTMA proceeds are distributed to the
  emancipated minor
• Transferor dies while acting as trustee of a
  2503(c) minors trust before minor turns 21

52
Deductions From Gross Estate to Compute Adjusted
Gross Estate

• The following deductions are subtracted from the
  gross estate to determine the adjusted gross
  estate (AGE)
• Reasonable funeral expenses
• Decedents final medical expenses
• Not reimbursed by medical insurance
• Estate administrative expenses
• Attorney and accountant fees, appraisal fees,
  etc.
• The decedents debts
• Casualty losses not covered by insurance
• To the decedents property occurring after death,
  but before the estate is settled

53
Deductions From the Adjusted Gross Estate

• Several deductions are permitted from the
  tentative taxable estate (AGE) to determine the
  tentative taxable estate. They are
• Marital deduction
• Unlimited for property passing to U. S. citizen
  spouse
• Charitable deduction
• Generally unlimited
• State death tax deduction
• For amounts actually paid (formerly a credit)

54
The Taxable Estate

• The taxable estate is the adjusted gross estate
  reduced by the marital charitable, and state
  death tax deduction.
• It is not always the amount to which the estate
  tax rate applies.
• Why?
• Because gt 1976 taxable gifts must be added to the
  taxable estate before the tax rate applies
• This reflects the cumulative nature of transfer
  tax during and after lifetime

55
Question 3-9

• In calculating Federal Estate Tax which of the
  following is multiplied by the tax rate?
• The gross estate
• The adjusted gross estate
• The taxable estate
• The tax base

56
2012 Transfer Tax Rates

• For transfers occurring in 2012
• Applicable Exclusion Amount - 5,120,000Estate
  Tax Rate 35Gifts Tax Exemption AMount
  -5,120.000Gift Tax Rate 35Generation
  Skipping Tax Exemption Amount - 5,120.000GST
  Transfer Tax Rate 35

57
Estate Tax Calculation

• 2012 Estate Tax Calculation
• Example Rex, a widower, died in 2012 with a
  7,500,000 tax base. His federal estate tax is
  calculated below
• Tax base 7,500,000
• -Exemption 5,120,000
• Taxable amount 2,380,000
• X tax rate _at_35 833,000
• The FET due is 833,000 assuming no credits other
  than the applicable credit
• The applicable credit was reflected in the
  exemption of 5,120,000 charitable

58
The Applicable Credit

• The estate tax credit operates like any tax
  credit reducing tax liability 1 for 1.
• Even if the gift tax applicable credit was used
  (fully or partially) during a decedents life
  time, the FULL estate tax credit is used
  (required) on Form 706.
• Why?
• Because gt 1976 taxable gifts must be added to the
  taxable estate to produce the tax base.

59
Relationship of Estate Tax Credit and Exemption

• The 2012 Federal Estate Tax credit amount is
  1,772,800.
• In the absence of this credit, 1,772,800 would
  be owed on transfers of 5,120,000 in property.
• Thus, the 5,120,000 represents the property
  exemption.

60
Portability of the Exemption

• In 2009 and prior years, married couples could
  transfer up to two times the federal estate tax
  exemption by including separate exemption
  equivalent trusts in their estate plans.
• The 2010 Tax Act may eliminate the need for
  separate trust planning for federal estate taxes
  by allowing married couples to add any unused
  portion of the estate tax exemption of the first
  spouse to die to the surviving spouse's estate
  tax exemption. This will effectively allow
  married couples to pass 10,240,000 (2012) to
  their heirs free from federal estate taxes with
  no planning.

61
Reporting the Portability

• To report the portability the surviving spouse
  must file IRS Form 706, United States United
  States Estate (and Generation-Skipping Transfer)
  Tax Return, in order to take advantage of the
  deceased spouse's unused estate tax exemption.
• A widow/er can not transfer portability of the
  estate tax exemption from a deceased spouse onto
  a new spouse.

62
Exemption Portability Example

• Assume Ted and Gloria are married and have all of
  their assets jointly titled and their net worth
  is 8,240,000, Ted dies first and the federal
  estate tax exemption is 5,120,000 on the date of
  Ted's death
• When Ted dies his estate won't need to use any of
  his 5,120,000 estate tax exemption since all of
  the assets are jointly titled and the unlimited
  marital deduction allows Ted to transfer his
  share of the joint assets to Gloria without
  incurring any federal estate taxes.
• Assume that at the time of Gloria's later death
  the federal estate tax exemption is still
  5,120,000, the estate tax rate is 35, and
  Gloria's estate is still worth 8,000,000.
• With full portability of the estate tax exemption
  between spouses, Ted's unused 5,120,000 estate
  tax exemption will be added to Gloria's
  5,120,000 exemption, in turn giving Gloria a
  10,240,000 exemption.
• Since Gloria has "inherited" Ted's unused estate
  tax exemption and she can pass on 10,240,000
  free from federal estate taxes at the time of her
  death, Gloria's 8,240,000,000 estate won't owe
  any estate taxes at all
• 8,000,000 estate - 10,000,000 exemption 0
  taxable estate

