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					              HALF DAY

     TAX CAMP™
           TAKING THE INTIMIDATION OUT OF
            THE INTERNAL REVENUE CODE
             FOR THE ESTATE PLANNER




          © 2011 WealthCounsel, LLC
Providing Knowledge & Tools for the Estate Planning Community


                    WealthCounsel, LLC
               Email:info@wealthcounsel.com
                    Phone: 888-659-4069
                      Fax: 888-292-6126




                              i                © 2011 WealthCounsel, LLC
                              PETER J. PARENTI
PETER J. PARENTI is a Wealth Strategies Estate Planning and Tax Attorney in private prac-
tice in the Law Offices of Peter J. Parenti, a Professional Corporation located at 20 Carriage Hills,
San Antonio, Texas 78257, Telephone (210) 698-3431, Fax (210) 568-6730, Mobile (210) 573-
8565, Email: peter.parenti@wealthcounsel.com.

Mr. Parenti received his Doctor of Jurisprudence (J.D.) degree from St. Mary's University School
of Law in 1973, and his Master of Laws (LL.M.) degree in Taxation from New York University
School of Law in 1974. He is also one of the very few attorneys in the state of Texas who is Board
Certified as a specialist in both Tax Law and Estate Planning and Probate Law by the State Bar of
Texas Board of Legal Specialization. Mr. Parenti has been an Adjunct Professor of Tax law at St.
Mary's University School of Law since 1975 where he taught courses in Federal Income Taxation,
Federal Business Entities Taxation, Estate Planning and Advanced Wealth Strategies Planning. He
was formerly a member of the Adjunct Faculty of the University Of Texas Health Science Center --
Lecturer on Business Entities.

Other than Advanced Wealth Strategies Planning, Estate Planning, Probate and Tax Law, Mr.
Parenti also handles Real Estate Transactions, Business Entities Planning, Business Buy-outs and
Sell-outs, Charitable Estate Planning, Living Trusts, Family Limited Partnership Creation and De-
sign and Asset Protection Estate Planning.

Mr. Parenti has also been a frequent lecturer in the areas of Federal Taxation, Business Entities,
Wills, Living Trusts, Probate and Estate Planning, Asset Protection Estate Planning, Family Lim-
ited Partnerships, and Charitable Estate Planning. He welcomes invitations to speak on any of the-
se topics.

Mr. Parenti is also a principal member of WealthCounsel, LLC (formerly The Jackson Group), an
advanced wealth strategies design and educational collaborative, and a principal member of the
WealthCounsel Advisors Forum, LLC.

Mr. Parenti is available for mentoring and co-counseling with other profes-
sionals.

Mr. Parenti has authored and co-authored many books and articles on estate planning for both the
public and the professional. His most current books for the public are LEGACY, Plan, Protect
and Preserve Your Estate and GENERATIONS – Planning Your Legacy. His most current pub-
lication for professionals is a six-volume set of books known as “The Family Limited Partnership
Practice System Compendium”.

                                   PETER J. PARENTI
                                 The Co-Counsel/Mentor
                        20 Carriage Hills, San Antonio, Texas 78257
            Telephone (210) 698-3431, Fax (210) 568-6730, Mobile (210) 573-8565
                          Email: peter.parenti@wealthcounsel.com



                                                 ii                      © 2011 WealthCounsel, LLC
                           TABLE OF TITLES

        THE CONSTITUTION OF THE UNITED STATES

                   Article I, Section 9, Clause 3

                            Amendment 16


       THE ECONOMIC GROWTH AND TAX RELIEF
             RECONCILIATION ACT OF 2001
 Title IV – Compliance with Congressional Budget Act
        Section 901, Sunset of Provisions of Act


                    UNITED STATES CODE

   INTERNAL REVENUE CODE - TITLE—26 USC

                           TABLE OF SUBTITLES

SUBTITLE                                                                   SECTION

*A. INCOME TAXES                                                                1
*B. ESTATE AND GIFT TAXES                                                    2001
      C. Employment Taxes                                                 3101
*D. MISCELLANEOUS EXCISE TAX                                                 4001
      E. Alcohol, Tobacco, and Certain Other Excise Taxes                 5001
                                      iii                   © 2011 WealthCounsel, LLC
*F. PROCEDURE AND ADMINISTRATION                                         6000
      G. The Joint Committee on Taxation                              8001
      H. Financing of Presidential Election Campaigns                 9001
      I. Trust Fund Code                                              9501
      J. Coal Industry Health Benefits                                9701
      K. Group Health Plan Requirements                               9801




                                      iv                © 2011 WealthCounsel, LLC
                                   TITLE 26 USC

                        INTERNAL REVENUE CODE

                 TABLE OF CHAPTERS IN SUBTITLES

                            *SUBTITLE A. INCOME TAXES

CHAPTER                                                                           SECTION

*1. NORMAL TAXES AND SURTAXES                                                           1

2.   Tax on Self-Employment Income                                                  1401

3.   Withholding of Tax on Nonresident Aliens and Foreign Corporations              1441

4.   Rules Applicable to Recovery of excessive Profits on Government
     Contracts [Repealed]                                                           1471

5.   Tax on Transfers to Avoid Income Tax [Repealed]                                1491

6.   Consolidated Returns                                                           1501

                   *SUBTITLE B. ESTATE AND GIFT TAXES
*11.   ESTATE TAX                                                                   2001
*12.   GIFT TAX                                                                     2501
*13.   TAX ON GENERATION-SKIPPING TRANSFERS                                         2601
*14.   SPECIAL VALUATION RULES                                                      2701

                            SUBTITLE C. EMPLOYMENT TAXES

21. Federal Insurance Contributions Act                                             3101
22. Railroad Retirement Tax Act                                                     3201
23. Federal Unemployment Tax Act                                                    3301
23A.Railroad Unemployment Repayment Tax                                             3321
24. Collection of Income Tax at Source on Wages                                     3401
25. General Provisions Relating to Employment Taxes                                 3501


                                             v                    © 2011 WealthCounsel, LLC
Chapter                                                                         Section

               *SUBTITLE D. MISCELLANEOUS EXCISE TAXES
31.   Retail Excise Taxes                                                           4001
32.   Manufacturers Excise Tax                                                      4061
33.   Facilities and Services                                                       4231
34.   Policies Issued by Foreign Insurers                                           4371
35.   Taxes on Wagering                                                             4401
36.   Certain Other Excise Taxes                                                    4461
37.   Sugar [Repealed]                                                              4501
38.   Environmental Taxes                                                           4611
39.   Registration-Required Obligations                                             4701
40.   General Provisions Relating to Occupational Taxes                             4901
*41. PUBLIC CHARITIES                                                              4911
*42. PRIVATE FOUNDATIONS; & CERTAIN OTHER TAX
     EXEMPT ORGANIZATIONS                                                          4940
43. Qualified Pension, Etc., Plans                                                  4971
44. Qualified Investment Entities                                                   4981
45. Windfall Profit Tax on Domestic Crude Oil [Repealed]                            4986
46. Golden Parachute Payments
4999
47. Certain Group Health Plans                                                      5000

Subtitle E. Alcohol, Tobacco, and Certain Other Excise Taxes
51.   Distilled Spirits, Wines, and Beer                                            5001
52.   Tobacco Products and Cigarette Papers and Tubes                               5701
53.   Machine Guns, Destructive Devices, and Certain Other Firearms                 5801
54.   Greenmail                                                                     5881


                   *SUBTITLE F. PROCEDURE AND ADMINISTRATION
*61. INFORMATION AND RETURNS                                                        6001
*62. TIME AND PLACE FOR PAYING TAX                                                  6151
*63. ASSESSMENT                                                                     6201
*64. COLLECTION                                                                     6301
65. Abatements, Credits, and Refunds                                                6401




                                              vi                  © 2011 WealthCounsel, LLC
Chapter                                                                Section

*66. LIMITATIONS                                                           6501
*67. INTEREST                                                              6601
*68. ADDITIONS TO THE TAX, ADDITIONAL AMOUNTS, AND ASSESSABLE
PENALTIES                                                                  6651
69. General Provisions Relating to Stamps                                  6801
*70. JEOPARDY, RECEIVERSHIP, ETC.                                          6851
*71. TRANSFEREES AND FIDUCIARIES                                           6901
72. Licensing and Registration                                             7001
73. Bonds                                                                  7101
74. Closing Agreements and Compromises                                     7121
*75. CRIMES, OTHER OFFENSES, AND FORFEITURES                               7201
*76. JUDICIAL PROCEEDINGS                                                  7401
*77. MISCELLANEOUS PROVISIONS                                              7501
78. Discovery of Liability and Enforcement of Title                        7601
*79. DEFINITIONS                                                           7701
*80. GENERAL RULES                                                         7801

                 SUBTITLE G. THE JOINT COMMITTEE ON TAXATION
91. Organization and Membership of the Joint Committee                     8001
92. Powers and Duties of the Joint Committee                               8021

        SUBTITLE H. FINANCING OF PRESIDENTIAL ELECTION CAMPAIGNS
95. Presidential Election Campaign Fund                                    9001
96. Presidential Primary Matching Payment Account                          9031

                           SUBTITLE I. TRUST FUND CODE
98. Trust Fund Code                                                        9501

                  SUBTITLE J. COAL INDUSTRY HEALTH BENEFITS
99. Coal Industry Health Benefits                                          9701

                SUBTITLE K. GROUP HEALTH PLAN REQUIREMENTS
100. Group Health Plan Requirements                                        9801




                                             vii         © 2011 WealthCounsel, LLC
                                          Tax Camp 2008
                                        TABLE OF CONTENTS

                                          U.S. CONSTITUTION,
 ARTICLE 1, Section 9, Clause 3……………………………...…....……….xxiii
 AMENDMENT 16, (Adopted in 1913)……………...………………..…….xxiii

THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF
                        2001,
 (HR 1836- RELIEF Act of 2001)
 TITLE IX – COMPLIANCE WITH CONGRESSIONAL BUDGET ACT
 SEC. 901. SUNSET OF PROVISIONS ACT………………….…….…...xxiv


          Table of Subtitles...............................................................................iii
Subtitle      Section.......................................................................................................... iii
*A. Income Taxes          1 .................................................................................................. iii
*B. Estate and Gift Taxes 2001 .................................................................................... iii
*D. Miscellaneous Excise Tax 4001 ............................................................................ iii
*F. Procedure and Administration 6000 .................................................................. iv
TABLE OF CHAPTERS IN SUBTITLES ...................................................... v
*Subtitle A. Income Taxes......................................................................................... v
Chapter     Section........................................................................................................... v
 *1. Normal Taxes and Surtaxes 1 ................................................................. v
*Subtitle B. Estate and Gift Taxes ....................................................................... v
  *11. Estate Tax 2001 v
  *12. Gift Tax 2501 .......................................................................................... v
  *13. Tax on Generation-Skipping Transfers 2601...................................... v
  *14. Special Valuation Rules 2701 ................................................................ v
Subtitle C. Employment Taxes ........................................................................................ v
*Subtitle D. Miscellaneous Excise Taxes ........................................................ vi
  *41. Public Charities 4911 ............................................................................. vi
  *42. Private Foundations; & Certain Other Tax ........................................... vi
  Exempt Organizations 4940 .......................................................................... vi
*Subtitle F. Procedure and Administration ............................................................... vi
                                                               viii                           © 2011 WealthCounsel, LLC
  *61. Information and Returns 6001 ............................................................. vi
  *62. Time and Place for Paying Tax 6151 ................................................... vi
  *63. Assessment6201 vi
  *64. Collection 6301 vi
  *66. Limitations        6501 ............................................................................. vii
  *67. Interest    6601 ........................................................................................ vii
  *68. Additions to the Tax, Additional Amounts, and Assessable ................ vii
  Penalties 6651 .............................................................................................. vii
  *70. Jeopardy, Receivership, Etc. 6851...................................................... vii
  *71. Transferees and Fiduciaries 6901........................................................ vii
  *75. Crimes, Other Offenses, and Forfeitures 7201 .................................. vii
  *76. Judicial Proceedings 7401 .................................................................... vii
  *77. Miscellaneous Provisions 7501 ............................................................ vii
  *79. Definitions 7701 vii
  *80. General Rules 7801 ............................................................................. vii
Subtitle G. The Joint Committee on Taxation ......................................................... vii
Subtitle H. Financing of Presidential Election Campaigns ................................. vii
Subtitle I. Trust Fund Code ........................................................................................... vii
Subtitle J. Coal Industry Health Benefits.................................................................. vii
Subtitle K. Group Health Plan Requirements ......................................................... vii
*****************************************************************
********************* ..................................................................................................... 1
*****************************************************************
********************* ..................................................................................................... 1
Title 26       Internal Revenue Code ........................................................................... 1
Subtitle A           (§§1-1564) Income Taxes ............................................................ 1
  Chapter 1         Normal Taxes and Surtaxes ................................................ 1
       Subchapter A               Determination of Tax Liability ........................... 1
       Part           Tax on Individuals ............................................................... 1
 §1            Tax Imposed ..................................................................................... 1
 §2            Definition And Special Rules .......................................................... 1
 §3            Tax Tables For Individuals ............................................................. 1
       Part II Tax on Corporations ....................................................................... 1
 §11           Tax Imposed ..................................................................................... 1
       Subchapter B       Computation of Taxable Incom .................................. 2
       Part I Definition of Gross Income, ............................................................ 2
       Adjusted Gross Income, Taxable Income, Etc. ........................................... 2
 §61           Gross Income Defined ..................................................................... 2
       Part II Items Specifically Included in Gross IncomeError! Bookmark not defined.2
                                                      ix                       © 2011 WealthCounsel, LLC
     Part III Items Specifically Excluded From Gross Income ......................... 2
§101          Certain Death Benefits .................................................................... 2
§102          Gifts and Inheritances ..................................................................... 5

     Subchapter C       Corporate Distributions and Adjustments ................ 5
     Part I Distributions by Corporations........................................................ 5
       Subpart A        Effects on Recipients .......................................................5
§301          Distributions of Property ................................................................ 5
§302          Distributions in Redemption of Stock ............................................ 6
§303          Distributions in Redemption of Stock to Pay Death Taxes .......... 8
       Subpart C        Definitions; Constructive Ownership of Stock.............8
§316          Dividend Defined ............................................................................. 8
§317          Other Definitions ............................................................................. 9
§318          Constructive Ownership of Stock .................................................. 9
     Part II Corporate Liquidations ................................................................. 10
       Subpart A        Effects on Recipients .....................................................10
§331          Gain or Loss to Shareholders in Corporate Liquidations ......... 10
§332          Complete Liquidation of Subsidiaries ......................................... 10
§334          Basis of Property Received in Liquidations ................................ 11
       Subpart B        Effects on Corporation .................................................11
§336          Gain or Loss Recognized on Property Distributed in Complete
                        Liquidation .................................................................... 11
§337          Nonrecognition for Property Distributed to Parent in
                        Complete Liquidation of Subsidiary ........................... 11
§338          Certain Stock Purchases Treated as Asset Acquisitions ............ 11
     Part III Corporate Organizations and Reorganizations .......................... 12
       Subpart A        Corporate Organizations..............................................12
§351          Transfers to Corporations Controlled by Transferor ................ 12
       Subpart C        Effects on Corporations................................................13
§368          Definitions Relating to Corporate Reorganization ..................... 13
     Part I      Corporations Improperly Accumulating Surplus ................. 15
§531-§537 Corporations Improperly Accumulating Surplus; Imposition
                        of Accumulated Earnings Tax ..................................... 15
     Part II Personal Holding Companies ....................................................... 15
§541-§545 Personal Holding Companies; Imposition of Personal Holding
                        Company Tax ................................................................ 15
     Subchapter J       Estates, Trusts, Beneficiaries, and Decedents ......... 17
     Part I Estates, Trusts, and Beneficiaries................................................. 17
                                                     x                        © 2011 WealthCounsel, LLC
       Subpart A      General Rules for Taxation of Estates and Trusts.....17
§641        Imposition of Tax ........................................................................... 17
§642        Special Rules for Credits and Deductions ................................... 17
§643        Definitions Applicable to Subparts A, B, C and D ..................... 18
§644        Taxable Year of Trusts .................................................................. 19
§645        Certain Revocable Trusts Treated as Part of Estate .................. 19
       Subpart B      Trusts Which Distributed Current Income Only ......20
§651        Deduction For Trusts Distributing Current Income Only ........ 20
§652        Inclusion of Amounts in Gross Income of Beneficiaries of
                      Trusts ............................................................................. 21
       Subpart C      Estates and Trusts Which May Accumulate Income 22
       or Which May Distribute Corpus ...........................................................22
§661        Deduction For Estates and Trusts Accumulating Income Or
                      Distributing Corpus ...................................................... 22
§662        Inclusion of Amounts in Gross Income of Beneficiaries of
                      Estates and Trusts Accumulating Income or
                      Distributing Corpus ..................................................... 22
§663        Special Rules Applicable to Sections 661 and 662 ...................... 23
§664        Charitable Remainder Trusts ....................................................... 24
       Subpart D      Treatment of Excess Distributions by Trusts .............26
§665        Definitions Applicable to Subpart D ............................................ 26
§666        Accumulation Distribution Allocated to Preceding Years ......... 26
§667        Treatment of Amounts Deemed Distributed by Trust in
                      Preceding Years ............................................................ 27
§668        Interest Charge on Accumulation Distributions from Foreign
                      Trusts ............................................................................. 27
       Subpart E                  Grantors and Others Treated as
                Substantial Owners .................................................................28
§671        Trust Income, Deductions, and Credits Attributable to
                      Grantors and Others as Substantial Owners ............. 28
§672        Definitions and Rules as Substantial Owners ............................. 29
§673        Reversionary Interests................................................................... 29
§674        Power to Control Beneficial Enjoyment ...................................... 30
§675        Administrative Powers .................................................................. 32
§676        Power to Revoke ............................................................................ 33
§677        Income for Benefit of Grantor ...................................................... 33
§678        Person Other than Grantor Treated as Substantial Owner ...... 34
§679        Foreign Trusts Having One or More United States
                      Beneficiaries................................................................... 36
                                                  xi                        © 2011 WealthCounsel, LLC
       Subpart F       Miscellaneous................. Error! Bookmark not defined.83
§681         Limitation on Charitable DeductionError! Bookmark not defined.83
§682         income of estate or trust in case of divorce, etc.Error! Bookmark not defined.84
§683         Use of Trust as an Exchange fund Error! Bookmark not defined.85
§684         Recognition of Gain on Certain Transfers to Certain Foreign
                       Trusts and Estates and Nonresident AliensError! Bookmark not defi
§685         treatment of funeral trusts ............ Error! Bookmark not defined.87
     Part II Income in Respect of Decedents ................................................... 37
§691         Recipients of Income in Respect of Decedents ............................ 37
§692         Income Taxes on Members of the Armed Forces, Astronauts
                       and Victims of Certain Terrorist Attacks on Death .. 38
     Subchapter K      Partnerships & Partners ........................................... 41
     Part I Determination of Tax Liability ..................................................... 41
§701         Partner, Not Partnership, Subject to Tax ................................... 41
§702         Income and Credit of Partners ..................................................... 41
§703         Partnership Computations............................................................ 41
§704         Partner’s Distributive Share......................................................... 41
§705         Determination of Basis of Partner’s Interest .............................. 42
§706         Taxable Years of Partner and Partnership ................................. 43
§707         Transactions Between Partner and Partnership ........................ 43
§708         Continuation of Partnership ......................................................... 45
§709         Treatment of Organizations and Syndication Fees .................... 46
     Part II Contributions, Distributions, and Transfers ............................... 47
       Subpart A       Contributions to a Partnership....................................47
§721         Nonrecognition of Gain or Loss on Contribution ....................... 47
§722         Basis of Contributing Partner’s Interest ..................................... 48
§723         Basis of Property Contributed to Partnership ............................ 48
§724         Character of Gain or Loss on Contributed Unrealized
                       Receivables, Inventory Items, and Capital Loss
                       Property ......................................................................... 49
       Subpart B       Distributions by a Partnership ....................................49
§731         Extent of Recognition of Gain or Loss on Distribution .............. 49
§732         Basis of Distributed Property Other than Money ...................... 50
§733         Basis of Distributee Partner’s Interest ........................................ 51
§734         Optional Adjustment to Basis of Undistributed Partnership
                       Property ......................................................................... 51
§735         Character of Gain or Loss on Disposition of Distributed
                       Property ......................................................................... 52
§736         Payments to A Retiring Partner or Deceased Partner’s
                                           xii                   © 2011 WealthCounsel, LLC
                           Successors in Interest .................................................... 52
§737          Recognition of Pre-contribution Gain in Case of Certain
                           Distributions to Contributing Partner ........................ 52
       Subpart C           Transfers of Interests in a Partnership .......................54
§741          Recognition and Character of Gain or Loss on Sale or
                           Exchange ........................................................................ 54
§742          Basis of Transferee Partner’s Interest ......................................... 54
§743          Optional Adjustments to Basis of Partnership Property ........... 54
       Subpart D           Provisions Common to Other Subparts ......................55
§751          Unrealized Receivables and Inventory Items .............................. 55
§752          Treatment of Certain Liabilities................................................... 56
§753          Partner Receiving Income in Respect of Decedent ..................... 56
§754          Manner of Electing Optional Adjustment to Basis of
                           Partnership Property .................................................... 56
§755          Rules For Allocation of Basis ........................................................ 57
     Part III Definitions....................................................................................... 57
§761          Terms Defined ................................................................................ 57
     Subchapter O          Gains and Losses on Disposition of Property .......... 59
     Part I Determination of Amount of and Recognition of Gain or
              Loss ................................................................................................. 59
§1001         Determination of Amount and Recognition of Gain or Loss ..... 59
     Part II Basis Rules of General Application .............................................. 59
§1011         Adjusted Basis for Determining Gain or Loss ............................ 59
§1012         Basis of Property Cost ................................................................... 59
§1014         Basis of Property Acquired From a Decedent ............................ 60
§1015         Basis of Property Acquired by Gift and Transfers in Trust...... 60
§1016         Adjustments to Basis ................... Error! Bookmark not defined.112


§1244       Losses on Small Business Stock .. Error! Bookmark not defined.131
     Part V Special Rules for Bonds and other Debt Instruments ................ 61
       Subpart A      Original Issue Discount ................................................61
§1274       Determination of Issue Price of Certain Debt Instruments
                      Issued for Property ....................................................... 61
§1274(d)    Determination of Applicable Federal Rate (AFR) ...................... 61
     Subchapter S     S Corporations ........................................................... 63
     Part I In General ....................................................................................... 63
§1361       S Corporation Defined .................................................................. 63
§1362       Election; Revocation; Termination .............................................. 73
                                                       xiii                         © 2011 WealthCounsel, LLC
 §1363         Effect of Election on Corporation ................................................ 74
      Part II Tax Treatment of Shareholders ................................................... 74
 §1366         Pass Through of Items to Shareholders ....................................... 74
 §1367         Adjustments to Basis of Stock of Shareholders, Etc. .................. 75
 §1368         Distributions ................................................................................... 76
      Part III Special Rules .................................................................................. 76
 §1371         Coordination with Subchapter C ................................................. 76
 §1372         Partnership Rules to Apply for Fringe Benefits Purposes ......... 77
 §1373         Foreign Income .............................................................................. 77
 §1374         Tax on Certain Built-In Gains ...................................................... 77
 §1375         Tax Imposed When Passive Investment Income of
                          Corporation Having Accumulated Earnings and
                          Profit Exceeds 25 Percent of Gross Receipts .............. 78
      Part IV Definitions; Miscellaneous ............................................................ 78
 §1377         Definitions and Special Rule ......................................................... 78
 §1378         Taxable Year of S Corporation .................................................... 79
 §1379         Transitional Rules on Enactment ................................................. 79
Subtitle B     Estate and Gift Taxes ............................................................................ 80
  Chapter 11       Estate Tax ............................................................................. 80
      Subchapter A        Estates of Citizens or Resident.................................. 80
      Part I Tax Imposed ................................................................................... 80
 §2001         Imposition and Rate of Tax .......................................................... 80
 §2002         Liability for Payment .................................................................... 80
      Part II Credits Against Tax ....................................................................... 81
 §2010         Unified Credit Against Estate Tax ............................................... 81
 §2011         Credit for State Death Taxes ........................................................ 83
 §2012         Credit for Gift Taxes ..................................................................... 84
 §2013         Credit for Tax on Prior Transfers ............................................... 84
 §2014         Credit for Foreign Death Taxes.................................................... 84
 §2015         Credit for Death Taxes on Remainders ....................................... 84
 §2016         Recovery of Taxes Claimed as Credit .......................................... 85
      Part III Gross Estate.................................................................................... 85
 2031          Definition of Gross Estate ............................................................. 85
 §2032         Alternate Valuation ....................................................................... 87
 §2032A        Valuation of Certain Farm, etc., Real Property ......................... 87
 §2033         Property in Which Decedent Had an Interest............................. 88
 §2034         Dower or Courtesy Interests ......................................................... 89
 §2035         Adjustments For Certain Gifts Made Within 3 Years of
                          Decedent’s Death........................................................... 89
                                                       xiv                        © 2011 WealthCounsel, LLC
§2036        Transfers With Retained Life Estate ........................................... 91
§2037        Transfers Taking Effect on Death ................................................ 92
§2038        Revocable Transfers ...................................................................... 93
§2039         Annuities ........................................................................................ 93
§2040        Joint Interests ................................................................................. 95
§2041        Powers Of Appointment ................................................................ 95
§2042        Proceeds of Life Insurance ............................................................ 97
§2043        Transfers For Insufficient Consideration .................................... 97
§2044        Certain Property For Which Marital Deduction Was
                        Previously Allowed ....................................................... 98
§2045        Prior Interests ................................................................................ 99
§2046        Disclaimers ..................................................................................... 99
     Part IV Taxable Estate .............................................................................. 100
§2051        Definition of Taxable Estate ....................................................... 100
§2052        Exemption (repealed) .................................................................. 100
§2053        Expenses, Indebtedness, and Taxes............................................ 100
§2054        Losses 101
§2055        Transfers for Public, Charitable, and Religious Uses .............. 101
§2056        Bequests, Etc., to Surviving Spouse ........................................... 103
§2056A       Qualified Domestic Trust ............................................................ 104
§2057        Family-Owned Business Interest ................................................ 105
§2058        State Death Taxes ........................................................................ 106
     Subchapter B       Estates of Nonresidents and Not Citizens .............. 107
§2101        Tax Imposed ................................................................................. 107
§2102        Credits Against Tax ..................................................................... 107
§2103        Definition of Gross Estate ........................................................... 108
§2104        Property Within the United States ............................................. 108
§2105        Property Without the United States .......................................... 108
§2106        Taxable Estates ............................................................................ 109
§2107        Expatriation to Avoid Tax .......................................................... 109
§2108        Application of Pre-1967 Estate Tax Provisions ........................ 109
     Subchapter C       Miscellaneous............................................................ 110
§2201        Combat Zone Related Deaths of Members of the Armed
                        Forces, Deaths of Astronauts, and Deaths of Victims
                        of Certain Terrorist Attacks ...................................... 110
§2203        Definition of Executor ................................................................. 111
§2204        Discharge of Fiduciary From Personal Liability ...................... 111
§2205        Reimbursement Out of Estate .................................................... 112
§2206        Liability of Life Insurance Beneficiaries ................................... 112
                                                      xv                         © 2011 WealthCounsel, LLC
§2207       Liability of Recipient of Property Over Which Decedent Had
                       Power of Appointment ............................................... 113
§2207A      Right of Recovery in the Case of Certain Marital Deduction
                       Property ....................................................................... 113
§2207B      Right of Recovery Where Decedent Retained Interest ............ 114
§2208       Certain Residents of Possessions Considered Citizens of the
                       United States ................................................................ 114
§2209       Certain Residents of Possessions Considered Nonresidents Not
                       Citizens of the United States ...................................... 114
§2210       Termination .................................................................................. 115
 Chapter 12     Gift Tax………………………………………………........116
     Subchapter A      Determination of Tax Liability ............................... 116
§2501       Imposition of Tax ......................................................................... 116
§2502       Rate of Tax ................................................................................... 117
§2503       Taxable Gifts ................................................................................ 117
§2504       Taxable Gifts for Preceding Calendar Periods ......................... 118
2505        Unified Credit Against Gift Tax ................................................. 119
     Subchapter B      Transfers ................................................................... 120
§2511       Transfers in General.................................................................... 120
§2512       Valuation of Gifts......................................................................... 120
§2513       Gift by Husband or Wife to Third Party ................................. 1210
§2514       Powers of Appointment ............................................................... 121
§2515       Treatment of Generation-Skipping Transfer Tax .................... 122
§2516       Certain Property Settlements ..................................................... 122
§2518       Disclaimers ................................................................................... 122
§2519       Dispositions of Certain Life Estates ........................................... 123
     Subchapter C      Deductions ................................................................ 124
§2522       Charitable and Similar Gifts ...................................................... 124
§2523       Gift to Spouse ............................................................................... 125
§2524       Extent of Deductions ................................................................... 126
 Chapter 13     Tax on Generation-Skipping Transfers ........................... 127
     Subchapter A      Tax Imposed ............................................................. 127
§2601       Tax Imposed ................................................................................. 127
§2602       Amount of Tax ............................................................................. 127
§2603       Liability of Tax............................................................................. 128
§2604       Credit for Certain State Taxes ................................................... 129
     Subchapter B      Generation-Skipping Transfers .............................. 130
§2611       Generation-Skipping Transfer Defined ..................................... 130
§2612       Taxable Termination; Taxable Distribution; Direct Skip ....... 131
                                                    xvi                       © 2011 WealthCounsel, LLC
§2613       Skip Person and Non-Skip Person Defined ............................... 132
     Subchapter C     Taxable Amount ....................................................... 133
§2621       Taxable Amount in Case of Taxable Distribution .................... 133
§2622       Taxable Amount in Case of Taxable Termination ................... 133
§2623       Taxable Amount in Case of Direct Skip .................................... 134
§2624       Valuation ...................................................................................... 134
     Subchapter D     GST Exemption ........................................................ 136
§2631       GST Exemption............................................................................ 136
§2632       Special Rules for Allocation of GST Exemption ....................... 137
     Subchapter E     Applicable Rate, Inclusion Ratio ............................ 140
§2641       Applicable Rate ............................................................................ 140
§2642       Inclusion Ratio ............................................................................. 140
     Subchapter F     Other Definitions and Special Rules ...................... 144
§2651       Generation Assignment ............................................................... 144
§2652       Other Definitions ......................................................................... 144
§2653       Taxation of Multiple Skips .......................................................... 145
§2654       Special Rules ................................................................................ 146
     Subchapter G     Administration ......................................................... 147
§2661        Administration ............................................................................ 147
§2662       Return Requirements .................................................................. 147
§2663       Regulations ................................................................................... 148
§2664       Termination .................................................................................. 148
     Chapter 14       Special Valuation Rules ........................................... 149
§2701       Special Valuation Rules in Case of Transfers of Certain
                      Interests to Corporations or Partnerships................ 149
§2702       Special Valuation Rules in Case of Transfers of Interests in
                      Trusts ........................................................................... 150
§2703       Certain Rights and Restrictions Disregarded ........................... 151
§2704       Treatment of Certain Lapsing Rights and Restrictions ........... 152

 Chapter 79     Definitions ........................................................................... 154
§7701       Definitions..................................................................................... 154
§7702       Life Insurance Contract Defined ................................................ 158
§7702A      Modified Endowment Contract Defined ................................... 158
§7703       Determination of Marital Status ................................................ 159
§7704       Certain Publicly Traded Partnerships Treated as
                      Corporations................................................................ 159
 Chapter 80     General Rules...................................................................... 161
    Subchapter A      Application of Internal Revenue Laws .................. 161
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§7801       Authority of Department of the Treasury ................................. 161
§7805       Rules and Regulations ................................................................. 161
     Subchapter C    Provisions Affecting More than One Subtitle ....... 163
§7872       Treatment of Loans with Below-Market Interest Rates .......... 163




                                               xviii                    © 2011 WealthCounsel, LLC
                              U.S. CONSTITUTION

                                   ARTICLE 1
                                       Section 9
                                       Clause 3

     “No capitation or other direct tax shall be laid, unless in
proportion to the census or enumeration herein before di-
rected to be taken.”

                             U.S. CONSTITUTION

                                AMENDMENT 16
                                (Adopted in 1913)

      “The Congress shall have power to lay and collect taxes on in-
comes, from whatever source derived, without apportionment among
the several states, and without regard to any census or enumeration.”
IMPORTANCE
The 16th Amendment overrides Article 1, Section 9, Clause 3, and as such allows
a direct tax on income from whatever source derived


CROSS REFERENCE
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes and Surtaxes
          Subchapter B, Computation of Taxable Income
               Part I   Definition of Gross Income, Adjusted Gross Income, Taxable Income,
                        Etc.
                        §61 Gross Income Defined




                                           xix                   © 2011 WealthCounsel, LLC
THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF
                        2001

                   (HR 1836- RELIEF Act of 2001)

     TITLE IX – COMPLIANCE WITH CONGRESSIONAL BUDGET
                          ACT

    SEC. 901. SUNSET OF PROVISIONS ACT.

          (a) IN GENERAL – all provisions of, and amendments made by,
                this Act shall not apply -

                (1)    to taxable, plan, or limitation years beginning after
                       December 31, 2012, or

                (2)   in the case of title V, to estates of decedents dying, gifts
                      made, or generation skipping transfers, after Decem-
                      ber 31, 2012.

          (b) APPLICATION OF CERTAIN LAWS – The Internal Revenue
               Code of 1986 and the Employee Retirement Income Security
               Act of 1974 shall be applied and administered to years, es-
               tates, gifts, and transfers described in subsection (a) as if the
               provisions and amendments described in subsection (a) had
               never been enacted.

     And the Senate agrees to the same.


    Note: As used herein, all references to The Economic Growth and Tax
    Relief Reconciliation Act of 2001 shall hereinafter be referred to as “HR
    1836 RELIEF Act of 2001”.

    Important Note: It is important to note that all references herein to HR
    1836 RELIEF Act of 2001, sunset on or before December 31, 2012, and
    provided above in §901.


                                     xx                  © 2011 WealthCounsel, LLC
‘‘Tax Relief, Unemployment Insurance Reauthorization, and
                 Job Creation Act of 2010’’

           Senate Amendment to House Amendment
                   to Senate Amendment:

Resolved, That the bill from the House of Representatives (H.R. 4853) enti-
tled ‘‘An Act to amend the Internal Revenue Code of 1986 to extend the
funding and expenditure authority of the Airport and Airway Trust Fund, to
amend title 49, United States Code, to extend authorizations for the airport
improvement program, and for other purposes.’’, do pass with the following:

In lieu of the matter proposed to be inserted, insert the following:

SECTION 1. SHORT TITLE; ETC.

(a) SHORT TITLE.—This Act may be cited as the ‘‘Tax Relief, Unemployment
Insurance Reauthorization, and Job Creation Act of 2010’’.

(b) AMENDMENT OF 1986 CODE.—Except as otherwise expressly provided,
whenever in this Act an amendment or repeal is expressed in terms of an
amendment to, or repeal of, a section or other provision, the reference shall
be considered to be made to a section or other provision of the Internal Rev-
enue Code of 1986.

SEC. 101. TEMPORARY EXTENSION OF 2001 TAX RELIEF.
(a) TEMPORARY EXTENSION.—

(1) IN GENERAL.—Section 901 of the Economic Growth and Tax Relief
Reconciliation Act of 2001 is amended by striking ‘‘December 31, 2010’’
both places it appears and inserting ‘‘December 31, 2012’’.

2) EFFECTIVE DATE.—The amendment made by this subsection shall take ef-
fect as if included in the enactment of the Economic Growth and Tax Relief Rec-
onciliation Act of 2001.



                                      xxi                 © 2011 WealthCounsel, LLC
**************************************************************************************
**************************************************************************************
TITLE 26                                                   INTERNAL REVENUE CODE
SUBTITLE A                                               (§§1-1564) INCOME TAXES
CHAPTER 1                                            NORMAL TAXES AND SURTAXES
SUBCHAPTER A                                         DETERMINATION OF TAX LIABILITY
PART                                                          TAX ON INDIVIDUALS

§1             TAX IMPOSED
§2             DEFINITION AND SPECIAL RULES
§3             TAX TABLES FOR INDIVIDUALS

OVERVIEW
Imposes the income tax and provides rates for different types of taxpayers (Individuals, estates and
trusts). Defines the types or the different status of taxpayers. Authorizes the IRS to promulgate tax
rates tables in lieu of §1.

IMPORTANCE
Estate Planners need to know the income tax rate imposed on their clients.
_______________________________________________________________________________

PART II                                                          TAX ON CORPORATIONS
§11            TAX IMPOSED

OVERVIEW
Imposes income taxes on domestic corporations as follows:
15% on the 1st $50,000 of taxable income
25% on next $25,000 of taxable income
34% on $75,000 to $10,000,000 of taxable income
35% on taxable income over $10,000,000 and on all of the taxable income of a personal service cor-
poration
Qualified Personal Service Corporations are taxed at a flat rate of 35% of taxable income.

IMPORTANCE
Estate Planners need to be aware of the corporate tax rates.

CROSS REFERENCE
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes and Surtaxes
          Subchapter C – Corporate Distributions and Adjustments (§§301-385)
Code Sec. 882. Tax on income of foreign corporations connected with United States business
______________________________________________________________________________
______________________________________________________________________________
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______________________________________________________________________________


SUBCHAPTER B                                     COMPUTATION OF TAXABLE INCOME
PART I                                              DEFINITION OF GROSS INCOME,
                                ADJUSTED GROSS INCOME, TAXABLE INCOME, ETC.

§61             GROSS INCOME DEFINED

OVERVIEW
Codifies the 16th Amendment to the U.S. Constitution, which overrides Article 1, Section 9, Clause 3
(No Direct Tax). Provides in general what gross income means – all income from whatever source
derived. All revenues are included in gross income unless specifically excluded by a specific code
section.

IMPORTANCE
An estate planner needs to know that all U.S. citizens and permanent residents must pay income tax
on their worldwide income. The general rule is that all revenues are included in gross income unless
there is a specific exception. Nothing is deductible unless there is a specific provision which allows
the deduction.

CROSS REFERENCE
U.S. Constitution – Article 1, Section 9, Clause 3, 16th Amendment


_______________________________________________________________________________


PART III                    ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME

§101            CERTAIN DEATH BENEFITS

OVERVIEW
1. Provides special rules for the exclusion from gross income of certain life insurance benefits paid
by reason of death or viatical settlements.
2. Provides special rules for the inclusion in gross income when a life insurance policy is trans-
ferred for value and provides exceptions to the rule for transfer by gift etc. and transfers to partners,
partnerships and corporations.

In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance
contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not
exceed an amount equal to the sum of the actual value of such consideration and the premiums and
other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case

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of such a transfer--

(A) If such contract or interest therein has a basis for determining gain or loss in the hands of a trans-
feree determined in whole or in part by reference to such basis of such contract or interest therein in
the hands of the transferor, or

(B) If such transfer is to the insured, to a partner of the insured, to a partnership in which the insured
is a partner, or to a corporation in which the insured is a shareholder or officer.


(g) TREATMENT OF CERTAIN ACCELERATED DEATH BENEFITS

(1) For purposes of section 101, the following amounts shall be treated as an amount paid by reason
of the death of an insured:

(A) Any amount received under a life insurance contract on the life of an insured who is a terminally
ill individual.

(B) Any amount received under a life insurance contract on the life of an insured who is a chronically
ill individual to the extent that the proceeds are used for the treatment of the chronic illness.

(2) TREATMENT OF VIATICAL SETTLEMENTS

If any portion of the death benefit under a life insurance contract on the life of an insured is sold or
assigned to a viatical settlement provider, the amount paid for the sale or assignment shall be treated
as an amount paid under the life insurance contract by reason of the death of such insured.


(h) SURVIVOR BENEFITS ATTRIBUTABLE TO SERVICE BY A PUBLIC SAFETY OFFICER
WHO IS KILLED IN THE LINE OF DUTY

Gross income shall not include any amount paid as a survivor annuity on account of the death of a
public safety officer

(A) if such annuity is provided, under a governmental plan which meets the requirements of section
401(a), to the spouse (or a former spouse) of the public safety officer or to a child of such officer;
and

(B) to the extent such annuity is attributable to such officer's service as a public safety officer.

(i) CERTAIN EMPLOYEE DEATH BENEFITS PAYABLE BY REASON OF DEATH OF CER-
TAIN TERRORIST VICTIMS OR ASTRONAUTS

Gross income does not include amounts (whether in a single sum or otherwise) paid by an employer

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by reason of the death of an employee who is a specified terrorist victim (as defined in section
692(d)(4)) or an Astronaut.

(j) TREATMENT OF CERTAIN EMPLOYER-OWNED LIFE INSURANCE CONTRACTS
(1)      GENERAL RULE
In the case of an employer-owned life insurance contract, the amount excluded from gross income of
an applicable policyholder by reason of paragraph (1) of subsection (a) shall not exceed an amount
equal to the sum of the premiums and other amounts paid by the policyholder for the contract.
(2)       EXCEPTIONS
      In the case of an employer-owned life insurance contract with respect to which the notice and
      consent requirements of paragraph (4) are met, paragraph (1) shall not apply to any of the follow-
      ing

(3) EMPLOYER-OWNED LIFE INSURANCE CONTRACT
   Means a life insurance contract which is owned by a person engaged in a trade or business
   and under which such person is the beneficiary under a contract that covers the life of an in-
   sured who is an employee

(4)      NOTICE AND CONSENT REQUIREMENTS

      If before the issuance of the contract, the employee:

             (A) is notified in writing that the applicable policyholder intends to insure the em-
                 ployee's life and the maximum face amount for which the employee could be in-
                 sured at the time the contract was issued;

             (B) provides written consent to being insured under the contract and that such cover-
                 age may continue after the insured terminates employment, and

             (C) is informed in writing that an applicable policyholder will be a beneficiary of any
                 proceeds payable upon the death of the employee

IMPORTANCE
Estate planners need to know and understand these special rules for income taxation of life insur-
ance.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter B – Computing Taxable Income
               Section 264 – Certain Amounts Paid in Connection with Insurance Contracts
Subtitle B – Estate & Gift Taxes
                                                    4                        ©2008 WealthCounsel, LLC
     Chapter 11 – Estate Taxes
         Subchapter A – Estates of Citizens and Residence
              Part III – Gross Estate
                   Sections 2035 – Adjustments for Certain Gifts Made Within 3 years of Dece-
                   dents Death
                   Section 2041 – Powers of Appointment
                   Section 2042 – Proceeds of Life Insurance
Subtitle B – Estate & Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter A – Determination of Tax Liability
               Section 2503 – Taxable Gifts
          Subchapter B – Transfers
               Section 2514 – Powers of Appointment

§102           GIFTS AND INHERITANCES

OVERVIEW
Excludes from gross income the value of gifts, bequests, devise, and inheritances other than in-
come from gifts and inheritances. Gifts to employees are not excluded from Gross Income

IMPORTANCE
Gifts and inheritances are properties which are not income. Art. I, Sec. 9, Clause 3 of the U.S.
Constitution prohibits a direct tax on property.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
Chapter 11 – Estate Tax
Chapter 12 – Gift Tax


___________________________________________________________________
______________________________________________________________________________


SUBCHAPTER C                          CORPORATE DISTRIBUTIONS AND Adjustments
PART I                                       DISTRIBUTIONS BY CORPORATIONS
SUBPART A                                            EFFECTS ON RECIPIENTS
§301           DISTRIBUTIONS OF PROPERTY

OVERVIEW
Defines corporate distributions. Provides rules for determining the amount. Provides a 3-tier
method for determining the taxable and non-taxable portions of the distributed amount:
       (1) Dividend to the extend of earnings and profits
       (2) Return of adjusted basis of stock
                                                 5                     ©2008 WealthCounsel, LLC
       (3) Capital gain


The basis of property received in a corporate distribution is FMV.

IMPORTANCE
The estate planner needs to know the tax effect of a distribution to a shareholder by a corporation.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter C - Corporate Distributions and Adjustments
               Part 1 - Distributions by Corporations
               Subpart C - Definitions; Constructive Ownership of Stock
                    Section 316 - Dividend Defined
                    Section 317 - Other Definition

§302             DISTRIBUTIONS IN REDEMPTION OF STOCK

OVERVIEW
Provides four methods by which a corporation may redeem corporate stock from a shareholder and
the shareholder will get capital gain treatment instead of ordinary income dividend treatment.

§302(a) provides for exchange treatment if a redemption qualified under §302(b)(1), (2), (3), or (4).

§302(b)(1) is a redemption, which is not substantially equivalent to a dividend. (This is not a very
reliable provision – what is meant by “substantially not equivalent to a dividend”?)

Substantially disproportionate redemptions
§302(b)(2)(B):      V.S.A.R.< 50% of all V.S.B.R.

§302(b)(2)(C):             VSAR                 VSBR
                          ALL VSAR          < 80% ALL VSBR

V.S.A.R.= Voting Stock After Redemption
V.S.B.R.= Voting Stock Before Redemption

Example
Stockholder A owns 100 Shares = 50%
Stockholder B owns 100 Shares = 50%

What is the least number of shares that must be redeemed from Stockholder A to be substantially
disproportionate? 34 shares must be redeemed

Under IRC §302 (b)(2)(B) test:     80% x 50% = 40%
                                                 6                        ©2008 WealthCounsel, LLC
IRC §302(b) (2)(C) Test:
     VSAR=66 shares                           VSBR= 100

     ALL VSAR=166 shares=39.75%             < 80%      ALL VSBR=200=50%

IRC §302(b) (2)(B) Test:
       66 shares
       166shares         = 39.759% < 50%

Answer:
34 shares must be redeemed to be a substantially disproportionate redemption.

§302(b)(3) Complete Termination of Interest. If all of shareholders shares are redeemed, provided
the §318 attribution rules do not cause another shareholder’s share to be attributable to the termina-
tion shareholder.

§302(c) provides special rules for the waiver of the §318 Family Attribution Rules to allow for the
§302(b)(3) complete termination of interest redemption.

§302(b)(4) provides special rules for redemptions from non-corporate shareholders in partial liquida-
tion of the redeeming corporation

§302(d) provides that if the redemption does not qualify under §302(a) for exchange treatment then
the redemption shall be considered a §301 distribution.

IMPORTANCE
Estate planners need to be aware of IRC §302 for purposes of designing entity or redemption
buy-sell agreements.

CROSS REFERENCE:
Chapter 1 – Normal Taxes & Surtaxes
    Subchapter C – Corporate Distributions and Adjustments
         Part I – Distribution by Corporations
              Subpart C – Definitions; Constructive Ownership of Stock
                    §303 - Distributions in Redemption of Stock to Pay Death Taxes
                    §316 – Dividend Defined
                    §317 – Other Definitions
                    §318 – Constructive Ownership of Stock
         Part II – Corporate Liquidations
              Subpart A - Effects on Recipients
                    §331      Gain or Loss to Shareholders in Corporate Liquidations


                                                  7                        ©2008 WealthCounsel, LLC
§303           DISTRIBUTIONS IN REDEMPTION OF STOCK TO PAY DEATH TAXES

OVERVIEW
Overrides IRC § 301 and §302 in that it allows capital gain treatment to a shareholder (be it the es-
tate of a deceased shareholder or a shareholder who has the responsibility to pay death taxes, funeral
expenses or administrative costs) on the redemption of all or any part of the stock included in the es-
tate up to the dollar amount of the death taxes and administrative costs and funeral expenses.
1. The value of all of the stock of the corporation included in the decedent’s estate must exceed
   35% of the decedents gross estate less IRC § 2053, (expenses, indebtedness and taxes) cost and
   less IRC § 2054 (losses) losses.
2. §318 does not apply to a §303 redemption.

IMPORTANCE

Section IRC § 303 is a good source for finding the dollars to pay death taxes, funeral expenses and
administrative costs while stripping out earnings and profits of a corporation at capital gain rates af-
ter a step us in basis.

Note: There is no obligation to actually use the proceeds of the redemption to pay the death
taxes, funeral expenses and administrative costs.

CROSS REFERENCE:
Chapter 1 – Normal Taxes & Surtaxes
       Subchapter C – Corporate Distributions and Adjustments
              Part I – Distribution by Corporations
Chapter 62 – Time and Place for Paying Tax
        Subchapter B – Extension of Time for Payment
             §6166 – Extension of Time for Payment of Estate Tax Where Estate Consists
             Largely of Interest in Closely Held Business


_______________________________________________________________________________


SUBPART C                   DEFINITIONS; CONSTRUCTIVE OWNERSHIP OF STOCK
§316           DIVIDEND DEFINED

OVERVIEW
In general, a corporation’s §301 distribution is always considered a dividend first, to the extent
of:
     current earnings and profits, and
     accumulated earnings and profits since February 28, 1913.

                                                   8                        ©2008 WealthCounsel, LLC
IMPORTANCE
In establishing various entities for estate planning purposes (i.e. Corporate General Partner for an
FLP), estate planners must understand how these entities and their shareholders will be taxed.

CROSS REFERENCE:
Chapter 1 – Normal Taxes & Surtaxes
Subchapter C – Corporate Distributions and Adjustments
    Part I – Distribution by Corporations
    Subpart A – Effects on Recipients
          Section 301 – Distributions of Property
          Section 302 – Distributions in Redemption of Stock
          Section 303 – Distributions in Redemption of Stock to Pay Death Taxes


§317           OTHER DEFINITIONS

OVERVIEW
Property - money, securities and other property excluding stock or rights of the subject corpora-
tion.