63
Question 3-10

• Maurice was married to Joan. When he died, he had
  3,120,000 in property all of which he left to
  Joan. Joan is quite wealthy from book royalties
  and when she dies twelve years later she is worth
  20 MM. Two years after Maurice died, Joan
  married Dagwood who is living at the time of her
  death. Which of the following is true assuming
  exemption amounts remain constant?
• Maurices unused 2 million can be rolled onto
  Joans estate.
• Maurices unused 2 million can be rolled to Joan
  then subsequently rolled onto Dagwoods estate
• Joans estate would only enjoy the 5,120,000
  exemption because Maurice died more than ten
  years prior to her death.
• Joans estate cannot avoid federal estate tax
  entirely.

64
Credit for Gift Taxes Paid

• Gift tax paid on gifts added to the taxable
  estate operates as a credit against federal
  estate tax otherwise due

65
Prior Transfer Credit

• The prior transfer credit applies when property
  passes through two taxable estates within a
  10-year window.
• A credit against the estate tax is allowed for
  federal estate tax paid on the transfer of
  property to the present decedent.

66
Prior Transfer Credit Amounts

• The amount of the credit is determined based on
  the amount of time between the two deaths. The
  Internal Revenue Code provides a percentage chart
  to determine the amount of applicable credit,
  expressed as a percentage of the prior tax
  allowed as a credit in the present estate
• Period of time exceeding Not exceeding
  Percent Allowable
• 0 years 2 years 100
• 2 years 4 years 80
• 4 years 6 years 60
• 6 years 8 years 40
• 8 years 10 years 20
• gt10 years  none

67
Estate Tax Formula Example

• Here is a sample calculation of the federal
  estate tax for Hanks estate, assuming he dies in
  2012
• Gross Estate
  8,530,000
• Less Funeral and Administration Expenses
  -30,000
• Tentative Taxable Estate/AGE
  8,500,000
• Less Marital Deduction
  -2,000,000
• Less Charitable Deduction
  -1,000,000
• Taxable Estate
  5,500,000
• Add Adjusted taxable gifts
  580,000
• Tentative Tax Base
  6,080,000
• Less exemption
  -5,120,000
• Tax base
  960,000
• X 35
  336,000
• Federal Estate Tax Payable336,000

68
Sources for Estate Liquidity Life Insurance

• Estate liquidity is often among reasons why life
  insurance is considered in a financial plan.
• It provides cash upon the death of the decedent.
• With appropriate trust planning, life insurance
  may be removed from the decedents gross estate
• If acquired through ILIT, gift to trust is
  premium
• If transferred through ILIT, gift is replacement
  value, and
• If transferor dies within three years of
  transfer, life insurance must be included in
  transferors estate.
• Life insurance is often used to fund buy/sell
  agreements
• Premiums not deductible
• Death proceeds not taxable
• May trigger corporate AMT in entity buy/sell

69
Sources for Estate Liquidity Asset Sales

• Assets may be sold to provide estate liquidity.
• Stepped up basis available on most assets
• Exceptions
• Cash
• Retirement accounts
• Income in respect to a decedent (IRD)
• Large holdings in illiquid assets require greater
  liquidity planning
• Closely held business interests
• Require business succession plan
• Real property
• Collectibles

70
Question 3-11

• Agnes estate is facing a significant federal
  estate tax liability. Which of the following
  among her assets would probably be least
  productive in generating liquidity to satisfy the
  tax obligation?
• A. Her mutual fund portfolio
• B. Her vested profit sharing account
• C. Her business
• D. Life insurance held in her trust

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Powers of Appointment

• Powers of appointment are granted through trusts
  and wills enabling the holder to determine who
  will receive/enjoy property subject to the power.
• Typically granted to trustees and executors
• The holder may address the power in one of three
  ways
• Release the power
• Holder relinquishes right to hold the power
• Lapse the power
• Not appoint property to self within a year
• May cause a deemed gift if holder could have
  appointed property to self without restriction
• Exercise the power
• By appointing it to self, or others
• May trigger gift tax if holder could have
  appointed property to self, but appoints it to
  others

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Exercise In Favor of Another Example

• Harvey is trustee of a trust established by his
  Aunt Millie. Millies trust granted him the power
  to appoint the property to anyone he chooses,
  including himself. Harvey appoints 50,000 of
  trust property to his sister, Lilly.
• Harvey is deemed to have made a 50,000 gift to
  Lilly.
• Why?
• Because he could have appointed the property to
  himself.