Redemption - any exchange of corporate property for its own stock.

IMPORTANCE
Estate planners need to understand the taxation of corporations and shareholders when a corpora-
tion redeems its own stock.

CROSS REFERENCE
Chapter 1 – Normal Taxes & Surtaxes
       Subchapter C – Corporate Distributions and Adjustments
          Part I – Distribution by Corporations
               Subpart A      Effects on Recipients
                               §302 –Distributions in Redemption of Stock
                               §303 – Distributions in Redemption of Stock to Pay Death Taxes


§318           CONSTRUCTIVE OWNERSHIP OF STOCK

OVERVIEW
In applying Subchapter C’s ownership tests, a shareholder is deemed to constructively own the
stock of certain family members and/or his family members’, partnerships, estates, trusts and
corporations.

IMPORTANCE
Many code sections refer to threshold percentages of ownership. Estate planners must usually
include stock owned by certain family members or related entities as owned by other family-

                                                 9                       ©2008 WealthCounsel, LLC
member shareholders or related entities when determining whether a client meets an ownership
thresholds if §318 applies to that code section.

CROSS REFERENCE
Any other section in Chapter 1 that expressly refers to IRC §318. (See Section 318(b) for a cross
reference to those code sections that expressly make IRC §318 applicable)




PART II                                                         CORPORATE LIQUIDATIONS
SUBPART A                                                       EFFECTS ON RECIPIENTS
§331            GAIN OR LOSS TO SHAREHOLDERS IN CORPORATE LIQUIDATIONS

OVERVIEW
(a) Distributions in Complete Liquidation Treated as Exchanges – Amounts received by a share-
    holder in a distribution in complete liquidation of a corporation shall be treated as in full pay-
    ment in exchange for the stock. [Capital Gain Treatment]
(b) Nonapplication of Section 301 – Section 301 (relating to effects on shareholder of distributions
    of property) shall not apply to any distribution of property (other than a distribution referred to in
    paragraph (2)(B) of section 316(b) [Personal Holding Companies]), in complete liquidation.


§332            COMPLETE LIQUIDATION OF SUBSIDIARIES

OVERVIEW
General Rule – No gain or loss shall be recognized on the receipt by a (parent) corporation of prop-
erty distributed in complete liquidation of a subsidiary corporation.




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§334            BASIS OF PROPERTY RECEIVED IN LIQUIDATIONS

OVERVIEW
(a) General Rule – If property is received in a distribution in complete liquidation, and if gain or loss
    is recognized on receipt of such property, then the basis of the property in the hands of the dis-
    tributee shall be the fair value of such property at the time of the distribution.

(b) Liquidation of Subsidiary –
    (1) In General – If property is received by a corporate distributee in a distribution in a complete
        liquidation to which section 332 applies (or in a transfer described in section 337(b)(1)), the
        basis of such property in the hands of such distributee shall be the same as it would be in the
        hands of the transferor; except that, in any case in which gain or loss is recognized by the liq-
        uidating corporation with respect to such property, the basis of such property in the hands of
        such distributee shall be the fair market value of the property at the time of the distribution.

______________________________________________________________________________


SUBPART B                                                     EFFECTS ON CORPORATION
§336            GAIN OR LOSS RECOGNIZED ON PROPERTY DISTRIBUTED IN COMPLETE LIQUI-
                DATION

OVERVIEW
General Rule – Except as otherwise provided in this section or section 337, gain or loss shall be rec-
ognized to a liquidating corporation on the distribution of property in complete liquidation as if such
property were sold to the distributee at its fair market value.


§337            NONRECOGNITION FOR PROPERTY DISTRIBUTED TO PARENT IN COMPLETE LIQ-
                UIDATION OF SUBSIDIARY

OVERVIEW
In General – No gain or loss shall be recognized to the liquidating corporation on the distribution to
the 80-percent distributee of any property in a complete liquidation to which section 332 applies.

§338            CERTAIN STOCK PURCHASES TREATED AS ASSET ACQUISITIONS

OVERVIEW
(a) General Rule – For purposes of this subtitle, if a purchasing corporation makes an election under
    this section (or is treated under subsection (e) as having made such an election), then, in the case
    of any qualified stock purchase, the target corporation –
    (1) shall be treated as having sold all of its assets at the close of the acquisition date at fair mar-
        ket value in a single transaction, and

                                                    11                        ©2008 WealthCounsel, LLC
    (2) shall be treated as a new corporation, which purchased all of the assets referred to in para-
        graph (1) as of the beginning of the day after the acquisition date.
(b) Basis of Assets After Deemed Purchase –
    (1) In General – For purposes of subsection (a), the assets of the target corporation shall be treat-
        ed as purchased for an amount equal to the sum of –
        (A) the grossed-up basis of the purchasing corporation’s recently purchased stock, and
        (B) the basis of the purchasing corporation’s non-recently purchased stock[in the target cor-
            poration].


______________________________________________________________________________

PART III                      CORPORATE ORGANIZATIONS AND REORGANIZATIONS
SUBPART A                                      CORPORATE ORGANIZATIONS

§351            TRANSFERS TO CORPORATIONS CONTROLLED BY TRANSFEROR

OVERVIEW
(a) General Rule - No gain or loss shall be recognized when property is transferred:
     to a corporation
     by one or more persons
     solely in exchange for stock in such corporation
     if immediately after the transfer or exchange
     the transferor(s) are in control of at least 80% of all classes of stock outstanding (as de-
       fined in §368(c))

(b) Receipt of Property – If subsection (a) would apply to an exchange but for the fact that there is
received, in addition to the stock permitted to be received under subsection (a), other property or
money, then -
     (1) gain (if any) to such recipient shall be recognized, but not it excess of -
          (A) the amount of money received, plus
          (B) the fair market value of such other property received; and
     (2) no loss to such recipient shall be recognized.

(c) Some Special Rules where Distributions are made to Shareholders

(d) Services, Certain Indebtedness, and Accrued Interest are not Treated as Property

(e) Exceptions – This section shall not apply to -

   (1) Transfer of Property to an Investment Company – The determination of whether a
company is an investment company shall be made -
   (A) by taking into account all stock and securities held by the company, and
                                                   12                        ©2008 WealthCounsel, LLC
     (B) by treating as stock and securities -
            (i)     money,
            (ii)    stocks and other equity interests in a corporation, evidences of indebtedness, op-
                    tions, forward or futures contracts, notional principal contracts and derivatives,
            (iii) any foreign currency,
            (iv)    any interest in a real estate investment trust, a common trust fund, a regulated
                    investment company, a publicly-traded partnership
            (v)     any interest in a precious metal, unless such metal is used or held in the active
                    conduct of a trade or business after the contribution,
            (vi)    interests in any entity if substantially all of the assets of such entity consist (di-
                    rectly or indirectly) of any assets described in any preceding clause or clause
                    (viii),
            (vii) any interest in any entity not described in clause (vi), but only to the extent of
                    the value of such interest that is attributable to assets listed in clauses (i) through
                    (v) or clause (viii), or
            (viii) any other asset specified in regulations prescribed by the Secretary. The Secre-
                    tary may prescribe regulations that, under appropriate circumstances, treat any
                    asset described in clauses (i) through (v) as not so listed.

IMPORTANCE
Estate planners need to know these §351 tax rules when establishing corporations, FLPs and LLCs,
and then transferring assets to them.


CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter K – Partners & Partnerships
               §721 – Non-recognition of Gain or Loss on Contribution

_________________________________________________________________________________


SUBPART C                                                   EFFECTS ON CORPORATIONS
§368            DEFINITIONS RELATING TO CORPORATE REORGANIZATION

OVERVIEW
§368(a) Reorganizations (1) In general sets at definitions for different kinds of corporate reorganiza-
tions.

     (A) a statutory merger or consolidation;
     (B) exchange of solely voting stock for stock and control of another corporation;
     (C) exchange of solely voting stock for substantially all assets of another corporation;
     (D) exchange of assets for control of another corporation [Divisive Reorganizations];
     (E) a recapitalization
                                               13                      ©2008 WealthCounsel, LLC
     (F) a mere change in identity, form or place of organization of one corporation, however
         effected
     (G) a transfer by a corporation of all or part of its assets to another corporation in a Title
         II (Bankruptcy) or similar case

§368(b) Party to a Reorganization (Defined)
    (A) a corporation resulting from a reorganization
    (B) both corporations, in the case of a reorganization resulting from the acquisition by one cor-
        poration of stock or properties of another corporation

§368(c) Control Defined
Ownership of stock possessing at least 80% of the total combined voting power of all classes of
stock entitled to vote and at least 80% of the total number of shares of all other classes of stock of
the corporation.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter C – Corporate Distributions and Adjustments
               §351 – Transfers to Corporations Controlled by Transferor


_________________________________________________________________________________




                                                 14                        ©2008 WealthCounsel, LLC
________________________________________________________________________________
________________________________________________________________________________

SUBCHAPTER G CORPORATIONS USED TO AVOID Income Tax on Shareholders
PART I                CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS
§531-§537       CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS; IMPOSITION OF ACCU-
                MULATED EARNINGS TAX

OVERVIEW
Importance Imposes for each taxable year a tax on the accumulated taxable income (as defined in
section 535) of each corporation described in section 532, an accumulated earnings tax equal to 15
percent of the accumulated taxable income of a corporation. Excess accumulated earnings and profits
are earnings and profits, which are accumulated beyond the reasonable needs of the business. The
idea is this, if a corporation is allowed to accumulate its earnings and profits beyond its needs and is
not plowing the profits back into expanding or growing the business, then it should distribute the
earnings and profits to its shareholders who will pay tax on these dividends at ordinary tax rates. All
corporations (other than personal service corporations) are allowed to accumulate $250,000 of earn-
ings and profits without having to justify reasonable business needs. Personal service corporations
may only accumulate $150,000; beyond that reasonable business needs must be proven.

IMPORTANCE
An understanding of corporate taxation is important for an estate planner.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter G – Corporations Used to Avoid Income Tax on Shareholders
               Part I – Corporations Improperly Accumulating Surplus


___________________________________________________________________


PART II                                                 PERSONAL HOLDING COMPANIES
§541-§545       PERSONAL HOLDING COMPANIES; IMPOSITION OF PERSONAL HOLDING COMPA-
                NY TAX

OVERVIEW
If a corporation is formed or availed upon to hold personal investments, it will pay tax at the rate of
15% on its undistributed personal holding company income. A personal holding company is a corpo-
ration, which derives at least 60% of its income from passive sources (investments) such as divi-
dends, interest, royalties and annuities. There are special exclusion rules for rents, mineral, oil and
gas royalties, copyright royalties, produced film rents if such activities constitute a trade or business
and pass certain 50% or more tests as to revenues. There are special rules for personal service corpo-
                                                  15                         ©2008 WealthCounsel, LLC
rations (such as professional corporations and associations) if some one other than a corporate officer
has the right to designate by name or description, the person who must perform personal services,
and the person performing the service owned 25% or more of the personal service corporation any-
time during the year. It is important that all 25% or more shareholder employees have an employ-
ment contract which provides that no one other than the corporation has the right to designate by
name or description who will provide the personal service to patients or clients.

IMPORTANCE
An understanding of corporate taxation is important for an estate planner. When creating a corpora-
tion for wealth transfer purposes, the estate planner needs to know when he or she may be triggering
the personal holding company tax.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter G – Corporations Used to Avoid Income Tax on Shareholders
               Part II – Personal Holding Companies

_______________________________________________________________________________




                                                  16                       ©2008 WealthCounsel, LLC
________________________________________________________________________________
_______________________________________________________________________________


SUBCHAPTER J       ESTATES, TRUSTS, BENEFICIARIES, AND DECEDENTS
PART I                       ESTATES, TRUSTS, AND BENEFICIARIES
SUBPART A    GENERAL RULES FOR TAXATION OF ESTATES AND TRUSTS
§641            IMPOSITION OF TAX

OVERVIEW
This section provides that estate or trust income is taxed either to the fiduciary or to the beneficiary,
depending on whether or not the fiduciary retains and accumulates the income or distributes or is re-
quired to distribute the income to the beneficiaries. In general, it causes the taxable income of an es-
tate or trust to be computed in the same manner as an individual. The income tax rates for estates
and trusts are found under IRC Sec. 1(e).

IMPORTANCE
Knowledge of the income tax treatment of estates, trusts and their beneficiaries is very important
when preparing trust instruments and in handling the administration of an estate. Good estate plan-
ning takes into consideration the relative income tax brackets of the parties.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart A – General Rules for Taxation of Estates and Trusts
                         §651, §652, §661, §662, §671-§679


§642            SPECIAL RULES FOR CREDITS AND DEDUCTIONS

OVERVIEW
This section sets forth certain rules for income tax credits and deductions for estates and trusts. Gen-
erally, the deductions and credits allowed to a trust or a decedent’s estate follow those allowed to an
individual. This section sets forth certain differences in the kind and scope of deductions and credits
available to an estate or trust. For instance, an estate is allowed a personal exemption of $600. A
simple trust, i.e., one that is required to distribute all of its income currently, is allowed a deduction
of $300. All other trusts are allowed a deduction of $100. Also, 642(g) provides that administrative
expenses and losses during an estate may be taken either as a deduction in computing the estate’s
taxable income or as a deduction in computing the decedent’s taxable estate for estate tax purposes,
thereby prohibiting a double deduction on the same item. To claim an income tax deduction, an
election must be filed waiving the item as an estate tax deduction.


                                                   17                        ©2008 WealthCounsel, LLC
§642(c) Deductions for Amounts Paid or Permanently Set Aside for a Charitable Purpose – This sub-
section sets out special rules for deductions in computing taxable income by a charitable pooled in-
come fund. It provides a definition of a pooled income fund and gives a special rule for determining
the tax deduction by a contributor to a pooled income fund. It cross-references IRC §681 Limitation
on Charitable Deduction.

IMPORTANCE
It is important to understand the special rules for credits and deductions for estates and trusts and
their differences with respect to rules for credits and deductions for individuals, so that the income
tax ramifications on whether a particular estate or trust distributes income or not can be weighed.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart A – General Rules for Taxation of Estates and Trusts
                           §641, §643, §651, §652, §661, §662, §681
Subtitle F- Procedure and Administration
     Chapter 61- Information Returns
          Subchapter A- Returns and Records
               Part III- Information Returns
                    Subpart A- Information Concerning Persons Subject to Special Provisions
                           §6034- Returns of Trustees Described in Section 4947(a)(2) or
                               Claiming Charitable Deduction Under Section 642(c)


§643            DEFINITIONS APPLICABLE TO SUBPARTS A, B, C AND D

OVERVIEW
This section defines several important terms that are used in connection with the provisions concern-
ing income taxation of estates and trusts. The most important term, “distributable net income”, ap-
plies to the taxation of estates and trusts and their beneficiaries. It limits the deductions allowable to
estates and trusts for amounts paid, credited, or required to be distributed to beneficiaries and is used
to determine how much of an amount paid, credited, or required to be distributed to a beneficiary
will be included in the beneficiary’s gross income. Generally, distributable net income is taxable in-
come, with adjustments for items such as extraordinary dividends and taxable stock dividends, capi-
tal gains and losses, non-taxable income, and certain deductions.

IMPORTANCE
This section and, in particular the definition of “distributable net income” is extremely important in
determining the income taxation of estates, trusts and their beneficiaries.

CROSS REFERENCE:
Subtitle A – Income Taxes
                                                   18                        ©2008 WealthCounsel, LLC
     Chapter 1 – Normal Taxes & Surtaxes
         Subchapter J – Estates Trusts, Beneficiaries and Decedents
              Part I – Estates, Trusts and Beneficiaries
                   Subpart A – General Rules for Taxation of Estates and Trusts
                        §641, §642, §651, §652, §661, §662


§644           TAXABLE YEAR OF TRUSTS

OVERVIEW
This section provides that generally all trusts must adopt a calendar year as their tax year. This re-
quirement does not apply to grantor trusts, employee and other trusts exempt for tax under Code Sec-
tion 501(a) or to charitable trusts described in Code Section 4947(a)(1). Estates can elect a fiscal
year (a year ending in a month other than December). A decedents grantor revocable living trust may
elect a fiscal year if it elects IRC §645 treatment.

IMPORTANCE
An estate planner should know that a trust must have a calendar year end.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart A – General Rules for Taxation of Estates and Trusts
                         §641, §643, §651, §652, §661, §662
          Subchapter E – Accounting Periods and Methods of Accounting
               Part I – Accounting Period
                    §441 – Period for Computing Taxable Income


§645           CERTAIN REVOCABLE TRUSTS TREATED AS PART OF ESTATE

OVERVIEW
The executor and the trustee of a “Qualified Revocable Trust” may elect to have the trust treated and
taxed like a probate estate for all taxable years ending after the Trustmaker’s death and before the
“applicable date”. A Qualified Revocable Trust is a trust that was a grantor trust under IRC § 676
while the Trustmaker was alive.
The applicable date:
        a. If no 706 Estate Tax Return is required – 2 years after the Trustmaker’s death
        b. If a 706 Estate Return is required – 6 months after the final determination of the estate
            tax liability (after the IRS issues a closing letter)

The election must be made on the first 1041 income tax return. Use IRS Form 8855 - Election to
Treat a Qualified Revocable Trust as Part of an Estate.
                                                19                   ©2008 WealthCounsel, LLC
IMPORTANCE
Sometimes it may be advantageous to have the post mortem living trust tax like a probate estate for
example:
      probate estates get a $600 exemption;
      simple trusts get a $300 exemption and;
      complex trusts get only a $100 exemption;
      probate estates can elect a fiscal year.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart A – General Rules for Taxation of Estates and Trusts
                         §641, §643, §651, §652, §661, §662

Subtitle F – Procedure and Administration
     Chapter 68 – Additions to the Tax, Additional Amounts, and Accessible Penalties
          Subchapter A – Additions to the Tax and Additional Amounts
               Part I – General Provisions
                    Section 6654 – Failure by Individuals to Pay Estimated Income Tax
                         Subsection 6654(l) – Estates and Trusts

Section 6654(l) Estates and Trusts

(2) Exception for Estates and Trusts
     (B) A decedent’s grantor trust is exempt from making any estimated tax payments for two years
     after the Grantor’s death.


_______________________________________________________________________________


SUBPART B                  TRUSTS WHICH DISTRIBUTED CURRENT INCOME ONLY
§651            DEDUCTION FOR TRUSTS DISTRIBUTING CURRENT INCOME ONLY

OVERVIEW
This section provides that any trust that requires the trustee to distribute all trust income each year is
entitled to a deduction for the amount of the distributed income, but the deduction may not exceed
the distributed net income of the trust.

IMPORTANCE
In preparing trust documents for estate planning purposes, it is important to be familiar the taxation
of “simple” trusts under this section, as opposed to the taxation of “complex” trusts, which is set
forth in IRC Section 661.
                                                20                        ©2008 WealthCounsel, LLC
CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart B – Trust Which Distribute Current Income Only
                         §641, §652, §661, §662, §671-§679


§652           INCLUSION OF AMOUNTS IN GROSS INCOME OF BENEFICIARIES OF TRUSTS

OVERVIEW
This section sets forth the amount of gross income that a beneficiary of a simple trust must include.
This amount is the lower of:

     (1) the amount of trust income for the tax year which the trustee is required to distribute to the
         beneficiary currently; or
     (2) the beneficiary’s proportionate share of the trust’s distributable net income.

IMPORTANCE
In preparing documents for estate planning purposes, it is important to be familiar with this Code
Section and to understand the taxation of a simple trust and its beneficiaries.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart B – Trusts Which Distribute Current Income Only
                         §641, §642, §643, §651, §661, §662




                                                  21                       ©2008 WealthCounsel, LLC
________________________________________________________________________________


SUBPART C              ESTATES AND TRUSTS WHICH MAY ACCUMULATE INCOME
                                        OR WHICH MAY DISTRIBUTE CORPUS
§661           DEDUCTION FOR ESTATES AND TRUSTS ACCUMULATING INCOME OR DISTRIB-
               UTING CORPUS

OVERVIEW
This section provides a deduction to an estate or trust, other than a simple trust, equal to amounts
which are required to be distributed currently and any other amounts actually paid or credited for
such year, but not in excess of the distributed net income of the estate or trust. It generally provides
that income retains its character on a proportionate basis.

IMPORTANCE
In preparing trusts for estate planning purposes, it is important to determine whether or not the trust
is a simple or complex trust in order to project the income tax ramifications to the fiduciary of the
estate or trust and its beneficiaries.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart C – Estates and Trusts Which May Accumulate Income or Which May
                    Distribute Corpus
                         §641, §651, §652, §662, §671-§679


§662           INCLUSION OF AMOUNTS IN GROSS INCOME OF BENEFICIARIES OF ESTATES AND
               TRUSTS ACCUMULATING INCOME OR DISTRIBUTING CORPUS

OVERVIEW
This section provides that a beneficiary of an estate or complex trust include in gross income the sum
of:

     (1) amount of income required to be distributed to the beneficiary, whether distributed or not,
         and
     (2) all other amounts properly paid, credited or required to be distributed to the beneficiary by
         the estate or trust.

If such amounts exceed the distributable net income of the estate or trust, the amount included in
gross income is limited to DNI (Distributable Net Income).


                                                  22                        ©2008 WealthCounsel, LLC
IMPORTANCE
In preparing documents for estate planning purposes or administering an estate, it is important to un-
derstand the taxation of an estate or a complex trust and its beneficiaries.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart C – Estates and Trusts Which May Accumulate Income or Which
                                  May Distribute Corpus
                         §641, §642, §643, §651, §652, §661


§663            SPECIAL RULES APPLICABLE TO SECTIONS 661 AND 662

OVERVIEW
This section provides that in order for a gift or bequest to be excludable from the gross income of the
recipient, (1) it must qualify as a gift or bequest of a specific sum of money or of specific property,
and (2) the terms of the governing instrument must not provide for its payment in more than three
installments. This section also provides that if an executor or trustee elects, amounts properly paid
or credited from an estate or trust within the first 65 days of any taxable year shall be considered paid
or credited on the last day of the preceding year.

It also provides for purposes of determining distributable net income that separate and independent
shares of different beneficiaries shall be treated as separate trusts.

IMPORTANCE
It is important that the fiduciary understand this section in particular, in determining whether or not
to make the 65-day rule election for a distribution to be made if it is apparent that the beneficiary will
pay less tax on the distribution by having it treated as a distribution made in the preceding tax year.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart C – Estates and Trusts Which May Accumulate Income or Which May
                    Distribute Corpus
                         §661, §662




                                                   23                        ©2008 WealthCounsel, LLC
§664            CHARITABLE REMAINDER TRUSTS

OVERVIEW
Authorization for charitable remainder trusts is found in Section 664. Basically, a charitable remain-
der trust makes distributions to non-charitable beneficiaries during the trust term and, when the trust
term ends, distributes its assets to charity. The remainder interest qualifies for the income, gift and
estate tax charitable deductions.

Essentially this section:

   Specifically authorizes taxpayers to create charitable remainder trusts. Section 664(a)

   Defines the manner in which distributions from the trust will be taxed to non-charitable recipi-
    ents of the trust. The manner of payments received, to the extent the trust had income of this
    character, are characterized in the following order: First, as ordinary income to the extent of
    trust ordinary income for the year and undistributed ordinary income for past years; Second, as
    capital gains to the extent of the trust capital gains for the year and undistributed capital gains for
    prior years; Third, as other income to the extent of the trust’s other income for the year and un-
    distributed other income for prior years; and, Fourth, as return of principal. Section 664(b)

   Declares the trust to be tax exempt except for any year in which it earns unrelated business taxa-
    ble income. Section 664(c)

   Defines the term of a charitable trust as measured by the lifetime or lifetimes of the recipients or
    a term not to exceed 20 years. Section 664(d)

   Creates four types of charitable remainder trusts:

Section 664(d)(1)(A). A charitable remainder annuity trust is one in which a fixed dollar amount of
not more than fifty percent (50%) nor less than five percent (5%) of the initial fair market value of
property (as finally determined for federal tax purposes) placed in the trust is paid at least annually to
the recipient.

    Section 664(d)(2)(A). The specified distribution to be paid at least annually by a charitable re-
    mainder unitrust must be a fixed percentage which is not more than fifty percent (50%) nor less
    than five percent (5%) of the net fair market value of the trust assets valued annually.

    Section 664(d)(3)(B). The specified distribution from a charitable remainder unitrust may also
    be determined by limiting it to the lesser of (i) the trust income or (ii) an amount calculated by
    reference to a fixed percentage (which cannot be less than 5%) of the net fair market value of the
    trust assets valued at least annually. Deficiencies in distributions (i.e. where trust income is less
    than the amount calculated by reference to the fixed percentage) are made up in later years if the
    trust income exceeds the amount calculated by reference to the fixed percentage.

                                                    24                        ©2008 WealthCounsel, LLC
    Section 664(d)(3)(A). This variation operates the same as in Section 664(d)(3)(A), but deficien-
    cies are not made up.

   Requires that the actuarially determined remainder value of the trust equal at least 10% or more
    of the amount initially contributed to the trust, or, in the case of a charitable remainder trust, add-
    ed to the trust. Section 664(d).

   Requires the charitable deduction calculation be based on distributions amount equal to at least
    5% (or greater if specified in the governing instrument) each year. Section 664(e)

   Provides for the shortening of the trust term upon the happening of a “qualified contingency.”
    Section 664(f)

   Provides rules for certain contributions involving employer securities. Section 664(g)

IMPORTANCE
The charitable remainder trust has become a standard – and necessary – estate planning device in the
repertoire of every estate planner.

Note: In the case of a charitable remainder trust, the Treasury Regulations promulgates by the
Treasury Department are almost more important than the statute itself. For example, the new FLIP-
CRUT is not part of the statute, but instead is a creature wholly of the Regulations that interpret and
apply Section 664. These very important regulations are found at Treas. Reg. §§1.664-1, -2, -3, and-
4.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter B – Computation of Taxable Income
               Part VI – Itemized Deductions for Individuals and Corporations
                    §170 – Charitable, Etc., Contributions and Gifts
           Subchapter F – Exempt Organizations
               Part I – General Rule
                    §501 – Exemption From Tax on Corporations, Certain Trusts, Etc.
Subtitle B – Estate and Gift Taxes
     Chapter 11 Estate Tax
          Subchapter A – Estates of Citizens and Residents
               Part IV – Taxable Estate
                    §2055 – Transfers for Public, Charitable, and Religious Uses
     Chapter 12 – Gift Tax
         Subchapter C – Deductions
              §2522 – Charitable and Similar Gifts

                                                    25                        ©2008 WealthCounsel, LLC
________________________________________________________________________________


SUBPART D                      TREATMENT OF EXCESS DISTRIBUTIONS BY TRUSTS
§665            DEFINITIONS APPLICABLE TO SUBPART D

OVERVIEW
This section defines those terms applicable to subpart D of subchapter J, which subpart deals with
the throw back rules for foreign trusts and pre-August 6, 1997 years of domestic trusts. The throw
back rules are designed to tax the beneficiary of a trust that accumulates all or part of its income as if
the income had been distributed to the beneficiary currently as earned, instead of being accumulated
in the trust. The taxes apply to accumulation distributions, which are defined in this section as cer-
tain distributions in excess of DNI. The throw back rules do not apply to any trust where the grantor
(or any other person) is treated as a substantial owner under the grantor trust rules.

IMPORTANCE
Knowledge of the throw back rules and their effect on the taxation of trusts and beneficiaries is very
important when considering the use of foreign trust vehicles.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    §641-679


§666            ACCUMULATION DISTRIBUTION ALLOCATED TO PRECEDING YEARS

OVERVIEW
This section provides that when an accumulation distribution occurs for the current year, the distribu-
tion is thrown back to one or more preceding years of the trust, to the extent the trust had undistrib-
uted net income in such years. The accumulation distribution is considered to be made first from the
earliest preceding year in which there was undistributed net income. The allocation to any one pre-
ceding year is made only to the extent of the undistributed net income for that year. An amount
equal to the taxes imposed on a trust for a preceding year on undistributed DNI is considered distrib-
uted as an additional distribution to the last day of that preceding tax year. This section also provides
that if any amount deemed an accumulation distribution for any taxable year is less than the undis-
tributed net income for such preceding taxable year, the additional amount attributable to the tax on
the undistributed net income shall be the pro rata portion of the trust income tax.

IMPORTANCE
Knowledge of the throw back rules is very important when considering the use of foreign trust vehi-
cles.

                                                   26                        ©2008 WealthCounsel, LLC
CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts, and Beneficiaries
                    §641-679


§667           TREATMENT OF AMOUNTS DEEMED DISTRIBUTED BY TRUST IN PRECEDING
               YEARS

OVERVIEW
This section deals with the tax on a beneficiary for the current year on accumulation distributions. A
beneficiary receiving an accumulation distribution is taxed on the amount “thrown back” to preced-
ing years as if the amounts were received on the last day of such previous year. This tax on the ac-
cumulation distributions is calculated using a complex formula. This section provides that all the
amounts considered distributed, including the trust’s taxes in preceding years under the throw back
rules, are included in the income of the beneficiary in the current year when paid, credited or required
to be distributed.

IMPORTANCE
Knowledge of the throw back rules is very important when considering the use of foreign trust vehi-
cles.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    §641-679


§668           INTEREST CHARGE ON ACCUMULATION DISTRIBUTIONS FROM FOREIGN TRUSTS

OVERVIEW
This section provides that distributions of accumulated income to a US beneficiary from foreign
trusts triggers an “interest charge.” The charge is the amount of interest, which would be determined
on a partial tax computed under Code Section 667. The period of interest is determined by the dif-
ference between the year in which the undistributed net income was earned and the year in which it
was distributed as an accumulation distribution multiplied by the annual interest charge, which, for
periods prior to January 1996, was 6%. For example, if a foreign trust made distribution of income
earned (and untaxed) five years earlier, the interest charge would be 30% (5 x 6%) and the benefi-
ciary must add 30% to the tax otherwise due on account of the distribution. The interest charge is
not deductible as interest for income tax purposes.

                                                  27                        ©2008 WealthCounsel, LLC
IMPORTANCE
Knowledge of the throw back rules and their effect on the taxation of trusts and beneficiaries is very
important when considering the use of foreign trust vehicles.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    §641-679


________________________________________________________________________________


SUBPART E                 GRANTORS AND OTHERS TREATED AS SUBSTANTIAL OWNERS
§671            TRUST INCOME, DEDUCTIONS, AND CREDITS ATTRIBUTABLE TO GRANTORS AND
                OTHERS AS SUBSTANTIAL OWNERS

OVERVIEW
This section provides that when the grantor trust rules of sections 671 through 679 apply to treat the
grantor or another person as the owner of all or a portion of a trust, then the grantor or other person
shall include those items of income, deductions and credits attributable to his or her portion of the
trust.

IMPORTANCE
It is very important for the estate planner to be familiar with this Section and the Sections following
it in subpart E. Under certain circumstances, the grantor trust rules may be used to create a trust
whereby the income of the trust is taxed to the grantor as “owner” while the trust corpus is not in-
cluded in the grantor’s gross estate for estate tax purposes. The grantor can then pay taxes on behalf
of the trust, thereby allowing the trust to grow faster while the grantor’s taxes attributable to the trust
reduce the grantor’s taxable estate. The taxes paid on behalf of the trust become gift tax-free gifts to
the trusts.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §672-679




                                                    28                        ©2008 WealthCounsel, LLC
§672            DEFINITIONS AND RULES AS SUBSTANTIAL OWNERS

OVERVIEW
This section sets forth grantor trust rule definitions of key terms used throughout Sections 671
through 679, among which are the following:

     adverse party                        any person having a substantial beneficial interest in the
                                          trust which would be adversely affected by the exercise or
                                          nonexercise of a power which he possessed respecting the
                                          trust

     nonadverse party                     any person who is not an adverse party

     related or subordinate party         any nonadverse party who is the grantor’s spouse, father,
                                          mother, issue, sibling, employee of the grantor, the corpora-
                                          tion or employee of the corporation for which the grantor
                                          has voting control, or a subordinate employee of the corpo-
                                          ration in which the grantor is an executive

Also, this section provides that for purposes of the grantor trust rules, the grantor is treated as hold-
ing any power or interest held by his or her spouse.

IMPORTANCE
You must know these definitions when applying the grantor trust rules to avoid unintentionally trig-
gering grantor trust status or to intentionally trigger grantor trust status to enable Trustmakers to
transfer more assets out of their estate by paying income and capital gains taxes on behalf of the
trust.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679


§673            REVERSIONARY INTERESTS

OVERVIEW
This Section treats the grantor as the owner of a trust if he or she has a reversionary interest in the
corpus or income valued at more than 5% of the value of the trust.

IMPORTANCE

                                                   29                        ©2008 WealthCounsel, LLC
When reviewing an existing trust or preparing a new trust, familiarity with the reversionary interest
rule under this Section is important in determining whether or not the grantor will be treated as own-
er of the trust for income tax purposes. Also, if the grantor has a reversionary interest in a trust equal
to or more than 5% of the value of the trust at his death, and the possession or enjoyment of the
property is contingent on surviving the grantor, then the trust property may be includable in the gran-
tor’s gross estate for federal estate tax purposes under §2037.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2037 – Transfers Taking Effect at Death


§674            POWER TO CONTROL BENEFICIAL ENJOYMENT

OVERVIEW
(a) This section treats the grantor as an owner of the trust if the grantor or a nonadverse party, or
both, without the consent of an adverse party, may control or change the beneficial enjoyment of the
income or corpus. Generally, this rule applies to powers of all kinds, including the power to change
beneficiaries or their interests.

(b) Key exceptions to this general rule include

     (1) POWER TO APPLY INCOME TO SUPPORT OF A DEPENDENT

    (2) POWER AFFECTING BENEFICIAL ENJOYMENT ONLY AFTER OCCURRENCE
OF EVENT

     (3) POWER EXERCISABLE ONLY BY WILL

     (4) POWER TO ALLOCATE AMONG CHARITABLE BENEFICIARIES

     (5) POWER TO DISTRIBUTE CORPUS

     (6) POWER TO WITHHOLD INCOME TEMPORARILY

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       (7) POWER TO WITHHOLD INCOME DURING DISABILITY OF A BENEFICIARY

       (8) POWER TO ALLOCATE BETWEEN CORPUS AND INCOME

(c) EXCEPTION FOR CERTAIN POWERS OF INDEPENDENT TRUSTEES


(d) POWER TO ALLOCATE INCOME IF LIMITED BY A STANDARD

       a power in the grantor or any other person to make distributions of corpus to a bene-
        ficiary or beneficiaries if the trust provides a reasonable and definite standard for the
        distributions;

       a power of any person other than the grantor to apply income to support a beneficiary
        whom the grantor is legally obligated to support;

       a power to distribute a portion of accumulated income to or for a beneficiary or bene-
        ficiaries exercisable by independent trustees;

       a power in any person other than the grantor or grantor’s spouse to distribute a por-
        tion of accumulated income to or for the benefit of the beneficiary or beneficiaries,
        provided the power is limited by a reasonably definite standard set forth in the trust.

IMPORTANCE
Knowledge of the general rule and its exceptions is important in determining the income tax ramifi-
cations of any trust provisions, which this section affects. Some of the powers referenced in this sec-
tion have an estate tax impact as well, particularly involving §2036, §2037, and §2038.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2036 – Transfers With Retained Life Estate
                    §2037 – Transfers Taking Effect at Death
                    §2038 – Revocable Transfers


                                                   31                        ©2008 WealthCounsel, LLC
§675            ADMINISTRATIVE POWERS

OVERVIEW
This Section treats the grantor as the owner of any portion of a trust if, under the terms of the trust:

       the grantor or nonadverse party, or both, may:
    
       (1) deal with trust property for less than full and adequate consideration or

       (2) may borrow property without adequate interest or security, without the consent of
        an adverse party;

       (3) the grantor has in fact borrowed trust property without adequate interest and ad-
        equate security and the trustee is not a related or subordinate to the grantor;

       (4) the grantor has either --
           the power to vote stock of a company where grantor has voting control; or
           the power to reacquire trust property by substituting other property of an equiva-
            lent value.

IMPORTANCE
Administrative powers retained by the grantor or a non-adverse party in a trust can cause income of
the trust to be taxable to the grantor. Careful drafting and use of certain of the provisions under this
section can produce the intended result of making the income of the trust taxable to the grantor while
keeping the trust property out of the grantor’s gross estate for estate tax purposes.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2036 – Transfers With Retained Life Estates
                    §2036(b) – Voting Rights (Anti-Byrum Rule)




                                                  32                        ©2008 WealthCounsel, LLC
§676            POWER TO REVOKE

OVERVIEW
This Section treats the grantor as the owner of any portion of a trust wherein the grantor has re-
served in himself or a nonadverse party a power to revest title in the trust property to himself. This
power to revest title may be in the form of a right to revoke, a right to terminate, a right to alter or
amend the trust, or a power to appoint beneficiaries.

IMPORTANCE
A reservation of a power by the grantor or nonadverse party to revest trust assets to the grantor will
result in income of the trust being taxable to the grantor. If such a power is held at the death of the
grantor, it may also result in the trust property being included in the grantor’s gross estate for estate
tax purposes under IRC Sections 2036 or 2038.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2036 – Transfers with Retained Life Estate
                    §2037 – Transfers Taking Effect at Death
                    §2038 – Revocable Transfers


§677            INCOME FOR BENEFIT OF GRANTOR

OVERVIEW
(a) This section treats the grantor as the owner of a portion of a trust that, without approval of an ad-
verse party, allows income to be:

     1.   Distributed to the grantor or to the grantor’s spouse;
     2.   Held or accumulated for future distribution to the grantor or the grantor’s spouse;
          or
     3.   Used to pay any premiums on life insurance policies on the life of the grantor or
          the grantor’s spouse.

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(b) OBLIGATIONS OF SUPPORT

Income of a trust shall not be considered taxable to the grantor merely because such income may be
applied or distributed for the support or maintenance of a beneficiary (other than the grantor's
spouse) whom the grantor is legally obligated to support or maintain, except to the extent that such
income is so applied or distributed.


IMPORTANCE
This section highlights additional grounds by which a grantor would be taxed on the income of a
trust. Also, if the trust contains such provisions upon the grantor’s death, the trust property may be
included in the grantors gross estate for federal estate tax purposes under IRC Section 2036.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2036 – Transfers With Retained Life Estate
                    §2037 – Transfers Taking Effect at Death


§678           PERSON OTHER THAN GRANTOR TREATED AS SUBSTANTIAL OWNER

OVERVIEW
a) A person other than the grantor shall be treated as the owner of any portion of a trust with respect
to which:

       (1) such person has a power exercisable solely by himself to vest the corpus or the
       income there from in himself, or

       (2) such person has previously partially released or otherwise modified such a power and af-
       ter the release or modification retains such control as would, within the principles of sections
       671 to 677, inclusive, subject to grantor of a trust to treatment as the owner thereof.

(b) EXCEPTION WHERE GRANTOR IS TAXABLE
       if the grantor of the trust or a transferor is otherwise treated as the owner under the provisions
                                                     34                        ©2008 WealthCounsel, LLC
       of this subpart other than this section.
(c) OBLIGATIONS OF SUPPORT
Subsection (a) shall not apply to a power, which enables such person, in the capacity of trustee or co-
trustee, merely to apply the income of the trust to the support or maintenance of a person whom the
holder of the power is obligated to support or maintain except to the extent that such income is so
applied.
(d) EFFECT OF RENUNCIATION OR DISCLAIMER
Subsection (a) shall not apply with respect to a power, which has been renounced or disclaimed with-
in a reasonable time after the holder of the power first became aware of its existence.
(e) CROSS REFERENCE
FOR PROVISION UNDER WHICH BENEFICIARY OF TRUST IS TREATED AS OWNER OF
THE PORTION OF THE TRUST WHICH CONSISTS OF STOCK IN AN S CORPORATION,
SEE SECTION 1361(d).

IMPORTANCE
This section is very important in drafting estate planning documents because caution must be given
not to give so much power to a beneficiary that they are taxed as “owners” of all or a portion of the
trust for income tax purposes.
Conversely, this rule can be used to intentionally produce income deductions for a beneficiary by
giving such powers to a beneficiary when appropriate.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §671-679
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2041 – Powers of Appointment
     Chapter 12 – Gift Tax
         Subchapter B – Transfers
              §2514 – Powers of Appointment




                                                  35                       ©2008 WealthCounsel, LLC
§679            FOREIGN TRUSTS HAVING ONE OR MORE UNITED STATES BENEFICIARIES

OVERVIEW
This section treats a U.S. transferor of property to a foreign trust that has a United States benefi-
ciary as the owner of that portion of the trust attributable to such transfer. This rule does not apply to
transfers by reason of death or to transfers at fair market value.

IMPORTANCE
This section is important when dealing with foreign trusts as part of an estate plan. Estate planners
contemplating offshore trusts must be familiar with the income tax ramifications of this section.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part I – Estates, Trusts and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         Sections 671-678


_________________________________________________________________________________




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_______________________________________________________________________________


PART II                                              INCOME IN RESPECT OF DECEDENTS
§691            RECIPIENTS OF INCOME IN RESPECT OF DECEDENTS

OVERVIEW
Income in respect of a decedent (“IRD”) is income that the decedent was entitled to receive but
which was not includable in his or her final return. This section provides that such income must be
reported in the taxable year received by either the decedent’s estate or beneficiaries. Items of gross
income typically treated as income in respect of a decedent include employee compensation, bonus-
es, benefit plan distributions, partnership income, interest, dividends, gain in the sale of property, and
installment obligations items.

Income in respect to a decedent is ordinarily part of the decedent’s estate for estate tax purposes.

To soften the double-impact of both the income tax and the estate tax on such items of income,
§691(c) allows a deduction for income tax purposes of the estate tax, which is attributable to IRD
items, included in the decedent’s gross estate for estate tax purposes.

IMPORTANCE
When reviewing clients’ financial data to plan their estates, it is important to recognize those assets
that will trigger income in respect of a decedent in order to plan for the impact of both estate taxation
and income taxation on such assets. In allocating assets to various trusts, it is important to take into
consideration the taxable income that property subject to income in respect of a decedent will gener-
ate.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries and Decedents
               Part II – Income in Respect of Decedents
          Subchapter O – Gain or Loss on Disposition of Property
               Part II – Basis Rules of General Application
                    §1014 – Basis of Property Acquired From a Decedent
                    §1014(c) – Property Representing Income in Respect of Decedent

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Part I – Tax Imposed
               §2001 – Imposition and Rate of Tax
          Part III – Gross Estate
               §2033 – Property in Which Decedent had an Interest
               §2039 - Annuities

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§692            INCOME TAXES ON MEMBERS OF THE ARMED FORCES, ASTRONAUTS AND VIC-
                TIMS OF CERTAIN TERRORIST ATTACKS ON DEATH

OVERVIEW

(a) In the case of any individual who dies while in active service as a member of the Armed Forces of
the United States, if such death occurred while serving in a combat zone or as a result of wounds,
disease, or injury incurred while so serving--

   (1) Any tax imposed by this subtitle shall not apply with respect to the taxable year in
which falls the date of his death, or with respect to any prior taxable year ending on or after
the first day he so served in a combat zone; and

    (2) Any tax under this subtitle for taxable years preceding those specified in paragraph (1)
which is unpaid at the date of his death (including interest, additions to the tax, and addition-
al amounts) shall not be assessed, and if assessed the assessment shall be abated, and if col-
lected shall be credited or refunded as an overpayment.

(b) INDIVIDUALS IN MISSING STATUS

In the case of an individual who was in a missing status, the date of his death shall be treated
as being not earlier than the date on which a determination of his death is made

(c) CERTAIN MILITARY OR CIVILIAN EMPLOYEES OF THE UNITED STATES
DYING AS A RESULT OF INJURIES

   (1) In the case of any individual who dies while a military or civilian employee of the
United States, if such death occurs as a result of wounds or injury which was incurred while
the individual was a military or civilian employee of the United States and which was in-
curred in a terroristic or military action, any tax imposed by this subtitle shall not apply--

       (A) With respect to the taxable year in which falls the date of his death, and

      (B) With respect to any prior taxable year in the period beginning with the last taxable
year ending before the taxable year in which the wounds or injury were incurred.


   (2) TERRORISTIC OR MILITARY ACTION

   The term "terroristic or military action" means--

      (A) Any terroristic activity which a preponderance of the evidence indicates was di-
rected against the United States or any of its allies, and


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      (B) Any military action involving the Armed Forces of the United States and resulting
from violence or aggression against the United States or any of its allies (or threat thereof).

   The term "military action" does not include training exercises.

   (3) TREATMENT OF MULTINATIONAL FORCES

   Any multinational force in which the United States is participating shall be treated as an ally of
the United States.

(d) INDIVIDUALS DYING AS A RESULT OF CERTAIN ATTACKS

  (1) In the case of a specified terrorist victim, any tax imposed by this chapter shall not apply

      (A) With respect to the taxable year in which falls the date of death, and

      (B) With respect to any prior taxable year in the period beginning with the last taxable year
ending before the taxable year in which the wounds, injury, or illness referred to in paragraph (3)
were incurred.

   (2) $10,000 MINIMUM BENEFIT

   If the amount of tax not imposed by paragraph (1) with respect to a specified terrorist victim is
less than $10,000, then such victim shall be treated as having made a payment against the tax im-
posed by this chapter for such victim's last taxable year in an amount equal to the excess of $10,000
over the amount of tax not so imposed.

   (3) TAXATION OF CERTAIN BENEFITS

  Paragraph (1) shall not apply to the amount of any tax imposed by this chapter, which would be
computed by only taking into account the items of income, gain, or other amounts attributable to

      (A) Deferred compensation which would have been payable after death if the individual had
died other than as a specified terrorist victim, or

      (B) Amounts payable in the taxable year which would not have been payable in such taxable
year but for an action taken after September 11, 2001.

   (4) SPECIFIED TERRORIST VICTIM

   For purposes of this subsection, the term 'specified terrorist victim' means any decedent

      (A) Who dies as a result of wounds or injury incurred as a result of the terrorist attacks against
the United States on April 19, 1995, or September 11, 2001, or

                                                  39                        ©2008 WealthCounsel, LLC
      (B) Who dies as a result of illness incurred as a result of an attack involving anthrax occurring
on or after September 11, 2001, and before January 1, 2002.

    Such term shall not include any individual identified by the Attorney General to have been a par-
ticipant or conspirator in any such attack or a representative of such an individual.

   (5) RELIEF WITH RESPECT TO ASTRONAUTS.

   The provisions of this subsection shall apply to any astronaut whose death occurs in the line of
duty, except that paragraph (3)(B) shall be applied by using the date of the death of the astronaut ra-
ther than September 11, 2001.


Importance:

This new amendment to Sec.692 put the Astronauts and victims of terrorists on an equal level as our
Members of the Armed Forces who are killed in a combat zone.

Cross Reference:

Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter C – Miscellaneous
                       Sec. 2201 – Combat Zone – Related Deaths of Members of the Armed
                       forces and Deaths of Victims of Certain Terrorist Attacks
______________________________________________________________________________




                                                  40                       ©2008 WealthCounsel, LLC
______________________________________________________________________________


SUBCHAPTER K                                                 PARTNERSHIPS & PARTNERS
PART I                                                  DETERMINATION OF TAX LIABILITY
§701            PARTNER, NOT PARTNERSHIP, SUBJECT TO TAX
OVERVIEW
This section provides that a partnership is not taxed as a separate entity, but is instead a conduit for
federal income tax purposes.
IMPORTANCE
The fact that a partnership is not taxed as a separate entity (unlike a corporation) is of tremendous
significance in structuring business entities, which are not subject to a second layer of taxation at the
entity level.

§702            INCOME AND CREDIT OF PARTNERS
OVERVIEW
This section requires each partner to take into account such partner’s distributive share of any in-
come, gain, loss, deduction or credit realized by the partnership. It required that certain items be
separately accounted for by each partner, and realized as if they came to the partner directly from the
source from which the partnership received them.
IMPORTANCE
The partnership is generally treated as a mere conduit for tax reporting purposes, so that each partner
recognizes such partner’s distributive share of tax items. The partnership typically has considerable
flexibility (subject to Section 704(b) in structuring each partner’s distributive share.

§703            PARTNERSHIP COMPUTATIONS
OVERVIEW
This section generally requires the partnership to compute its taxable income in the same manner as
an individual taxpayer with certain listed exceptions. It also provides a general rule that tax elections
affecting the computation of taxable income shall be made by the partnership.
IMPORTANCE
This section bolsters the conduit approach to partnership taxation.

§704            PARTNER’S DISTRIBUTIVE SHARE
OVERVIEW
§704(a) - This section requires that each partner’s distributive share of income, gain, loss, deduction



                                                   41                        ©2008 WealthCounsel, LLC
or credit to be determined according to the partnership agreement unless the agreement is silent or
the allocations of distributive share of these tax attributes lacks “substantial economic effect.” In-
come, gain, loss, deduction, and credit are referred to as “tax attributes.”
§704(b) – Allows the partners to agree on special allocations of distributive shares of tax attributes.
§704(c) – Sets out rules for determining distributive shares of tax attributes in regard to contributed
property.
§704(d) – Limits the deductibility of a partner’s distributive share of loss to the partner’s adjusted
basis of the partner’s partnership interest. Any excess loss may be carried forward to years when the
excess is repaid by either additional contributions to capital or by offset against future distributive
shares of partnership income.

§704(e) – The family partnership rules.