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General Powers of Appointment

• A power that can be exercised under any
  conditions is a general power of appointment.
  Implied under a general power of appointment is
  that the holder may exercise that power, thus
  appointing the property to
• Him/herself
• His/her creditors
• His/her estate
• Creditors of his/her estate

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Estate Inclusion of General Powers

• Property subject to a general power of
  appointment is included in the estate of the
  holder of such power.
• Why?
• If the holder had the right to assume the
  property, s/he had the power to transfer that
  property.
• Thus TRANSFER tax applies
• At death, estate tax
• Lapsing a power during life, gift tax
• attributable to year when power lapsed or
  released

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Special/Limited Powers of Appointment

• If the holder may exercise the power, appointing
  the property only under specific conditions or
  only to a predetermined list of beneficiaries,
  the power becomes a special (limited) power of
  appointment.
• Implied in a special power of appointment is that
  the holder may not appoint the property to
• Him/herself
• His/her creditors
• His/her estate
• Creditors of his/her estate
• Because the holder of the special power has no
  right to transfer the property to him/herself (or
  financial equivalents) the holder is not deemed
  to transfer property upon death or annual lapse
• Thus, neither estate nor gift tax is triggered

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Five or Five Power

• Under a 5 or 5 power (also called a 5 and 5
  power) the holder of an otherwise general power
  of appointment must include in his/her estate
  only the property subject to the 5 or 5 power.
• The 5 or 5 power enables the holder to appoint to
  him/herself only the greater of
• 5,000 or
• 5 of the trust principal (corpus)
• Thus, only that amount is included in the
  holders estate upon death
• Nothing is included for federal gift tax purposes
  upon the lifetime annual lapse of a 5 or 5 power

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5 or 5 Power Example

• Albert is granted a 5 or 5 power over a trust
  holding 2 million in property. When Albert dies,
  only 100,000 is included in his gross estate.
• 2,000,000 x 5 100,000
• Greater than 5,000
• Had Albert lived through the year not exercising
  his power he would NOT be deemed to have made a
  gift to other beneficiaries
• In the absence of the 5 or 5 power, the annual
  lapse of the right to appoint property to oneself
  is deemed a gift to other beneficiaries
• May be subject to federal gift tax

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Powers Subject to an Ascertainable Standard

• If the holders right to appoint trust property
  to himself, and/or creditors is subject to an
  ascertainable standard, such property is not
  considered subject to treatment as a general
  power of appointment. The allowable ascertainable
  standards are (only)
• Health
• Virtually all bona fide expenses including LTC
• Education
• Maintenance
• Support
• Maintenance and support not required to be at
  basic levels

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Why Is Ascertainable Standard Property Not
Included in Gross Estate?

• Ascertainable standard triggered withdrawals
  (HEMS) are not included in the recipients estate
  under the presumption that withdrawals for
  health, education, maintenance and support will
  be consumed rather than transferred to another.

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Characteristics Shared by Gift and Estate Tax

• Gift and estate taxes are both
• Cumulative for all taxable transfers
• Subject to a progressive tax rate
• More transferred higher transfer tax rate
• Each tax has applicable credit and exemption
  amount
• Gift tax credit remains 1,772,800 representing
  5,120,000 in lifetime transfer
• 2012 estate tax credit is 1,77,800 representing
  5,120,000 in property transferred at death
• Unlimited marital deduction
• Unlimited charitable deduction

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Question 3-12

• Which of the following operates under a
  progressive tax system?
• Federal estate tax
• Federal gift tax
• Municipal interest tax
• Both A and B

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Characteristics Unique to Estate Tax

• Certain characteristics are unique to federal
  estate tax including
• Inability to split post death transfers
• Although spousal exemption portability is
  available
• No annual estate tax exclusion
• Basis steps up
• For income tax purposes when heir sells inherited
  property
• Unlike the gift tax, the estate tax is considered
  tax inclusive because the donee receives the
  bequeathed property, less the estate tax owed on
  it.
• Alternate valuation date may be available

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Tax Exclusive Example

• In 2012, Alice dies and leaves a bequest of
  200,000 to her daughter, Tiffany. Since this is
  a bequest, the entire 200,000 would be liable
  for its share of the estate tax. In addition,
  since estate tax is measured tax inclusively.
  Given the 35 estate tax rate applied to
  200,000, only 130,000 would actually go to
  Tiffany.