     (1) A person will be recognized as a partner if he owns a capital interest in a partnership in
         which capital is a material income product factor, whether or not such interest was acquired
         by purchase or gift.
     (2) If a donor of a partnership interest renders services to the partnership, the donee’s distribu-
         tive share of the attribute will be recognized as long as the donor is being reasonably com-
         pensated for such services to the partnership.
     (3) The purchase of a partnership interest from a family member is considered donated capital.
         The term “family” includes spouse, ancestors, lineal descendants, and trusts for such family
         members.
IMPORTANCE
This section is of tremendous significance in designing a partnership. The partnership agreement
may provide for the special allocation of items of income and loss (such as allocating income or loss
from a specific partnership asset to the contributing partner) so long as the allocation has substantial
economic effect, as defined under the voluminous Treasury Regulations issued under Section 704(b).

§705            DETERMINATION OF BASIS OF PARTNER’S INTEREST
OVERVIEW
The starting point for determining basis of a partner’s interest is §722 (contributed basis) or §742
(purchase basis), then this section provides the means to determine a partner’s basis in the partner’s
interest in the partnership, by causing the basis to increase to the extent of income allocated to the
partner, and by causing the basis to be decreased to the extent of any distributions or losses to the
partner.
IMPORTANCE
This section sets forth the basic rules to determine the partner’s basis in the partnership interest (also
known as the “outside basis”).




                                                   42                        ©2008 WealthCounsel, LLC
§706            TAXABLE YEARS OF PARTNER AND PARTNERSHIP
OVERVIEW
This section requires a partnership to maintain the same taxable year as the majority in interest of its
partners, and sets out rules for when a different taxable year may be selected.

IMPORTANCE
This section generally eliminates the opportunity to defer partnership income to subsequent taxa-
ble years.


§707            TRANSACTIONS BETWEEN PARTNER AND PARTNERSHIP

OVERVIEW
This section allows transactions between a partner and the partnership to be treated as a transaction
between unrelated parties under certain circumstances.

(a) PARTNER NOT ACTING IN CAPACITY AS PARTNER

       (1) IN GENERAL

If a partner engages in a transaction with a partnership other than in his capacity as a member of such
partnership, the transaction shall be considered as occurring between the partnership and one who is
not a partner.

(2) TREATMENT OF PAYMENTS TO PARTNERS FOR PROPERTY OR SERVICES

(A) TREATMENT OF CERTAIN SERVICES AND TRANSFERS OF PROPERTY

If--

(i) a partner performs services for a partnership or transfers property to a partnership,

(ii) there is a related direct or indirect allocation and distribution to such partner, and

(iii) the performance of such services (or such transfer) and the allocation and distribution, when
viewed together, are properly characterized as a transaction occurring between the partnership and a
partner acting other than in his capacity as a member of the partnership, such allocation and distribu-
tion shall be treated as a transaction occurring between the partnership and one who is not a partner.


(B) TREATMENT OF CERTAIN PROPERTY TRANSFERS



                                                   43                        ©2008 WealthCounsel, LLC
If--

(i) there is a direct or indirect transfer of money or other property by a partner to a partnership,

(ii) there is a related direct or indirect transfer of money or other property by the partnership to such
partner (or another partner), and

(iii) the transfers when viewed together, are properly characterized as a sale or exchange of property,

such transfers shall be treated either as a transaction as occurring between the partnership and one
who is not a partner or as a transaction between 2 or more partners acting other than in their capacity
as members of the partnership.


(b) CERTAIN SALES OR EXCHANGES OF PROPERTY WITH RESPECT TO CON-
TROLLED PARTNERSHIPS

(1) LOSSES DISALLOWED

No deduction shall be allowed in respect of losses from sales or exchanges of property (other than an
interest in the partnership), directly or indirectly, between--

(A) a partnership and a person owning, directly or indirectly, more than 50 percent of the capital in-
terest, or the profits interest, in such partnership, or

(B) two partnerships in which the same persons own, directly or indirectly, more than 50 percent of
the capital interests or profits interests.

267(d) shall be applicable as if the loss were disallowed under section 267(a)(1). For purposes of
section 267(a)(2), partnerships described in subparagraph (B) of this paragraph shall be treated as
persons specified in section 267(b).


(2) GAINS TREATED AS ORDINARY INCOME

In the case of a sale or exchange, directly or indirectly, of property, which in the hands of the trans-
feree, is property other than a capital asset as defined in section 1221--

(A) between a partnership and a person owning, directly or indirectly, more than 50 percent of the
capital interest, or profits interest, in such partnership, or

(B) between two partnerships in which the same persons own, directly or indirectly, more than 50
percent of the capital interest or profits interests,

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any gain recognized shall be considered as ordinary income.


(3) OWNERSHIP OF A CAPITAL OR PROFITS INTEREST

For purposes of paragraphs (1) and (2) of this subsection, the ownership of a capital or profits inter-
est in a partnership shall be determined in accordance with the rules for constructive ownership of
stock provided in section 267(c) other than paragraph (3) of such section.


(c) GUARANTEED PAYMENTS

To the extent determined without regard to the income of the partnership, payments to a partner for
services or the use of capital shall be considered as made to one who is not a member of the partner-
ship, but only for the purposes of section 61(a) (relating to gross income) and, subject to section 263,
for purposes of section 162(a) (relating to trade or business expenses).


IMPORTANCE
A partnership may deduct expenses (such as rent paid to a partner for the lease of his property, or
such as management fees as so called “§707(c) guaranteed payments”) prior to determining net part-
nership income subject to the distribution rules under §702. This provides additional flexibility in
allocating partnership income.


§708           CONTINUATION OF PARTNERSHIP

OVERVIEW
General Rule – An existing partnership keeps on continuing.

This section treats a partnership as having been terminated if fifty percent or more of the partnership
interests are sold or exchanged within any given twelve month period.

(a) For purposes of this subchapter, an existing partnership shall be considered as continuing if it
is not terminated.


(b) TERMINATION

For purposes of subsection (a), a partnership shall be considered as terminated only if--

(A) no part of any business, financial operation, or venture of the partnership continues to be car-
ried on by any of its partners in a partnership, or

(B) within a 12-month period there is a sale or exchange of 50 percent or more of the total inter-
                                                  45                        ©2008 WealthCounsel, LLC
est in partnership capital and profits.


IMPORTANCE
This section is of less significance in the estate planning context because the IRS has issued regula-
tions indicating that a gift or bequest, which results in a change of fifty percent or more of the part-
nership interest, does not trigger termination of the partnership.

If a termination should occur under IRC §708, the tax year ends at that time and all tax elec-
tions, such as an IRC §754 election, are also terminated. After termination if a new partner-
ship is constituted, then a new tax year will begin and new elections must be made if there is a
desire for such elections to be in effect.


§709            TREATMENT OF ORGANIZATIONS AND SYNDICATION FEES

OVERVIEW
(a) GENERAL RULE

Except as provided in subsection (b), no deduction shall be allowed under this chapter to the partner-
ship or to any partner for any amounts paid or incurred to organize a partnership or to promote the
sale of (or to sell) an interest in such partnership.


(b) DEDUCTION OF ORGANIZATION FEES

     (1) ALLOWANCE OF DEDUCTION.

     If a taxpayer elects the application of this subsection with respect to any organizational expens-
     es--

          (A) the taxpayer shall be allowed a deduction for the taxable year in which the partnership
          begins business in an amount equal to the lesser of--

               (i) the amount of organizational expenses with respect to the partnership, or

               (ii) $5,000, reduced (but not below zero) by the amount by which such organizational
               expenses exceed $50,000, and

          (B) the remainder of such organizational expenses shall be allowed as a deduction ratably
          over the 180-month period beginning with the month in which the partnership begins
          business.

     (2) DISPOSITIONS BEFORE CLOSE OF AMORTIZATION PERIOD.

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     In any case in which a partnership is liquidated before the end of the period to which paragraph
     (1)(B) applies, any deferred expenses attributable to the partnership which were not allowed as
     a deduction by reason of this section may be deducted to the extent allowable under section 165.

     (3) ORGANIZATIONAL EXPENSES DEFINED

     The organizational expenses to which paragraph (1) applies, are expenditures which--

          (A) are incident to the creation of the partnership;

          (B) are chargeable to capital account; and

          (C) are of a character which, if expended incident to the creation of a partnership having
          an ascertainable life, would be amortized over such life.


IMPORTANCE
The partnership’s taxable income will be increased to the extent that its organizational expenses can-
not be used as a current deduction.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter B – Computation of Taxable Income
               Part VI – Itemized Deductions for Individuals and Corporations
                    §195 – Start-up Expenditures
               Part VIII – Special Deductions for Corporations
                    §248 – Organizational Expenditures


______________________________________________________________________________


PART II                          CONTRIBUTIONS, DISTRIBUTIONS, AND TRANSFERS
SUBPART A                                   CONTRIBUTIONS TO A PARTNERSHIP
§721           NONRECOGNITION OF GAIN OR LOSS ON CONTRIBUTION

OVERVIEW
This section provides that no gain or loss is recognized upon the contribution of assets to a partner-
ship, except for partnerships where more than eighty percent of the value of the partnership is com-
prised of securities. §721(b) provides that the investment company rules of §351(e) applies when
appreciated securities are contributed to a partnership.



                                                 47                        ©2008 WealthCounsel, LLC
IMPORTANCE
The general lack of recognition of gain or loss on contribution of assets to a partnership means that
there are normally no negative income tax consequences to the formation of a partnership. Great care
must be taken to avoid inadvertent recognition of gain when eighty percent or more the partnership’s
assets are securities.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter C – Corporate Distributions and Adjustments
               Part III – Corporate Organizations and Reorganizations
                    Subpart A – Corporate Organizations
                          §351 – Transfers to Corporation Controlled by Transferor
                          §351(a) – General Rule
                          §351(e) – Exceptions



§722           BASIS OF CONTRIBUTING PARTNER’S INTEREST

OVERVIEW
A partner’s basis in the partnership interest acquired by contribution of property is deemed to be the
amount of cash paid plus the partner’s adjusted basis in the property contributed to the partnership,
increased by any gain recognized under §721(b).

IMPORTANCE
This section sets forth the general rule to determine basis of a partnership interest acquired by the
contribution of money or assets, and other than by gift or bequest or by purchase.

CROSS REFERENCE:
§742 – Basis of Transferee of Partner’s Interest

§723           BASIS OF PROPERTY CONTRIBUTED TO PARTNERSHIP

OVERVIEW
The partnership’s basis in contributed property is the same as the contributing partner’s basis in the
property, increased by any gain recognized under §721(b) by the contributing partner.

IMPORTANCE
The determination of basis of contributed property is consistent with the nonrecognition of gain or
loss under § 721.




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§724            CHARACTER OF GAIN OR LOSS ON CONTRIBUTED UNREALIZED RECEIVABLES,
                INVENTORY ITEMS, AND CAPITAL LOSS PROPERTY

OVERVIEW
(a) Unrealized Receivables – The gain or loss recognized by the partnership upon the disposition of
contributed unrealized receivables is ordinary gain or ordinary loss, as the case may be.

(b) Inventory – The gain or loss recognized by the partnership upon the disposition inventory items
contributed by a partner, within 5 years of its contribution, is ordinary gain or ordinary loss, as the
case may be.

(c) Capital Loss Property – The loss recognized by the partnership upon the deposit of contributed
capital loss property within 5 years of its contribution is treated as a capital loss to the extent that the
adjusted basis of the asset exceeded its fair market value on the date of contribution.

IMPORTANCE
The partnership may not be used as a means to transform ordinary income into capital gain.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter K – Partnerships & Partners
               Part II – Contributions, Distributions & Transfers
                    Subpart D – Provisions Common to Other Subparts
                          §751 – Unrealized Receivables and Inventory Items
                          §751(c) – Unrealized Receivables
                          §751(d) – Inventory Items


_____________________________________________________________________________


SUBPART B                                            DISTRIBUTIONS BY A PARTNERSHIP
§731            EXTENT OF RECOGNITION OF GAIN OR LOSS ON DISTRIBUTION

OVERVIEW
1. The Gain Rule for Partners: Partnership distributions, as a general rule, do not give rise to recog-
nition of gain to a partner, except to the extent that money distributed exceeds the partner’s adjusted
basis in his partnership interest before the distribution. In general, the gain recognized is a capital
gain.

2. The Loss Rule for Partners: Loss is generally not recognized on distributions to a partner, except
in the case of a distribution in liquidation of a partner’s interest, and then only where the only
items distributed in liquidation to the partner consist of money, inventory of unrealized receivables,
                                                    49                         ©2008 WealthCounsel, LLC
loss will be recognized to the extent that the partner’s adjusted basis in his partnership interest ex-
ceeds the amount of money distributed, and the partner’s §732 basis in the inventory and unrealized
receivables distributed. In general, the loss recognized is a capital loss.

3. The No Gain or Loss Rule for Partnerships: No gain or loss is recognized by a partnership upon
the distribution of property or money to partners.

4. Special Rules:

(a) §731(c) provides for some special complicated rules for distributions of “marketable securities”
(as therein defined) which treats such marketable securities as money for the recognition of gain rule
for distributions to partners and for §737 purposes.

(b) §731(d) provides that sections 736, 737, and 751 can override these rules in §731.

IMPORTANCE
Since partnerships are generally treated as conduits, this allows distributions to occur without nega-
tive income tax consequences. This represents a significant advantage over other forms of doing
business (such as corporations).

§732            BASIS OF DISTRIBUTED PROPERTY OTHER THAN MONEY

OVERVIEW
(a) Distributions Other Than Liquidation – The basis of property distributed to a partner other
than in liquidation shall be the same as its adjusted basis to the partnership less any money dis-
tributed on the same distribution and limited to the adjusted basis of the partner’s partnership inter-
est.

(b) Distribution in Liquidation – The basis of property distributed by a partnership to a partner in
liquidation of the partner’s interest shall be the same as the partner’s partnership interest reduced
by any money distributed to the partner on the liquidation of his interest.

(c) Allocation of Basis – The basis of distributed property is allocated:

     First – To unrealized receivables and inventory, but only up to the partnerships basis.

     Second – If any basis remains, then to other distributed property.

(d) Special Partnership Basis to Transferee – If no sec. 754 election is in effect, and a transferee of a
partnership interest is distributed property (other than money) within two years of having received
the partnership interest from the transferor partner, he or she may elect to treat the adjusted basis of
such distributed property just as it would have been under sec. 743(b) if a sec. 754 election were
made. If the fair market value of the distributed property exceeds 110% of the partnerships adjusted
basis in the property, the IRS can require application of sec. 732(d).

                                                   50                        ©2008 WealthCounsel, LLC
IMPORTANCE
Partnerships may structure terminations of a partner’s interest either as a liquidation or as the sale of
a partnership interest, which may result in vastly different tax consequences.

§733            BASIS OF DISTRIBUTEE PARTNER’S INTEREST

OVERVIEW
In the case of a non-liquidation distribution, a partner’s basis in his partnership interest is reduced by
the amount of any money received in a distribution, and the adjusted basis of partnership property
received in a distribution.

IMPORTANCE
This rule is consistent with the other rules governing the impact of distributions on the partner and
the partnership.

§734            OPTIONAL ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY

OVERVIEW
(a) General Rule –If no Section 754 election is in effect, then no adjustment may be made to the ba-
sis of partnership property remaining after a distribution, unless there is a “Substantial Basis
Reduction”.

(b) If a partnership has made an election under Section 754, then the partnership’s basis in its assets
(the “inside basis”) is adjusted up to the extent of any gain recognized by the distributee partner on a
distribution of property, and is adjusted down to the extent of any loss recognized by the distributee
partner on a distribution of property.

(c) Section 755 provides for special rules for the allocation of the increase or decrease of the basis of
partnership property remaining after a distribution.

(d) A “Substantial Basis Reduction” means a reduction of more than $250,000.

(e) Exception for a “Securitization Partnership” as defined in IRC §743 (f), shall not be considered as
having a substantial basis reduction.

IMPORTANCE
The redemption of a partner’s interest can result in the adjustment of the partnership inside basis of
its assets. This section allows the partnership to make an adjustment in its inside basis, which may
increase its depreciation allowance, when a §754 election is in effect.




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§735            CHARACTER OF GAIN OR LOSS ON DISPOSITION OF DISTRIBUTED PROPERTY

OVERVIEW
A partner who sells unrealized receivables or inventory received as a partnership distribution must
treat the sales proceeds as ordinary income rather than as capital gain. In addition, a partner who re-
ceives a partnership distribution is deemed to succeed to the partnership’s holding period for such
assets.

IMPORTANCE
The partnership cannot be used as a means to convert ordinary income to capital gains.

§736            PAYMENTS TO A RETIRING PARTNER OR DECEASED PARTNER’S SUCCESSORS
                IN INTEREST

OVERVIEW
(a) The Income Distribution Rule: Payments to a retiring partner or the successor in interest of a de-
ceased partner in liquidation of the partner’s interest in the partnership are generally treated (1) as a
distribution of the partner’s distributive share of partnership income (if determined with regard to
partnership income), or (2) as a Section 707(c) guaranteed payment (if determined without regard to
partnership income).

(b) The Property Distribution Rule: Payments made in liquidation of the interest of a retiring partner
or deceased partner which are determined (under the regulations) to be in exchange for the partner’s
interest in partnership property, shall be considered as a Section 731 distribution, and not as a distri-
bution of income or a guaranteed payment.

IMPORTANCE
The partnership has significant flexibility in designing the payout to a retiring or deceased partner.

§737            RECOGNITION OF PRE-CONTRIBUTION GAIN IN CASE OF CERTAIN DISTRIBU-
                TIONS TO CONTRIBUTING PARTNER

OVERVIEW
(a) A partner who has contributed appreciated property to a partnership and who receives appreciated
property, which he did not contribute, as a distribution from the partnership, may have to recognized
gain under some circumstances. The amount of gain, which must be recognized, is the lesser of:

     (1) The excess (if any) of:

          (A) The fair market value of the distributed property (other than money) over




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          (B) The adjusted basis of the distributee partner’s partnership interest immediately before
          the distribution reduced (but not below zero) by any money received in the same distribu-
          tion; or

     (2) The net (unrecognized) pre-contribution gain of the distributee partner.

The above gain recognized is in addition to any IRC §731 gain, which must be recognized on the dis-
tribution. The character of the gain is determined by looking to the character of the net pre-
contribution gain not recognized when the distributee contributed the other appreciated property to
the partnership.

(b) In determining the amount of a distributee partners net pre-contribution gain, we look to the
amount of all unrecognized gain on all appreciated property contributed by the distributee partner to
the partnership within the last seven (7) years as of the date of the distribution of the property the dis-
tributee did not contribute to the partnership.

(c) Basis Rules

     (1)(a) The distributee partner will increase the basis of his or her partnership interest by the gain
     he or she must recognize under IRC §737.

     (1)(b) The basis of the distributed property in the hands of the distributee partner is determined
     under IRC §732(a)(1) (the adjusted basis of the partnership in the distributed property) in-
     creased by the gain recognized by the distributee.

     (2) The partnership gets to adjust the basis of the property that the distributee partner contribut-
     ed by the gain recognized by the distributee.

(d) Exceptions

     (1) If a portion of the property distributed to the partner included property that he or she con-
     tributed to the partnership, you exclude that property from the calculations of gain under IRC
     §737. If an interest in an entity owned by the partnership is distributed to a partner, you do not
     exclude the value of property contributed by the distributee partner to the partnership, which
     was later contributed by the partnership to the entity.

     (2) §751(b) overrides §737.

(e) Look to §731(c) for the treatment of marketable securities as money.

IMPORTANCE
In-kind distributions of appreciated property must be carefully monitored in order to avoid unantici-
pated recognition of gain.


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_______________________________________________________________________________


SUBPART C                             TRANSFERS OF INTERESTS IN A PARTNERSHIP
§741            RECOGNITION AND CHARACTER OF GAIN OR LOSS ON SALE OR EXCHANGE

OVERVIEW
On the sale or exchange of a partnership interest gain or loss shall be recognized by a transferor part-
ner. The sale or exchange of a partnership interest is treated as the sale of a capital asset except to
the extent that IRC §751 requires ordinary income treatment for the value of unrealized receivables
or inventory that may be involved.

IMPORTANCE
There are different ways to terminate a partner’s interest in a partnership, including selling the inter-
est, liquidating the interest, or retiring the interest, which may give rise to strikingly different tax
consequences.

§742            BASIS OF TRANSFEREE PARTNER’S INTEREST

OVERVIEW
The basis of a partner’s interest in the partnership (other than a partnership interest acquired by con-
tribution of property) is determined by the general rules concerning basis of property under Subchap-
ter O, Part II (§1011 and following).

IMPORTANCE
Partnership interests are similar to other assets with regard to the determination of outside basis.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter O – Gains and Loss on Disposition of Property
               Part II – Basis Rules of General Application
                    §1011 – Adjusted Basis for Determining Gain or Loss
                    §1012 – Basis of Property Cost
                    §1014 – Basis of Property Acquired from a Decedent
               §1015 – Basis of Property Acquired by Gift and Transfers in Trust
               §1016 – Adjustments to Basis

§743            OPTIONAL ADJUSTMENTS TO BASIS OF PARTNERSHIP PROPERTY

OVERVIEW
If a partnership has an IRC §754 election in effect then when a transfer of a partnership interest oc-
curs as a result of a sale or exchange of a partnership interest or as a result of the death of a part-
ner, the inside basis of partnership assets will be adjusted to reflect any adjustments to the outside
                                                   54                        ©2008 WealthCounsel, LLC
basis of the transferee’s IRC §1012 cost basis or the transferee’s IRC §1014 inherited basis, or unless
the partnership has a “Substantial Built-in Loss” immediately after such transfer. A “Substantial
Built-in Loss” means a loss that requires an adjustment to basis that is more than $250,000 of the fair
market value of such property. Exception is made for an “Electing Investment Partnership”.

The basis adjustment will

     (1). Increase the adjusted basis of partnership property by the excess of the basis of the new
     transferee partner’s partnership interest over the transferee’s proportionate share of the adjusted
     basis of the partnership property.

     (2) Decrease the adjusted basis of partnership property by the excess of the new transferee part-
     ner’s proportionate share of the adjusted basis of the partnership property over the basis of the
     transferee partner’s partnership interest.

The increase or decrease is an adjustment to basis of partnership property with respect to only the
transferee partner, and is determined in accordance with the transferee’s interest in partnership capi-
tal.

IMPORTANCE
The basis adjustment provisions under Sections 743 and 754 are useful for increasing the inside basis
of partnership assets for depreciation and other purposes.


_______________________________________________________________________________


SUBPART D                              PROVISIONS COMMON TO OTHER SUBPARTS
§751           UNREALIZED RECEIVABLES AND INVENTORY ITEMS

OVERVIEW
Unrealized receivables (defined as contract rights attributable to the sale of noncapital assets or the
rendering of service) and inventory items received as partnership distributions, give rise to ordinary
income or loss treatment rather than capital gain or loss treatment.

Exception – When unrealized receivables or inventory is distributed to a partner in exchange for all
or a part of his partnership interest, or a partner’s interest in other partnership property.

IMPORTANCE
A partnership cannot be used to transform ordinary income into capital gain. This is particularly sig-
nificant when there is a significant difference between the tax rates on ordinary income (as high as
39.6%) and capital gains (limited to 20%).



                                                  55                        ©2008 WealthCounsel, LLC
§752            TREATMENT OF CERTAIN LIABILITIES

OVERVIEW
Any increase in a partner’s share of partnership liabilities or the assumption of partnership liabilities
by a partner will be treated as equivalent to the contribution of money by the partner.

Any decrease in a partner’s share of the liabilities of a partnership or any decrease in a partner’s indi-
vidual liabilities by reason of the assumption by the partnership shall be treated as a distribution of
money to the partner.

IMPORTANCE
The assumption of liability by a partner is one way for a partner to increase his/her basis in the
partnership interest. There are a number of other rules, which limit the types of liabilities, which may
be considered for this purpose. In particular, the at-risk limitations set forth in Section 465 are in-
tended to restrict the assumption of liabilities to those that have real economic consequences to the
assuming partner.

§753            PARTNER RECEIVING INCOME IN RESPECT OF DECEDENT

OVERVIEW
Payments received by a decedent’s successor in interest in liquidation of a partnership interest under
§736(a) are considered to be income in respect of a decedent (“IRD”) as defined in §691

IMPORTANCE
IRD payments are not subject to a basis adjustment and are treated as ordinary income in the hands
of the recipient of the payments. Since §736(a) liquidation payments are generally treated as ordinary
income to a retiring partner, this section creates conformity between payment to a retiring living
partner and the successor in interest of a retired deceased partner.

§754            MANNER OF ELECTING OPTIONAL ADJUSTMENT TO BASIS OF PARTNERSHIP
                PROPERTY

OVERVIEW
The partnership (acting through its tax matters partner) may elect under §754 to adjust its basis in its
assets (the “inside basis”) in the event of a distribution under §734 or a transfer of a partnership
interest under §743. The election applies to all distributions of property by the partnership and to
all transfers of partnership interest during the taxable year of election and to all subsequent taxable
years.

IMPORTANCE
The §754 election is significant because it allows the partnership to adjust its basis in its assets to
take into account events, which have caused a partner’s basis in his/her partnership interest to be ad-
justed. This may be of benefit when there are depreciable assets in the partnership. It should be noted
that the §754 election is discretionary, and that some commentators have suggested that a partnership
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agreement, which explicitly precludes the §754 election, may be entitled to enhanced valuation dis-
counts for estate and gift tax purposes.

§755            RULES FOR ALLOCATION OF BASIS

OVERVIEW
If a partnership elects under §754 to adjust the basis of its assets under §734(b) or §743(b), then the
basis adjustment is carried out in a manner, which reduces the difference between the fair market
value of the partnership’s assets and the partnership’s basis in such assets. This generally means that
the basis adjustment is to be carried out ratably against all partnership assets, and not targeted to spe-
cific partnership assets.

(c) NO ALLOCATION OF BASIS DECREASE TO STOCK OF CORPORATE PARTNER

(1) no allocation may be made to stock in a corporation (or any person related (within the meaning of
sections 267(b) and 707(b)(1)) to such corporation) which is a partner in the partnership, and

(2) any amount not allocable to stock by reason of paragraph (1) shall be allocated under subsection
(a) to other partnership property.

Gain shall be recognized to the partnership to the extent that the amount required to be allocated un-
der paragraph (2) to other partnership property exceeds the aggregate adjusted basis of such other
property immediately before the allocation required by paragraph (2).

IMPORTANCE
This is a rule, which is intended to prevent taxpayers from taking unfair advantage of a tax benefit.


_________________________________________________________________________________


PART III                                                                           DEFINITIONS

§761            TERMS DEFINED

OVERVIEW
(a) Partnership - For purposes of Subtitle A Income Taxes - A partnership is defined to be any syn-
dicate, group, pool, joint venture or other unincorporated organization through by the means
of which any business, financial operation or venture is carried on and which is not a corpora-
tion or trust or estate. All the members of an unincorporated organization may elect to have the
organization excluded from all or part of Subchapter K if it is availed of (1) for investment
purposes only, and not for the active conduct of a business, or (2) for the joint production, extrac-
tion, or use of property.


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(b) Partners – Means members of a partnership.

(c) Partnership Agreement – Includes any modifications made at or prior to the time for the 1065 tax
return, and which is agreed to by all partners.

(d) Liquidation of a Partnership Interest – Termination of a partner’s entire interest by means of one
or more distribution to the partner.

(e) Distribution of Partnership Interest Treated as Exchanges – For purposes of §708, §743 or any
other provision in subchapter K, any distributions of a partnership interest is treated as an exchange.

IMPORTANCE
The definition of partnership for federal income tax purposes is extraordinarily broad and also gener-
ally includes limited liability companies. Virtually any unincorporated business carried on by two or
more partners, which possesses some type of business purpose, will be recognized as a partnership
for federal income tax purposes. The IRS cannot refuse to recognize an unincorporated entity of two
or more members (which is not a trust or an estate) as a partnership if all of its members have not
elected out of Subchapter K treatment.

CROSS REFERENCE:
Subtitle F – Procedure and Administration
     Chapter 79 – Definitions
          §7701 – Definitions
          §7701(a)(2) – Partnership and Partner
See also Treasury Regulation §301.7701-2 & 3, popularly known as the “Check-The-Box” regula-
tions. See also IRS Form 8832, “Choice of Business Entity Election”, and the Instruction for IRS
Form 8832.




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_______________________________________________________________________________
______________________________________________________________________________

SUBCHAPTER O            GAINS AND LOSSES ON DISPOSITION OF PROPERTY
PART I DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS
§1001          DETERMINATION OF AMOUNT AND RECOGNITION OF GAIN OR LOSS

OVERVIEW
Gain Realized = Amount realized minus adjusted basis

Loss Realized = adjusted basis minus amount realized

Amount Realized = money plus FMV of property received

Recognized Gain or Loss = except as otherwise provided all gains or losses realized shall be recog-
nized

IMPORTANCE
It is important for estate planners to know how to calculate gains or losses.

__________________________________________________________________

PART II                                      BASIS RULES OF GENERAL APPLICATION
§1011          ADJUSTED BASIS FOR DETERMINING GAIN OR LOSS

OVERVIEW
Adjusted basis = cost basis or other applicable losses adjusted as provided by IRC § 1016. This
section provided special rules for determining adjusted basis and for determining the basis to be used
when bargain sales are made to charity.

IMPORTANCE
Estate planners need to know how to calculate the adjusted basis for purposes of determining gain or
loss.

§1012          BASIS OF PROPERTY COST

OVERVIEW
Nicknamed “The Basic Basis Code Section.” Except as provided elsewhere in Subchapters 0, C, K,
and P, the basis property is its cost. Real estate taxes are not part of the cost basis of property.

IMPORTANCE
Unless you can find a basis section to the contrary Basis = Cost.



                                                 59                       ©2008 WealthCounsel, LLC
§1014           BASIS OF PROPERTY ACQUIRED FROM A DECEDENT

OVERVIEW
§1014(a) – Provides rules for determining the FMV basis of property acquired from a decedent.
Basic rule – The property must be included in the decedent’s estate. The basis of property in the
hands of a person acquiring the property from a decedent or to whom property passed from a dece-
dent, shall, if not sold, or otherwise disposed of before the decedent’s death by such person, be

     (1) the FMV on the date of decedent’s death, or
     (2) FMV as of the applicable alternate valuation date if an IRC §2032 election is made.

§1014(b)(6) – Allows for a double step-up in basis of property, which is community property under
the laws of any state as long as at least half of the value of such property is included in the estate of
the deceased spouse.

§1014(c) – Assets, which are IRC §691 income in respect of a decedent’s assets, do not get an IRC
§1014(a) FMV basis.

§1014(e) – In the case of a decedent who died after 1981- If the decedent acquired appreciated prop-
erty by gift within one year of death, and the donor of such property acquires it back from the dece-
dent upon the decedent’s death, then the basis of such property in the hands of the donor (or the do-
nor’s spouse) shall be the adjusted basis of the decedent immediately before the death of the dece-
dent and not the §1014(a) FMV basis.

§1014(f) – Termination - §1014 shall not apply to property acquired from a decedent dying after De-
cember 31, 2009, and if repeal continues after December 31, 2010. New §1022 will apply.

IMPORTANCE
It is important for an estate planner to be familiar with the rules of IRC §1014

CROSS REFERENCE:
§1022 – Treatment of Property Acquired from a Decedent Dying After December 31, 2009
    Subtitle B – Estate and Gift Taxes
         Chapter 11 – Estate Taxes


§1015           BASIS OF PROPERTY ACQUIRED BY GIFT AND TRANSFERS IN TRUST

OVERVIEW
Provides a rule for determining basis for property acquired by gift
Basis for determining gain is the donor’s basis
The basis for determining loss is the FMV, if FMV is less than donor’s basis

If gift tax is paid by a donor for the year of the gift, then the basis as determined by §1015(a) shall be

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increased (but not beyond FMV) by a pro rata share of the gift tax paid by the donor on all gifts made
for that year.

IMPORTANCE
Estate Planners need to know how to compute the basis of property acquired by gift.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax


_________________________________________________________________________________


PART V              SPECIAL RULES FOR BONDS AND OTHER DEBT INSTRUMENTS
SUBPART A                                     ORIGINAL ISSUE DISCOUNT
§1274          DETERMINATION OF ISSUE PRICE OF CERTAIN DEBT INSTRUMENTS ISSUED FOR
               PROPERTY
§1274(d)       DETERMINATION OF APPLICABLE FEDERAL RATE (AFR)

OVERVIEW
During each calendar month the Secretary of the US Treasury must determine the applicable federal
rates, which shall apply during the following calendar month. The following “Applicable Federal
Rates” (AFR) must be determined each month:

     Debt Instruments with a Term of:                         The Applicable Federal Rate is:

     Not over 3 years                                         The Federal Short-term Rate
     Over 3 years but not over 9 years                        The Federal Mid-term Rate
     Over 9 years                                             The Federal Long-term Rate

Taxpayers may elect to use the lowest 3-month rate on any sale or exchange, being the month of the
sale or exchange and the two prior months.

IMPORTANCE
The Applicable Federal Rate (AFR) is used for determining the rates for a number of estate planning
tools.

CROSS REFERENCE:
Subtitle F – Procedure and Administration
     Chapter 77 – Miscellaneous Provisions
          §7520 – Valuation Tables

Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
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        Subchapter E – Accounting Periods and Methods of Accounting
            Part III – Adjustments
                 §483 – Interest on Certain Deferred Payments

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SUBCHAPTER S                                                                  S CORPORATIONS
PART I                                                                           IN GENERAL
§1361            S CORPORATION DEFINED

OVERVIEW
An “S” Corporation is a small business corporation, which has filed an IRS Form 2553 electing “S”
Corporation status under IRC §1362(a).

When a corporation, which has elected under subchapter S not to be taxed under §11 it enables the
corporation to avoid the double tax levied upon the income of a “C” corporation and upon distribu-
tions to its shareholders. The S Corporation rules, although more flexible in the past, restrict the elec-
tion to eligible corporations with one class of stock outstanding*, which have 100 or fewer share-
holders, who are individuals (except for qualifying estates or certain types of trusts), none of who are
non-resident aliens.

Permitted Trusts include:

(1)   Grantor trusts (and for 2 years after the grantor’s death)
(2)   A testamentary trust for 2 years
(3)   Qualified Subchapter S trusts (QSST)
(4)   Electing small business trust (ESBT)
(5)   A voting trust

Other permitted entity shareholders:
(1) IRC §401(a) qualified retirement plans (exempt from taxation under IRC §501(a))
(2) ESOPS
(3) IRC §501(c)(3) exempt organizations

*As to one class of stock outstanding rule; voting common and non-voting common stock is permis-
sible. Straight debit is not considered a second class of stock.

Ineligible Corporations include:

(1)   Financial Institutions using §585 bad debt reserves;
(2)   Insurance companies taxable under subchapter L;
(3)   Corporations electing §936 treatment;
(4)   Domestic International Sales Corporations (DISCs); and
(5)   Corporations with more than one class of stock outstanding.

A husband and wife and a“Family”are now considered one shareholder for the 100 or fewer share-
holder rule.
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Straight Debts are debts with the following characteristics:

(1)   The interest rate and the interest and principal payments are not contingent upon profits;
(2)   Are not convertible into stock;
(3)   Creditors are not non-resident alien; and
(4)   The payee is a creditor who is regularly engaged in lending money, or is a shareholder.

A Qualified Subchapter S Trust (QSST) is a trust in which:

(1)   Has only one citizen or resident income beneficiaries;
(2)   Corpus may be distributed but only to the income beneficiaries;
(3)   All income must be distributed at least annually to the income beneficiaries;
(4)   Upon termination, all assets must be distributed to the income beneficiaries.

An Electing Small Business Trust (ESBT) is a trust in which:

(1) The only beneficiaries may be individuals or estates;
(2) Shares were not acquired by purchase but by gift or bequest;
(3) Is not a QSST or a CRT.

A Qualified Wholly-Owned Subsidiary is:

(1)   Not treated as separate corporation or taxpayer;
(2)   A domestic corporation;
(3)   Not ineligible
(4)   100% owned by the parent S corporation, and all assets, liabilities, income, and deductions are
      treated as owned by the parent S corporation.

If the parent or subsidiary S corporation losses its S corporation status, the corporation may not elect
S status for 5 years, unless it can prove the loss was inadvertent.

Classes of Stock:

     Voting common

     Non-voting common

(Both must be identical in all other respects)

A trick of the trade: Always have a second class of stock, such as preferred, authorized, but not
issued, in the S corporation’s corporate charter. This way the S election may be quickly and easily
terminated in the future when a termination is desired by issuing the disqualifying 2nd class of stock.


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A SUMMARY OF IRC §1361              S Corporation Defined

(a) (1) S CORPORATION DEFINED

       A small business corporation is a corporation for which an election under section 1362(a) is
       in effect for such year.

       (2) C CORPORATION
       A corporation, which is not an S corporation for such year.


(b) SMALL BUSINESS CORPORATION

        (1) The term "small business corporation" means a domestic corporation which is not an
ineligible corporation and which does not--

       (A) have more than 100 shareholders,

       (B) have as a shareholder a person (other than an estate, a trust described in subsection (c)(2),
       or an organization described in subsection (c)(6)) who is not an individual,

       (C) have a nonresident alien as a shareholder, and

       (D) have more than 1 class of stock.


       (2) INELIGIBLE CORPORATION DEFINED

       The term “Ineligible Corporation” means any corporation, which is--

       (A) a financial institution, which uses the reserve method of accounting for bad debts de-
       scribed in section 585,

       (B) an insurance company subject to tax under subchapter L,

       (C) a corporation to which an election under section 936 applies, or

       (D) a DISC or former DISC.

       (3) TREATMENT OF CERTAIN WHOLLY OWNED SUBSIDIARIES

            (A) (i) a corporation that is a qualified subchapter S subsidiary shall not be treated as a
            separate corporation,
            and

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        (ii) all assets, liabilities, and items of income, deduction, and credit of a qualified sub-
        chapter S subsidiary shall be treated as assets, liabilities, and such items (as the case
        may be) of the S corporation.

        (B) QUALIFIED SUBCHAPTER S SUBSIDIARY

        means any domestic corporation which is not an ineligible corporation if--

        (i) 100 percent of the stock of such corporation is held by the S corporation, and

        (ii) the S corporation elects to treat such corporation as a qualified subchapter S subsidi-
        ary.

        (C) TREATMENT OF TERMINATIONS OF QUALIFIED SUBCHAPTER S SUB-
        SIDIARY STATUS
        If any corporation which was a qualified subchapter S subsidiary ceases to meet the re-
        quirements such corporation shall be treated as a new corporation acquiring all of its as-
        sets (and assuming all of its liabilities) immediately before such cessation from the S
        corporation in exchange for its stock.

        (D) ELECTION AFTER TERMINATION

        If a corporation's status as a qualified subchapter S subsidiary terminates, such corpora-
        tion (and any successor corporation) shall not be eligible to make--

        (i) an election to be treated as a qualified subchapter S subsidiary, or

        (ii) an election to be treated as an S corporation,

        before its 5th taxable year which begins after the 1st taxable year for which such termi-
        nation was effective, unless the Secretary consents to such election.


(c) SPECIAL RULES FOR APPLYING SUBSECTION (b)

     (1) MEMBERS OF FAMILY TREATED AS 1 SHAREHOLDER

          (A) IN GENERAL
          (i) a husband and wife (and their estates) shall be treated as 1 shareholder, and

          (ii) All members of the family shall be treated as 1 shareholder.

          (B) MEMBERS OF THE FAMILY

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    The term "members of the family" means the common ancestor, lineal descendants
    of the common ancestor, and the spouses (or former spouses) of such lineal descend-
    ants or common ancestor.

    (ii) COMMON ANCESTOR
    An individual shall not be considered a common ancestor if, the individual is more
    than 6 generations removed from the youngest generation of shareholders who would
    (but for this clause) be members of the family. For purposes of the preceding sen-
    tence, a spouse (or former spouse) shall be treated as being of the same generation as
    the individual to which such spouse is (or was) married.

    (C) EFFECT OF ADOPTION, ETC the rules of section 152(b)(2) (DEPEND-
    ANTS)shall apply to determine if an adopted person is a members of the family

    (D) ELECTION

    An election

    (i) may be made by any member of the family, and

    (ii) shall remain in effect until terminated.


(2) CERTAIN TRUSTS PERMITTED AS SHAREHOLDERS

    (A) IN GENERAL

    (i) GRANTOR TRUSTS: A trust all of which is treated as a Grantor Trust (under
    subpart E of part I of subchapter J of this chapter) as owned by an individual who is a
    citizen or resident of the United States.

    (ii) A Trust which was a Grantor Trust immediately before the death of the deemed
    owner and which continues in existence after such death, but only for the 2-year
    period beginning on the day of the deemed owner's death.

    (iii) A trust with respect to stock transferred to it pursuant to the terms of a will,
    but only for the 2-year period beginning on the day on which such stock is trans-
    ferred to it.

    (iv) A trust created primarily to exercise the voting power of stock transferred to it.

    (v) An electing small business trust (ESBT).


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       (vi) In the case of a corporation which is a bank (as defined in section 581), a trust
       which constitutes an individual retirement account under section 408(a), including
       one designated as a Roth IRA under section 408A, but only to the extent of the stock
       held by such trust in such bank as of the date of the enactment of this clause.

       This subparagraph shall not apply to any foreign trust.


       (B) TREATMENT AS SHAREHOLDERS

       (i) In the case of a trust described in clause (i) of subparagraph (A), the deemed own-
       er shall be treated as the shareholder.

       (ii) In the case of a trust described in clause (ii) of subparagraph (A), the estate of the
       deemed owner shall be treated as the shareholder.

       (iii) In the case of a trust described in clause (iii) of subparagraph (A), the estate of
       the testator shall be treated as the shareholder.

       (iv) In the case of a trust described in clause (iv) of subparagraph (A), each benefi-
       ciary of the trust shall be treated as a shareholder.

       (v) In the case of a trust described in clause (v) of subparagraph (A), each potential
       current beneficiary of such trust shall be treated as a shareholder; except that, if for
       any period there is no potential current beneficiary of such trust, such trust shall be
       treated as the shareholder during such period.

       (vi) In the case of a trust described in clause (vi) of subparagraph (A), the individual
       for whose benefit the trust was created shall be treated as a shareholder.

(3) ESTATE OF INDIVIDUAL IN BANKRUPTCY MAY BE SHAREHOLDER

(4) DIFFERENCES IN COMMON STOCK VOTING RIGHTS DISREGARDED
A corporation shall not be treated as having more than 1 class of stock solely because there
are differences in voting rights among the shares of common stock.

(5) STRAIGHT DEBT SAFE HARBOR

       (A) IN GENERAL
       Straight debt shall not be treated as a second class of stock.

       (B) STRAIGHT DEBT DEFINED
       Any written unconditional promise to pay on demand or on a specified date a sum
       certain in money if--

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            (i) the interest rate (and interest payment dates) are not contingent on profits, the bor-
            rower's discretion, or similar factors,

            (ii) there is no convertibility (directly or indirectly) into stock, and

            (iii) the creditor is an individual (other than a nonresident alien), an estate, a trust de-
            scribed in paragraph (2), or a person, which is actively and regularly engaged in the
            business of lending money.

            (C) REGULATIONS
            The Secretary shall prescribe such regulations as may be necessary or appropriate to
            provide for the proper treatment of straight debt.

     (6) CERTAIN EXEMPT ORGANIZATIONS PERMITTED AS SHAREHOLDERS.--

     An Exempt Organization, which is--(A) described in section 401(a) or 501(c)(3), and (B)
     exempt from taxation under section 501(a), may be a shareholder in an S corporation.


(d) SPECIAL RULE FOR QUALIFIED SUBCHAPTER S TRUST (QSST)

     (1) IN GENERAL In the case of a qualified subchapter S trust with respect to which a bene-
     ficiary makes an election under paragraph (2)--

     (A) such trust shall be treated as a trust described in subsection (c)(2)(A)(i) (A Grantor
     Trust),

     (B) for purposes of section 678(a), the beneficiary of such trust shall be treated as the owner
     of that portion of the trust which consists of stock in an S corporation with respect to which
     the election under paragraph (2) is made, and

     (C) for purposes of applying sections 465 and 469 to the beneficiary of the trust, the disposi-
     tion of the S corporation stock by the trust shall be treated as a disposition by such benefi-
     ciary.

     (2) ELECTION

     (A) A beneficiary of a qualified subchapter S trust (or his legal representative) may elect to
     have this subsection apply.

     (B) MANNER AND TIME OF ELECTION

     (i) SEPARATE ELECTION WITH RESPECT TO EACH CORPORATION

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An election under this paragraph shall be made separately with respect to each corporation
the stock of which is held by the trust.

(ii) ELECTIONS WITH RESPECT TO SUCCESSIVE INCOME BENEFICIARIES

If there is an election under this paragraph with respect to any beneficiary, an election under
this paragraph shall be treated as made by each successive beneficiary unless such benefi-
ciary affirmatively refuses to consent to such election.

(iii) TIME, MANNER, AND FORM OF ELECTION

Any election, or refusal, under this paragraph shall be made in such manner and form, and at
such time, as the Secretary may prescribe.

(C) ELECTION IRREVOCABLE

An election under this paragraph, once made, may be revoked only with the consent of the
Secretary.

(D) GRACE PERIOD

An election under this paragraph shall be effective up to 15 days and 2 months before the
date of the election.

(3) QUALIFIED SUBCHAPTER S TRUST (QSST)

The term "qualified subchapter S trust" means a trust--

(A) the terms of which require that--

(i) during the life of the current income beneficiary, there shall be only 1 income beneficiary
of the trust,

(ii) any corpus distributed during the life of the current income beneficiary may be distributed
only to such beneficiary,

(iii) the income interest of the current income beneficiary in the trust shall terminate on the
earlier of such beneficiary's death or the termination of the trust, and

(iv) upon the termination of the trust during the life of the current income beneficiary, the
trust shall distribute all of its assets to such beneficiary, and

(B) all of the income (within the meaning of section 643(b)) of which is distributed (or re-

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       quired to be distributed) currently to 1 individual who is a citizen or resident of the United
       States.

       A substantially separate and independent share of a trust within the meaning of section
       663(c) shall be treated as a separate trust for purposes of this subsection and subsection (c).

       (4) TRUST CEASING TO BE QUALIFIED

       (A) FAILURE TO MEET REQUIREMENTS OF PARAGRAPH (3)(A)

        If a qualified subchapter S trust ceases to meet any requirement of paragraph (3)(A), the pro-
visions of this subsection shall not apply to such trust as of the date it ceases to meet such require-
ment.


       (B) FAILURE TO MEET REQUIREMENTS OF PARAGRAPH (3)(B)

       If any qualified subchapter S trust ceases to meet any requirement of paragraph (3)(B) but
       continues to meet the requirements of paragraph (3)(A), the provisions of this subsection
       shall not apply to such trust as of the first day of the first taxable year beginning after the first
       taxable year for which it failed to meet the requirements of paragraph (3)(B).


(e) ELECTING SMALL BUSINESS TRUST DEFINED (ESBT)

       (1) ELECTING SMALL BUSINESS TRUST

       (A) Means any trust if--

       i) such trust does not have as a beneficiary any person other than--

               (I) an individual,

               (II) an estate,

               (III) an organization described in paragraph (2), (3), (4), or (5) of section 170(c), or

               (IV) an organization described in section 170(c)(1) which holds a contingent interest
               in such trust and is not a potential current beneficiary,

       (ii) no interest in such trust was acquired by purchase, and

       (iii) an election under this subsection applies to such trust.


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       (B) CERTAIN TRUSTS NOT ELIGIBLE

       The term "electing small business trust" shall not include--

       (i) any qualified subchapter S trust (as defined in subsection (d)(3)) if an election under sub-
       section (d)(2) applies to any corporation the stock of which is held by such trust,

       (ii) any trust exempt from tax under this subtitle, and

       (iii) any charitable remainder annuity trust or charitable remainder unitrust (as defined in sec-
       tion 664(d)).

       (C) PURCHASE

       For purposes of subparagraph (A), the term "purchase" means any acquisition if the basis of
       the property acquired is determined under section 1012.

       (2) POTENTIAL CURRENT BENEFICIARY

       The term "potential current beneficiary" means, with respect to any period, any person who at
       any time during such period is entitled to, or at the discretion of any person may receive, a
       distribution from the principal or income of the trust (determined without regard to any pow-
       er of appointment to the extent such power remains unexercised at the end of such period).
       If a trust disposes of all of the stock, which it holds in an S corporation, then, with respect
       to such corporation, the term "potential current beneficiary" does not include any person
       who first met the requirements of the preceding sentence during the 1-year period ending on
       the date of such disposition.

       (3) ELECTION

       An election under this subsection shall be made by the trustee. Any such election shall apply
       to the taxable year of the trust for which made and all subsequent taxable years of such trust
       unless revoked with the consent of the Secretary.

       (4) CROSS REFERENCE
       For special treatment of electing small business trusts, see section 641(c)


IMPORTANCE
Although overshadowed by the more flexible Limited Liability Company, the S Corporation election
allows small business owners to avoid double taxation.




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§1362            ELECTION; REVOCATION; TERMINATION

OVERVIEW
If all shareholders of a corporation consent, a corporation may elect S Corporation status. Elections
must be made either in the year prior or within the first 2½ months of the beginning of the taxable
year. The election is effective for the year it is made and for all subsequent years until terminated or
revoked.

If an S corporation looses its “S” status, the corporation may only elect S corporation status after
waiting 5 years unless the shareholders can prove the loss was inadvertent.

Election for next taxable year:

(1) If all requirements of §1361 are not met;
(2) If not all shareholders consented the Secretary may consent to treating the election as timely.

§1362 (d) (1) - Termination by Consent:

(1)   By revocation;
(2)   If more than half the shareholders consent;
(3)   Effective as of 1st day of year if made in first 2-1/2 months;
(4)   Effective for future years if made after first 2-1/2 months.

§1362 (d) (3) - Automatic Termination (for prior “C” corporation):

(1) When passive income exceeds 25% of gross receipts;
(2) For 3 consecutive years
(3) If the corporation has accumulated earnings and profits from previous “C” corporation years.

§1362 (d) (2) – TERMINATION BY CORPORATION CEASING TO BE SMALL BUSINESS
CORPORATION

§1362 f - Inadvertent Terminations

       §1362 (f) contains procedures for the Commissioner of the Internal Revenue Service to waive
       inadvertent terminations and inadvertent invalid elections.

Passive Investment Income includes:

(1)   Royalties;
(2)   Rents;
(3)   Dividends;
(4)   Interest;
(5)   Sales of stock

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Passive Investment Income excludes:

(1) Interest on notes from sales of inventory;
(2) Income from a finance business;
(3) Corporate liquidation proceeds when the corporation owns more than 50% of each outstanding
    class of stock of the liquidating corporation;
(4) Dividends attributable to earnings and profits from an active trade or business.


§1363          EFFECT OF ELECTION ON CORPORATION

OVERVIEW
  • S Corporations pay no §11 income tax. “The taxable income of S Corporations shall be com-
     puted in the same manner as…an individual except…” that certain items of income or loss
     are separately stated. Items that should be separately stated are listed in §1366, §248, and
     §291. No §703(a)(2) deductions are allowed. No §704(b) Special Allocations are allowed.

If the corporation elected S status after accounting for inventoried goods under the LIFO method, the
benefits of the LIFO method are recaptured and taxed to the corporation.

Recapture of LIFO Benefits (for prior “C” corporations)

LIFO recapture must be included in the gross income of a corporation:

(1) Previously taxed as a “C” corporation;
(2) That inventoried goods under the LIFO method is determined under §452.


_________________________________________________________________


PART II                                          TAX TREATMENT OF SHAREHOLDERS
§1366          PASS THROUGH OF ITEMS TO SHAREHOLDERS

OVERVIEW
  • Tax of a shareholder of a subchapter S Corporation is determined by a pro rata “pass-
     through” of items of income (including tax exempt income) and loss. Non-separately com-
     puted income or loss is calculated by subtracting losses, expense, and other deductions from
     gross income. Each shareholder will receive a Form 1120S Schedule K-1 from the S Corpo-
     ration. Under Section 1366 net earnings are taxed to shareholders on their individual returns
     whether distributed or not. Losses and deductions are limited to the shareholders pro rata ba-
     sis in the stock and loans to the corporation by the shareholder. Any disallowed losses re-
     ceive an indefinite carry over. After 2004 this rule applies to S corporation stock transferred
     between spouses or incident to a divorce. Items of income and gains retain their character

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         upon passing through to the shareholders. The family partnership rules of IRC §704(e) apply
         to S Corporation in regards to personal service income. No §704(b) Special Allocations are
         allowed.

IMPORTANCE
Prior to the adoption in all states of LLCs, §1366 was the key section that allowed corporate limited
liability protection to shareholders while avoiding the double taxation of C corporations.

§1367            ADJUSTMENTS TO BASIS OF STOCK OF SHAREHOLDERS, ETC.

OVERVIEW
A shareholder’s basis is increased by:

(1) Items of §1366(A)(1) income;
(2) Non separately computed income under §1366(A)(1)(b);
(3) Excess of deductions for depletion over basis.
A shareholder’s basis is decreased by:
(1)   Distributions that are not income of the shareholder under §1368;
(2)   Loss and deduction items under §1366(A);
(3)   Nonseparately computed loss under §1366(A);
(4)   Nondeductible corporate expenses not charged to capital;
(5)   Shareholder depletion deductions for oil & gas property.
Decreases by reason of a charitable contribution of property made before Jan. 1, 2008, shall be
the amount equal to the shareholder’s pro rata share of the adjusted basis of such property.
Special Income Rules:
Income shown on a shareholder’s return shall be increased or decreased by adjustment to the share-
holder’s liability. There is no comparable provision for a §754 basis adjustments for the inside
basis of assets.
Adjustment in Basis of Indebtedness:
(1) If any adjustments exceed the amount to reduce the basis to zero;
(2) The excess shall be applied to reduce the shareholder’s basis in indebtedness;
(3) But not below zero.
Basis of Inherited S Corporation Stock:
(1) IRD is applied to items of income as if the decedent held his pro rata share;
(2) Adjustments to basis are reduced by IRD.
IMPORTANCE
Section 1367 determines when distributions under Section 1368 are taxable income or loss under
Section 1366, or whether they are return of basis.

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§1368          DISTRIBUTIONS
OVERVIEW
(a) §301(c) of Subchapter C applies to S Corporations, except as otherwise provided in §1368.
(b) Distributions from S Corporations that do not have earnings and profits are a tax-free return of
basis to the extent of basis, and the excess is taxed as a sale or exchange.
(c) Distributions from S corporations that have earnings and profits are taxed differently than distri-
butions from S corporations that do not. Only S corporations that have been converted from C corpo-
rations will have earnings and profits. Distributions are considered as to be made from the follow-
ing sources:
     (1) First all distributions are from the Accumulated Adjustments Account to the extent thereof.
     (2) §316 dividends to the extent of any “C” earnings and profits.
     (3) Once all “C” earnings and profits are exhausted then §1368(b) applies to any remaining dis-
         tributions.
(d) Certain basis and AAA adjustments will still occur when applying (b) and (c) above.
(e) Accumulated Adjustments Account (AAA)- S Corporations must maintain an accumulated ad-
justments account for the corporation which for the most part reflects the accumulated basis of all
shareholders stock and loans with several minor exceptions as provided in §1368(e)(1).
IMPORTANCE
The tie-in between basis and taxable distribution rules enable one level of taxation that distinguishes
S corporations from C corporations. The earnings and profits distinction provides for the taxation as
dividends on income earned while a C corporation but distributed after election of S corporation sta-
tus.

______________________________________________________________________________


PART III                                                                    SPECIAL RULES
§1371          COORDINATION WITH SUBCHAPTER C
OVERVIEW
(a) The rules of Subchapter C apply to “S” corporations, except as otherwise provided in Subchapter
    S or anywhere else in Title 26 (the Internal Revenue Code).
(b) No carry forwards and carry backs, such as net capital losses (NCL) and Net Operating Losses
    (NOL) from “C” years, may be used during the “S” corporation period. “S” corporation years
    count against any carry forward years (15 years on NOL and 5 years on NCL). NOL and NCL
    from C years may be used if the “S” election is terminated and carry forward years have not ex-
    pired.


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(c) Earnings and profits from “C” years are only adjusted by apply the Subchapter S rules first, then
    the Subchapter C rules apply (i.e. AAA account must be used up first before §316 dividends can
    be paid) except as otherwise provided in §1371.

IMPORTANCE
An example of how the “S” Corporation rules override the Subchapter C rules.

§1372          PARTNERSHIP RULES TO APPLY FOR FRINGE BENEFITS PURPOSES
OVERVIEW
S corporations are treated as partnerships for employee fringe benefits. Individuals with over a 2%
shareholder interest on any day during an “S” year are treated as partners.

Importance
The less generous income tax deductibility of fringe benefits of partnerships also applies to S corpo-
ration shareholders. Certain payments such as medical insurance premiums and expenses are deduct-
ible to the S corporation but are taxed to the shareholders.

CROSS REFERENCE:
§61    Gross Income Defined
§318   Constructive Ownership of Stock
§707   Transactions between Partner and Partnership

§1373          FOREIGN INCOME
OVERVIEW
S Corporation and S shareholders are considered partnerships and partners for Subchapter N purpos-
es as to foreign source income.
IMPORTANCE
Another example as to the similarity of partnerships and S corporations.

§1374          TAX ON CERTAIN BUILT-IN GAINS
OVERVIEW
For S corporations that were formerly C corporations, the §11(b) 35% tax is imposed upon what
would have been corporate-level taxable gain. Upon a sale or exchange the taxable gain is due to
unrealized appreciation of corporate assets or where a sale results in a gain over adjusted basis due to
C corporation depreciation deductions.
IMPORTANCE
This section only applies to S corporations that were formerly C corporations and elected S status
after January 1, 1987. Carefully consider how built-in gains will be taxed before making an S corpo-
ration election.


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CROSS REFERENCE:
§1201 Alternative Tax for Corporations
§1016 Adjustments to Basis
§1363 Effect of Election on Corporations

§1375          TAX IMPOSED WHEN PASSIVE INVESTMENT INCOME OF CORPORATION HAVING
               ACCUMULATED EARNINGS AND PROFIT EXCEEDS 25 PERCENT OF GROSS RE-
               CEIPTS

OVERVIEW
Imposes a tax when passive investment income of a corporation having accumulated earnings and
profits exceeds 25% of gross receipts.
If S corporation status was elected by a former C corporation with accumulated earnings and profits,
tax is imposed when passive income exceeds 25% of gross receipts. The tax is imposed at the highest
corporate rate on the excessive passive income. (§11(b) – 35%)
Passive income is gross receipts from royalties, rents, dividends, interest and sales of securities.
If a good faith determination was made that there was no earnings and profits, a waiver of passive
investment tax may be sought from the IRS.
IMPORTANCE
§1375 was designed to discourage the election of “S” status by personal holding company “C” cor-
porations in an attempt to avoid the §541 personal holding company tax.
CROSS REFERENCE:
§1374 Tax on Built-In Gains
§1366 Pass-Through to Shareholders
§316   Dividend Defined
§541   Imposition of Personal Holding Company Tax

_______________________________________________________________________________


PART IV                                                  DEFINITIONS; MISCELLANEOUS
§1377          DEFINITIONS AND SPECIAL RULE
OVERVIEW
This section provides several special definitions for Subchapter S purposes.
IMPORTANCE
To understand the special rules of Subchapter S it is important to understand the special Sub-
chapter S terminology.



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§1378          TAXABLE YEAR OF S CORPORATION
OVERVIEW
A taxable year of an S corporation is a permitted year, which is a calendar year ending December 31
or a fiscal year established for a business purpose. Deferral of shareholder income is not a business
purpose.
CROSS REFERENCE:
§444   Election of a Taxable Year Other Than a Required Taxable Year

§1379          TRANSITIONAL RULES ON ENACTMENT
OVERVIEW
In 1982 Congress enacted the Subchapter S Revision Act of 1982 updating the old 1958 rules of
Subchapter S. §1379 contains some special transitional rules for existing S corporations at that
time.

IMPORTANCE
Very little importance except historical.
_______________________________________________________________________________
_______________________________________________________________________________




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______________________________________________________________________________
_______________________________________________________________________________

SUBTITLE B                                                        ESTATE AND GIFT TAXES
CHAPTER 11                                                                  ESTATE TAX
SUBCHAPTER A                                          ESTATES OF CITIZENS OR RESIDENT
PART I                                                                  TAX IMPOSED
§2001          IMPOSITION AND RATE OF TAX

OVERVIEW
§2001 imposes and computes wealth transfer taxes on U.S. citizens and residents.

IMPORTANCE
The seminal tax code section of Chapter 11. It sets for the tax rates on taxable estates.

HR 1836 – RELIEF Act of 2001 – The maximum estate tax rate will decline to 50% in 2002, 49% in
2003, 48% in 2004, 47% in 2005, 46% in 2006, 45% in 2007-2009 and 35% in 2010 - 2012. In 2013
the maximum estate tax rate will be back to 55%. Starting in 2002 the 5% surtax is repealed and will
not be reinstated after December 31, 2012.

        TAX & TAX RATE:                         For estates over $500,000     The tax is$155,800,
        plus 35 percent of the excess of such amount over $500,000.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter A – Determination of Tax Liability
               §2501 – Imposition of Tax

§2002          LIABILITY FOR PAYMENT

OVERVIEW
The estate tax imposed by Chapter 11 shall be paid by the executor.

IMPORTANCE
Establishes who is primarily liable to pay estate tax.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter C - Miscellaneous
               §2203 – Definition of Executor
               §2204 – Discharge of Fiduciary from Personal Liability
               §2206 – Tax Liability of Life Insurance Beneficiaries

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               §2207 – Tax Liability of Recipients of General Power of Appointment Property

Subtitle F – Procedure and Administration
     Chapter 64- Collection
          Subchapter C- Liens For Taxes
          §6324- Special Lien for Estate and Gift Taxes
     Chapter 71 – Transferees and Fiduciaries
          §6905 – Discharge of Executor for Personal Liability of Decedent’s Income and Gift Taxes


__________________________________________________________________


PART II                                                          CREDITS AGAINST TAX
§2010          UNIFIED CREDIT AGAINST ESTATE TAX

OVERVIEW
§2010 Sets the amount of “Applicable Exclusion Amount” against the estate tax imposed by §2001
for estates of citizens and resident non-citizens at $5,000,000. (Under §2102, estates of non-
residents - non-citizens, have only a $60,000 Applicable Exclusion Amount).

        §2010 (c) Applicable credit amount. ($1,730,800)
               (1) In general.
               The applicable credit amount is the amount of the tentative tax which would be
               determined under section 2001(c) if the amount with respect to which such tenta-
               tive tax is to be computed were equal to the applicable exclusion amount.

               (2) Applicable exclusion amount.
               The applicable exclusion amount is the sum of—
                     (A) the basic exclusion amount, and
                     (B) in the case of a surviving spouse, the deceased spousal unused ex-
                     clusion amount.

               (3) Basic exclusion amount.
                     (A) The basic exclusion amount is $5,000,000.
                     (B) Inflation adjustment. In the case of any decedent dying in a calen-
                     dar year after 2011, the dollar amount in subparagraph (A) shall be in-
                     creased by an amount equal to—
                             (i) such dollar amount, multiplied by
                             (ii) the cost-of-living adjustment determined under section 1(f)(3)
                             for such calendar year by substituting “calendar year 2010” for
                             “calendar year 1992” in subparagraph (B) thereof.

        If any amount as adjusted under the preceding sentence is not a multiple of $10,000,
        such amount shall be rounded to the nearest multiple of $10,000.

               (4) Deceased spousal unused exclusion amount.
               With respect to a surviving spouse of a deceased spouse dying after December 31,
               2010, the term “deceased spousal unused exclusion amount” means the
               lesser of—
                      (A) the basic exclusion amount, or
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                      (B) the excess of—
                              (i) the basic exclusion amount of the last such deceased spouse of
                              such surviving spouse, over
                              (ii) the amount with respect to which the tentative tax is deter-
                              mined under section 2001(b)(1) on the estate of such deceased
                              spouse.
               (5) Special rules.
                      (A) Election required. A deceased spousal unused exclusion amount may
                      not be taken into account by a surviving spouse under paragraph (2) un-
                      less the executor of the estate of the deceased spouse files an estate tax
                      return on which such amount is computed and makes an election on such
                      return that such amount may be so taken into account. Such election,
                      once made, shall be irrevocable. No election may be made under this
                      subparagraph if such return is filed after the time prescribed by law (in-
                      cluding extensions) for filing such return.

                      (B) Examination of prior returns after expiration of period of limitations
                      with respect to deceased spousal unused exclusion amount. Notwithstand-
                      ing any period of limitation in section 6501 (3 years), after the time has
                      expired under section 6501 within which a tax may be assessed under
                      chapter 11 or 12 with respect to a deceased spousal unused exclusion
                      amount, the Secretary may examine a return of the deceased spouse to
                      make determinations with respect to such amount for purposes of carrying
                      out this subsection.

               (6) Regulations.
               The Secretary shall prescribe such regulations as may be necessary or appropriate
               to carry out this subsection .

       (d) Limitation based on amount of tax.
       The amount of the credit allowed by subsection (a) shall not exceed the amount of the
       tax imposed by section 2001 .

IMPORTANCE
Provides a gradually increasing offset to the estate tax imposed in §2001.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter B – Estates of Nonresidents and Not Citizens
               §2102 – Credit Against Tax ($13,000)
     Chapter 12 – Gift Tax
          Subchapter A – Determination of Tax Liability
               §2505 – Unified Credit Against Gift Tax




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§2011           CREDIT FOR STATE DEATH TAXES

OVERVIEW
§2011 – Credit for State Death Taxes – The US Estate Tax imposed under §2001 is credited with the
amount of any estate, inheritance, legacy, or succession taxes actually paid to any state or the District
of Columbia. The credit is limited to amount set out in §2011(b).

These sections provide for credits that may be applied against estate taxes for various transfer taxes
previously paid.

§2011(d) – Additional Estate Tax = 125% of the §2011(b) credit minus the Basic (§2001 or §2101)
Estate Tax. Thus, if the §2011(b) State Death Tax Credit exceeds the “Basic Federal Estate Tax”, the
“Additional Estate Tax” is 125% of the excess. [The Additional Estate Tax was repealed in 2002
as a result of the April 19, 1995 and the September 11, 2001 terrorist attacks.]

HR 1836 RELIEF Act of 2001 – For 2002 the maximum state death tax credit is reduced:

     for estates over $2,040,000, the maximum credit is $106,800 plus 8% of the excess over
     $2,040,000 (75% of the credit for the year 2001)

For 2003 the maximum state death tax credit is reduced:

     for estates over $1,540,000, the maximum credit is $70,800 plus 7.2% of the excess over
     $1,540,000 (50% of the credit for the year 2001)

For 2004 the maximum state death tax credit is reduced:

     for estates over $1,540,000, the maximum credit is $70,800 plus 7.04% of the excess over
     $1,540,000 (25% of the credit for the year 2001)

After 2004 and until 2013 the §2011 credit is repealed, but is fully reinstated to
the 2001 level in 2013. From 2005 to 2012 new §2058 State Death Taxes allows a
deduction for state death taxes.
IMPORTANCE
§2011 – Credit for State and Death Taxes – A majority of the states use the §2011(b) credit as
their death tax. A Number of state have decoupled from the this section.

Provides a gradually increasing offset to the estate tax imposed in §2001.




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§2012          CREDIT FOR GIFT TAXES
OVERVIEW
§2012 provides special rules for applying a credit for gift taxes paid when the value of the gifted
property is brought back into the value of the gross estate.

IMPORTANCE
The §2012 credit calculation is very complicated, but necessary.


§2013          CREDIT FOR TAX ON PRIOR TRANSFERS

OVERVIEW
The estate of a decedent is allowed a credit for federal estate taxes paid on property received by that
decedent from a prior decedent transferor’s estate if the death occurred within ten years of the subse-
quent decedent claiming the credit. The credit declines by 2-year intervals from as much as 100% to
20% before expiration.

IMPORTANCE
Estate taxes may be significantly reduced where substantial taxable property was subject to estate tax
within the previous ten years.


§2014          CREDIT FOR FOREIGN DEATH TAXES

OVERVIEW
§2014 allows a credit for foreign death taxes paid when the value of the gross estate includes the val-
ue of property situated in a foreign country, and is subject to death taxes in that foreign country.

IMPORTANCE
§2014 prevents the value of foreign assets from being death tax twice.


§2015          CREDIT FOR DEATH TAXES ON REMAINDERS

OVERVIEW
Allows credit for tax if election to postpone payment was made under Section 6163(a), where the
estate includes a reversion or remainder interest not yet mature.

IMPORTANCE
This is one of a number of tax credits that may be claimed to offset estate tax such as the unified
credit§2010 and credit for inherited property received within 10 years of death, under S §2013.

CROSS REFERENCE:

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Subtitle F – Procedure and Administration
     Chapter 62 – Time and Place for Paying Tax Shown on Return
          Subchapter B – Extension of Time for Payment
               §6163(a) – Extension of Time for Paying Estate Tax on Value of Reversionary Inter-
                    est in Property


§2016          RECOVERY OF TAXES CLAIMED AS CREDIT

OVERVIEW
Places an affirmative duty upon the executor, “or any other person” who receives a refund of tax
such as foreign death taxes previously claimed as credit must notify IRS within 30 days of receipt.

IMPORTANCE
Affirms the principle – “He who takes what isn’t his’n gives it back or goes to prison.”

CROSS REFERENCE:
§2014 – Foreign Death Tax Credit


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PART III                                                                     GROSS ESTATE
2031           DEFINITION OF GROSS ESTATE

OVERVIEW
(a) The value of the gross estate of a decedent includes the value at the time of a decedent’s death of
    all property, real or personal, tangible or intangible, wherever in the world situated.

(b) Special Rules For – Valuation of unlisted stock and securities – use the value of listed stock or
    securities engaged in the same or similar line of business as comparables.

(c) Special Rules For – Estate Tax with Respect to Land Subject to a Qualified Conservation Ease-
    ment.
    (1) If an executor so elects, then the value of the gross estate may be determined by excluding
         from the gross estate the lesser of
         (A) the “Applicable Percentage” or
         (B) the “Exclusion Limitation”
              1998 = $100,000
              1999 = $200,000
              2000 = $300,000
              2001 = $400,000
  2002 or thereafter = $500,000

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2031(c)(8) Definitions

          (A) Land subject to a “Qualified Conservation Easement” means land
              (i) within the US or any possession
              (ii) owned at least 3 years prior to death
              (iii) which is subject to a qualified conservation easement as of the date of contribu-
              tion.
          (B) A “Qualified Conservation Easement” means a qualified conservation easement
              contribution as defined by §170(h)

HR 1836 RELIEF Act of 2001

(a) Repeal of Certain Restrictions on Where Land is Located – Clause (i) of section 2031(c)(8)(A)
(defining land subject to a qualified conservation easement) is amended to read as follows:

               (i)   which is located in the United States or any possession of the United States,”.

(b) Clarification of Date for Determining Value of Land and Easement – Section 2031(c)(2)
(defining applicable percentage) is amended by adding at the end the following new sentence:
“The values taken into account under the preceding sentence shall be such values as of the date
of the contribution referred to in paragraph (8)(B).”.

(c) Effective Date – The amendments made by this section shall apply to estates of decedents
dying after December 31,2000.

IMPORTANCE
Under Article I, §9, Clause 3 of the US Constitution, the US Government is prohibited from directly
taxing property. Chapter 11 of the IRC does not directly tax property, but taxes the value of property
being transferred by the decedent at the time of his or her death.

CROSS REFERENCE:
All of Chapter 11, Part III of Subchapter A, Estates of Citizens or Residents (§2031-2046)
IRC §1014(a)(1)




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§2032          ALTERNATE VALUATION

OVERVIEW
(a) In valuing the gross estate and all property includable in the gross estate, an executor may elect
    alternate valuation dates as follows:

   (1) If an asset was distributed, sold, exchanged or otherwise disposed of within six months after
       a decedent’s death, such asset shall be valued as of the date it was distributed, sold, ex-
       changed or disposed.
   (2) If an asset is still owned by the estate, such property shall be valued as of the date six months
       after the decedent’s death.
   (3) The executor must factor out any valuation changes due to mere lapse of time.

(b) The value determined in (a) above must be used as the value for all other purposes.

(c) Alternate valuation cannot be elected unless it decreases the value of the gross estate and reduces
    the estate tax and any generation-skipping tax.

(d) The election must be made on the Form 706 Estate Tax Return, and may not be made if the es-
    tate tax return is filed more than 1 year late.

IMPORTANCE
Alternate valuation can help save estate taxes where disasters occur within 6 months after a dece-
dent’s death or where the value of an asset declines due to the decedent’s death.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter O – Gain or Loss on Disposition of Property
               Part II – Basis Rules of General Application
                    §1014 – Basis of Property Acquired From a Decedent
                    §1014(a)(2)


§2032A         VALUATION OF CERTAIN FARM, ETC., REAL PROPERTY

OVERVIEW
Allows certain property used for farming, ranching, etc., or in any other trade or business to be val-
ued at its “special use value” rather than at the normal “highest and best use value.” The maximum
reduction in value is $750,000 adjusted for inflation after 1998.

50% or more of the adjusted value of the gross estate must consist of real or personal special use
property and 25% or more must be special use real estate.


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The decedent or a member of his family must have materially participated in the special use activity
for 5 out of the last 8 years prior to his death, and for 10 years after the decedent’s death a qualified
heir must continue to materially participate in the conduct of the special use activity.

IMPORTANCE
Prior to the enactment of §2032A, the death of an owner of a family farm, ranch or business could
also have meant the death of the family farm, ranch or business due to the federal estate tax resulting
from the farm, ranch or business being valued at its “highest and best use value” and not at its “spe-
cial use value.”

HR 1836 RELIEF Act of 2001 – Section 581 of the RELIEF Act of 2001 is entitled “Waiver of Stat-
ute of Limitation for Taxes on Certain Valuations” and provides: If on the date of the enactment of
this Act (or at any time within 1 year after the date of the enactment) a refund or credit of any over-
payment of tax resulting from the application of section 2032A(c)(7)(E) of the Internal Revenue
Code of 1986 is barred by any law or rule of law, the refund or credit of such overpayment shall,
nevertheless, be made or allowed if claim therefore is filed before the date 1 year after the date of the
enactment of this Act (June 7, 2002).

Cross Reference:
Subtitle A- Income Taxes
Chapter 1 – Normal Taxes & Surtaxes
     Subchapter O – Gain or Loss on Disposition of Property
          Part II – Basis Rules of General Application
               §1014(a)(3)

Subtitle F- Procedure and Administration
Chapter 62 – Time and Place for Paying Tax
     Subchapter B – Extensions of Time for Payment
          §6166 – Extension of Time for Payment of Estate Tax Where Estate Consists Largely
                   of Interest in Closely Held Business
Chapter 64- Collection
     Subchapter C- Lien for Taxes
          §6324B – Special Lien for Additional Estate Taxes Attributable to Farm, Etc., Valuation.


§2033           PROPERTY IN WHICH DECEDENT HAD AN INTEREST

OVERVIEW
The value of the gross estate shall include the value of all property to the extent of the interest therein
of the decedent at the time of his death.

IMPORTANCE
The value of property is included in the gross estate, which may or may not be in the probate estate.
Interests in property will include those interests that are beneficially owned, including indebtedness
due and dividends payable. §2033 is unable to capture the value of a decedent’s interest in tenancy
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by the entire property or joint tenants with rights of survivorship property due to the fact that under
state law the decedent’s interest is extinguished at death, and as such its value is zero. IRC §2040
was designed to capture the value of a decedent’s interest in tenancy by the entirety and joint tenants
with rights of survivorship property.


§2034             DOWER OR COURTESY INTERESTS

OVERVIEW
The value of the gross estate shall include the value of all property to the extent of any interest there-
in of the surviving spouse, existing at the time of the decedent’s death as dower or courtesy, or by
virtue of a statute created in lieu of dower or courtesy.

IMPORTANCE
Includable in the estate and possibly deductible under §2056, depending upon the state law dower or
courtesy interest of the surviving spouse, and whether it qualifies for the marital deduction.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens and Residents
               Part IV – Taxable Estate
                    § 2056 - Bequests To Surviving Spouse


§2035             ADJUSTMENTS FOR CERTAIN GIFTS MADE WITHIN 3 YEARS OF DECEDENT’S
                  DEATH

OVERVIEW
(a) (1) If a decedent made transfers of property or relinquished power during the 3 year period end-
ing on his or her death, AND (2) if it were not for the transfer or relinquishment, the property would
have been in his or her estate under §2036, §2037, §2038 or §2042, THEN the value of his or her
gross estate shall include the value of any such property.

(b) Gift taxes paid within 3 years of death are also included in the gross estate.


(c) (1) For purposes of the percentage requirements of

          (i)      §303(b) (Subchapter C – Distribution in Redemption of Stock to Pay Death Taxes)
          (ii)     §2032A Special Use Valuation
          (iii)    Chapter 64, Subchapter C (Lien for Taxes)

The value of the gross estate shall include the value of all property to the extent of any interest of
which a decedent at any time made a transfer, by trust or otherwise, within 3 years of his death.
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     (2) §6166 allows for installment payments of estate tax over 15 years if 35% of the adjusted
     gross estate consists of one or more closely held business. The 35% test will be met only if the
     estate meets the 35% with and without the application of (C)(1) above.

     (3) Except for life insurance – Marital Deduction Gifts (§2523), Annual Exclusion Gifts
     (§2503), and Charitable Gifts (§2522) do not come back into the gross estate; however, as
     to §2503 and §2522 gifts if they were required to be claimed on a gift tax return under
     §6019, they will come back into the gross estate if §2035 applies.

(d) Exception: IRC §2035 does not apply to bona fide sales for adequate and full consideration
money or money’s worth

(e) Gifts from revocable living trusts are now considered direct transfers and not transfers
under §2038.

IMPORTANCE
§2035 is mostly applicable to transfers of life insurance polices. An insured has to live 3 years from
the transfer of a life insurance policy to remove the policy.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens and Residents
               Part III, §2036, 2037, 2038, 2032A, 2042

Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter C – Corporate Distributions and Adjustments
               §303(b) – Distributions in Redemptions of Stock to Pay Death Taxes

Subtitle F – Procedure and Administration
     Chapter 61 – Information and Returns
          Subchapter A – Returns and Records
               Part II – Tax Returns and Statements
                    Subpart C – Estate and Gift Tax Returns
                          §6019(2) – Gift Tax Returns

Chapter 62 – Time and Pace for Paying Tax
    Subchapter B – Extension of Time for Payment
         §6166 – Extension of Time for Payment of Estate Tax Where Estate Consists Largely
                  of Interest in Closely Held Business




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§2036          TRANSFERS WITH RETAINED LIFE ESTATE

OVERVIEW
(a) Includes in the value of the gross estate of the decedent the value of any property that he trans-
    ferred, but retained strings of enjoyment or control. Examples: retained life estate; enjoyment of
    income for a period that had not expired at date of death; retention of the right to designate the
    person who shall possess or enjoy property or the income from property. Exception: a bona-fide
    sale for an adequate and full consideration in money or money’s worth.

(b) Includes in the value of the gross estate the value of any voting stock in a controlled corporation.
     A controlled corporation is one where the decedent owned (under IRC §318) at least 20% of the
    total voting power of all classes of stock within 3 years of his death. §2036(b) is known as the
    “Anti-Byrum Rule”.

Section 2036(a)

(a) General Rule – The value of the gross estate shall include the value of all property to the extent
of any interest therein of which the decedent has at any time made a transfer (except in case of a bona
fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise,
under which he has retained for his life or for any period not ascertainable without reference to his
death or for any period which does not in fact end before his death

     (1) the possession or enjoyment of, or the right to the income from, the property, or
     (2) the right, either alone or in conjunction with any person, to designate the persons who shall
         possess or enjoy the property or the income there from.

Section 2036(b)

(b) Voting Rights

     (1) In General – For purposes of subsection (a)(1), the retention of the right to vote (directly or
         indirectly) shares of stock of a controlled corporation shall be considered to be a retention
         of the enjoyment of transferred property.
     (2) Controlled Corporation – For purposes of paragraph (1), a corporation shall be treated as a
         controlled corporation if, at any time after the transfer of the property and during the 3-
         year period ending on the date of the decedent’s death, the decedent owned (with the ap-
         plication of section 318), or had the right (either alone or in conjunction with any person)
         to vote stock possessing at least 20 percent of the total combined voting power of all clas-
         ses of stock.
     (3) Coordination with Section 2035 – For purposes of applying section 2035 with respect to
         paragraph (1), the relinquishment or cessation of voting rights shall be treated as a transfer
         of property made by the decedent.

§2036(b) is known as the Anti-Byrum Rule. US vs. Byrum, 408 US 125 (1972), 1972-1 C.B. 518.
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IMPORTANCE
Forces truly completed gifts if estate tax avoidance is desired.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter C – Corporate Distributions and Adjustments
               Part I – Distributions and Adjustments
                    Subpart C – Definitions; Constructive Ownership of Stock
                         §318 – Constructive Ownership of Stock

          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
              Part I – Estates, Trusts, and Beneficiaries
                   Subpart E – Grantors and Others Treated as Owners
                        §675 – Administrative Powers
                        §676 – Power to Revoke
                        §677 – Income for Benefit of Grantor


§2037          TRANSFERS TAKING EFFECT ON DEATH

OVERVIEW
(a) The value of the gross estate includes the value of any interest in property transferred by a dece-
    dent (by trust or otherwise) where possession or enjoyment can only be obtained by surviving
    the decedent and the decedent has retained a reversionary interest, which exceeds 5% of the
    value of the property. Exception: A bona-fide sale for adequate and full consideration in money
    or money’s worth.

(b) Special Rule: A retained “Reversionary Interest” includes a possibility that property transferred
    by a decedent (and not the income alone) may be returned to him or his estate or may be subject
    to a power of disposition by him. Mortality and actuarial tables are to be used to calculate the
    value of a reversionary interest. Exception: If possession or enjoyment could be obtained by a
    beneficiary who had a general power of appointment which was exercisable during decedent’s
    lifetime.

IMPORTANCE
Purported gifts of joint tenancy assets are brought back into estates under § 2037 as well as §2040.

CROSS REFERENCE:
Title A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
              Part I – Estates, Trusts, and Beneficiaries
                   Subpart E – Grantors and Others Treated as Owners
                        §673 – Reversionary Interest
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                          §676 – Powers to Revoke
                          §677 – Income for Benefit of Grantor


§2038           REVOCABLE TRANSFERS

OVERVIEW
The value of the gross estate includes the value of all property to the extent of any interest therein of
which a decedent made a transfer (by trust or otherwise) where the decedent retained a power to al-
ter, amend, revoke, or terminate the enjoyment in the property, or where a decedent relinquished any
of these powers within 3 years of his death. Exception: A bona-fide sales for adequate and full con-
sideration in money or money’s worth.

IMPORTANCE
Revocable living trusts are not excluded from the calculation of the value of the gross estate.

CROSS REFERENCE:
Title A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
              Part I – Estates, Trusts, and Beneficiaries
                   Subpart E – Grantors and Others Treated as Owners
                        §674 – Power to Control Beneficial Enjoyment
                        §676 – Powers to Revoke
                        §677 – Income for Benefit of Grantor


§2039                ANNUITIES

OVERVIEW
(a) In General – The value of a decedent’s gross estate includes under section 2039(a) and (b) the
value of an annuity or other payment receivable by any beneficiary by reason of surviving the de-
cedent under certain agreements or plans to the extent that the value of the annuity or other pay-
ment is attributable to contributions made by the decedent or his employer. Section 2039(a) and
(b), however, has no application to an amount, which constitutes the proceeds of insurance under
a policy on the decedent’s life. The fact that an annuity or other payment is not includible in a
decedent’s gross estate under section 2039(a) and (b) does not mean that it is not includible under
some other section of Part III of Subchapter A of Chapter 11.

(b) Amount Includible in the Gross Estate –The amount to be included in a decedent’s gross estate
under section 2039(a) and (b) is an amount which bears the same ratio to the value at the decedent’s
death of the annuity or other payment receivable by the beneficiary as the contribution made by the
decedent, or made by his employer (or former employer) for any reason connected with his employ-
ment, to the cost of the contract or agreement bears to its total cost.

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Example (1). The decedent and his wife each contributed $15,000 to the purchase price of an annui-
ty contract under the terms of which the issuing company agreed to pay an annuity to the decedent
and his wife for their joint lives and to continue the annuity to the survivor for his life. Assume that
the value of the survivor’s annuity at the decedent’s death is $20,000. Since the decedent contributed
one-half of the cost of the contract, the amount to be included in his gross estate under section
2039(a) and (b) is $10,000.

Example (2). Under the terms of an employment contract the employer and the employee made con-
tributions to a fund which was to provide the employee, upon his retirement at age 60, with an annui-
ty for life, and which was to provide his designated beneficiary, upon the employee’s death after re-
tirement, with a similar annuity for life. Assume that the employer and the employee each contribut-
ed $5,000 to the retirement fund. Assume further, that the employee died after retirement at which
time the value of the survivor’s annuity was $8,000. Since the employer’s contributions were made
by reason of the decedent’s employment, the amount to be included in his gross estate under section
2039(a) and (b) is the entire $8,000. If, in the above example, only the employer made contributions
to the fund, the amount to be included in the gross estate would still be $8,000.

(c) Insurance Under Policies on the Life of the Decedent – If an annuity or other payment receivable
by a beneficiary under a contract or agreement is in substance the proceeds of insurance under a poli-
cy on the life of the decedent, section 2039(a) and (b) does not apply. For the extent to which such
an annuity or other payment is includable in a decedent’s gross estate, see section 2042.

IMPORTANCE
Annuities can be great income tax planning tools, but they are a very difficult asset to do things with
in estate planning. Unlike life insurance, it is very difficult to create strategies for removing annui-
ties from the gross estate.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter I – Normal Taxes & Surtaxes
          Subchapter B – Computation of Taxable Income
               Part II – Item Specifically Included in Gross Income
                    §72 – Annuities, Certain Proceeds of Endowment and Life Insurance Contracts
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part II – Income in Respect of Decedents
                    §691- Recipients of Income in Respect of Decedent




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§2040           JOINT INTERESTS

OVERVIEW
The value of the gross estate includes 100 percent of the value of property jointly owned by the de-
cedent as “joint tenants with rights of survivorship” or as “tenants by the entirety” less the portion
that the surviving joint tenant contributed, originally owned or actually paid the decedent in money
or money’s worth. The burden is upon the decedent’s estate to prove the contribution of the surviv-
ing joint tenant. If the property was acquired by the decedent and others together by gift, bequest,
devise or inheritance as joint tenants with rights of survivorship, then only the value of decedents pro
rata share of the value of the property is included in the decedent's gross estate. If surviving joint ten-
ant is a spouse then only 50 percent of the value of the property owed is included in the decedent’s
gross estate.

IMPORTANCE
Entire value of joint tenancy assets are included in the estate of the first joint holder to die unless the
executor sufficiently shows it was not acquired entirely by consideration provided by the decedent.
If a spouse is the surviving tenant, then only half of the property is includable in the gross estate, thus
stepping up in basis only half of the property for the surviving spouse. Property that is “communi-
ty property with rights of survivorship” (CPWROS) is technically not covered by §2040, and
as such there is no IRC §1014(a) fair market value adjustment to the basis. §1014(b)(6) re-
quires an inclusion of at least 50% of the value in gross estate before it applies. The decedent’s in-
terest in CPWROS is extinguished at death and there is no Chapter 11 section which causes 50% of
the value of CPWROS to be included in a deceased spouse’s gross estate.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter O – Gain or Loss on Disposition of Property
               Part II – Basis Rules of General Application
                    § 1014 - Basis of Property Acquired from a Decedent


§2041           POWERS OF APPOINTMENT

OVERVIEW
(a) The value of the gross estate includes the value of all property to the extent in which a decedent
    held a general power of appointment (GP of A), or to the extent in which the decedent exercised
    or released a general power of appointment within 3 years of his death. The exercise or release
    of a general power of appointment includes the transfer or creation of a general power of ap-
    pointment exercisable by another person.

(b)(1) A general power of appointment (GP of A) means a power, which is exercisable in favor of
       the decedent, his estate, his creditors or the creditors of his estate. A GP of A does not
       Include:
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     (i)     A power to consume, invade, or appropriate property for the benefit of the decedent
             which is limited to an ascertainable standard relating to the health, education, support,
             or maintenance of the decedent.
     (ii)    A power of appointment which is exercisable by the decedent only in conjunction with
             another person:
             1) If the GP of A was created on or before October 21, 1942.
             2) If the GP of A was created after October 21, 1942, only if the other person: (a) is the
                 creator, or (b) has a substantial adverse interest in the property.

(b)(2) The lapse of a GP of A is considered a release.

IMPORTANCE
This section defines and separates general powers of appointment (estate taxable) from special lim-
ited powers of appointment (nontaxable). A general power of appointment is exercisable in favor of
anyone including decedent, his estate, his creditors or creditors of his estate. A limited power is de-
fined by Reg. §20.2041-1(c)(1) as the right to appoint to anyone except to those that would make it a
general power. Additionally, a holder who is a donee may act as agent for the donor to do things not
contemplated by the donor without including the property in the donee estate. The holder may, if
subject ascertainable standards of health, education, support and maintenance, use discretion to con-
sume or invade the property. A general power of appointment is still included in the gross estate if it
was exercised or released such that it would be estate tax includable under Sections 2035-2038. A
lapse of a power of appointment is considered a release to the extent of the value of property, which
could have been appointed by the exercise of the lapsed powers, exceeded the greater of $5,000 or
5% of the aggregate value of the assets out of which, or the proceeds of which, the exercise of the
lapsed power could have been satisfied. If the value of the property, which could have been appoint-
ed, does not exceed the greater of $5,000 or 5%, then the lapse is not a release of a general power of
appointment.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedent’s
               Part I – Estates, Trusts, and Beneficiaries
                    Subpart E – Grantors and Others Treated as Owner
                         §678 – Person Other Than Grantor Treated as Owner

Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter B - Transfers
               §2514 - Powers of Appointment (gift tax section)




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§2042          PROCEEDS OF LIFE INSURANCE

OVERVIEW
The value of the gross estate includes the value of all life insurance proceeds under policies on the
life of a decedent to the extent:

     (1) received by the decedent’s executor (or his estate)
     (2) received by all other beneficiaries with respect to which the decedent possessed at his death
         any incidents of ownership in an insurance policy on his life.

Incidents of ownership include a reversionary interest that exceeds 5% of the value of the policy im-
mediately before an insured decedent’s death.

IMPORTANCE
Ownership is really incidents of ownership. These incidents are defined in the regulations as: rights
to change the beneficiary; surrender the policy; assign the policy; revoke an assignment; pledge the
policy for a loan; obtain a loan from the insurer secured by the surrender value; hold a reversionary
interest in policy exceeding 5 percent of value and when transferred within 3 years of death. Policies
on an insured’s life owned by a corporation where the insured is a 50 percent or more owner will be
includable in his gross estate by way of §2031 or §2033 to the extent of the value of his interest in
the corporation as augmented by the value of the life insurance proceeds. This is in spite of whatever
IRS regulations or ruling might provide. If this were not the case there would be a double inclusion
in a decedent’s estate. Once under IRC §2042, and once under IRC §2031 or IRC §2033 by includ-
ing the extent of the value of decedent’s interest in his stock ownership of his estate.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts, and Beneficiaries
                    Subpart E – Grantors and Others Treated as Owner
                         §677 – Income for Benefit of Grantor
                         §2031 – Definition of Gross Estate
                         §2033 – Property Over Which the Decedent had an Interest
                         §2035 – Adjustments for Certain Gifts Made Within 3 Years of Death
                                    dent’s Death

§2043          TRANSFERS FOR INSUFFICIENT CONSIDERATION

OVERVIEW
Sections 2035, 2036, 2037, and 2038 all contain an exception for bona-fide sales for an adequate and
full consideration in money or money’s worth. Section 2043 will include in the value of the gross
estate the value of transfers, trusts, interests, rights, or powers enumerated and described in Sections


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2035-2038 and §2041 if made, created, exercised, or relinquished ONLY to the extent of the failure
of the adequate and full consideration property.

IMPORTANCE
Allows the IRS, generally upon audit, to revalue transfers and to include only the additional value in
the estate of decedent that was not for adequate and full consideration in money or money’s worth.

CROSS REFERENCE:
§2035 – Adjustments for Certain Transfers Made Within 3 Years of Decedent’s Death
§2036 – Transfers With Retained Life Interest
§2037 – Transfers Taking Effect at Death
§2038 – Revocable Transfers
§2041 – Powers of Appointment


§2044          CERTAIN PROPERTY FOR WHICH MARITAL DEDUCTION WAS PREVIOUSLY AL-
               LOWED

OVERVIEW
§2044 includes in the value of the gross estate of a decedent the value property in a marital deduction
QTIP Trust, established under §2056(b)(7) or §2523(f), of which the decedent was the beneficiary.

§2044 also includes in the value of the gross estate the value of any property to which the decedent
had a qualified income interest for life and if §2519 (relating to dispositions of certain life estates)
did not apply to part or all of such property.

IMPORTANCE
Section 2044 allows the IRS to capture the transfer taxes due on property, which had previously been
postponed by virtue of the estate tax or gift tax marital deductions.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estate of Citizens and Residents
               Part IV – Taxable Estate
                    §2056 – Bequest, Etc. to Surviving Spouse
          Subchapter C - Miscellaneous
                    §2207 – Right of Recovery of Certain Marital Deduction Property
     Chapter 12 – Gift Taxes
          Subchapter B – Transfers
                    §2519 – Disposition of Certain Life Estates
          Subchapter C – Deductions
                    §2523 – Gifts to Spouse



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§2045           PRIOR INTERESTS

OVERVIEW
Each of the Sections 2034-2042 dealing with inclusion of value of property in the value of the gross
estate, also apply to include in the value of the gross estate to transfers, trusts, estates, interests,
rights, powers, and relinquishment whenever made, created, arising, existing, exercised, or relin-
quished.

IMPORTANCE
This is an IRS blanket tax compliance section.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estates of Citizens and Residents
               Part III – Gross Estate
                    §2034 – Dower and Courtesy Interests
                    §2035 – Adjustments for Certain Gifts Made With 3 Years of Decedent’s
                               Death
                    §2036 – Transfers With Retained Life Interest
                    §2037 – Transfers Taking Effect at Death
                    §2038 – Revocable Transfers
                    §2039 – Annuities
                    §2040 – Joint Interests
                    §2041 – Powers of Appointment
                    §2042 – Proceeds of Life Insurance


§2046           DISCLAIMERS

OVERVIEW
Cross reference to gift tax section on qualified disclaimers § 2518

IMPORTANCE
Includes in the value gross estate the value of property that was subject to a failed disclaimer. Proper-
ly disclaimed assets are an exception to the gift tax rules since the disclaimant is assumed for that
property to have predeceased the decedent who owned the property. A failed disclaimer under the
gift tax exception of §2518 thus will include the value of that property in the value of the gross estate
under this section of the code.

CROSS REFERENCE:
Chapter 12 – Gift Tax
    Subchapter B - Transfers
         §2518 – Disclaimers (Gift Tax section)

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PART IV                                                                    TAXABLE ESTATE
§2051          DEFINITION OF TAXABLE ESTATE

OVERVIEW
For purposes of the tax imposed by §2001, the value of the taxable estate shall be determined by de-
ducting from the value of the gross estate the deduction provided for in Part IV of Chapter 11.

IMPORTANCE
Nothing is deductible from the gross estate unless specifically allowed.



§2052          EXEMPTION (REPEALED)

OVERVIEW
This was the old $60,000 exemption allowed prior to 1977.


§2053          EXPENSES, INDEBTEDNESS, AND TAXES

OVERVIEW
The value of the taxable estate shall be determined by deduction from the value of the gross estate
such amounts for funeral expenses, estate administration expenses, claims against the estate, and un-
paid mortgages and any indebtedness in respect of property where the gross value of decedent’s in-
terest is included in the value of the gross estate.

Also deductible are certain taxes:

     (1) Income taxes on income received before death
     (2) Property taxes accrued before death
     (3) State or D.C. death taxes imposed on property donated or left to §170(c) exempt organiza-
         tions
     (4) Foreign death taxes actually paid to a foreign country on the value of property situated in
         such foreign country and included in the value of gross estate

If a deduction is taken for items (3) or (4) above it will constitute a waiver of that portion of the
§2011 credit for state death taxes and the §2014 credit for foreign death taxes.

IMPORTANCE
Attorney’s fees and accounting fees are also deductible. We can help our clients save estate taxes by
charging larger fees.

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§2054          LOSSES

OVERVIEW
The value of the taxable estate shall be determined by deducting from the value of the gross estate
losses incurred during the settlement of the estate arising from fires, storms, shipwrecks, or other
casualties, or from theft when such losses are not compensated for by insurance or otherwise.

IMPORTANCE
The US Treasury will share in the burden of such losses by allowing a deduction.


§2055          TRANSFERS FOR PUBLIC, CHARITABLE, AND RELIGIOUS USES

OVERVIEW
(a) The value of the taxable estate shall be determined by deducting from the value of the gross es-
    tate the amount of all bequests, legacies, devisees, or transfers to:

   (i)     The USA, any state or political subdivision, D.C. for exclusively public purposes
   (ii)    §501(c)(3) exempt organizations
   (iii)   Civic organizations for the use of §501(c)(3) purposes
   (iv)    Veterans organizations
   (v)     ESOPS

A life estate left of an individual with a remainder to an organization described above or gift to an
individual contingent upon survivorship where the default beneficiary is an organization described
above also is deductible if the individual dies before the estate tax return is due.

(b) If the decedent exercises a GP of A included in the estate under §2041 in favor of an organization
    described in (a) above, the value of such property is considered a deductible §2055 bequest.

(c) Death taxes payable out of a §2055 bequest will reduce the §2055 deduction.

(d) The §2055 deduction is limited to the value of the property included in the value of the gross es-
    tate.

(e) Disallows a deduction in certain cases.

Code Section 2055, is the estate tax counterpart to Section 170, the income tax section allowing de-
ductions for donations to specified charities. However, a major difference between the estate tax
charity deduction and the income tax deduction is that there is no limitation or percentage restriction
on the estate deduction. Therefore, a decedent may leave his or her entire estate to a qualified chari-
ty, and, if he does so, there will be nothing left for the federal estate tax to tax.



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The charitable deduction is limited only to the amount required to be included in the gross estate.
Section 2055(d). The valuation of the bequest is the same as the date of death valuation, unless al-
ternate six-month valuation has been elected. If alternate valuation is chosen, Section 2032(b) re-
quires that the property shall be valued as of the date of decedent’s death with adjustment for any
difference in value of the property as of the date six months after the decedent’s death.

If estate taxes (or any other estate, succession, legacy, or inheritance taxes, are payable) – either un-
der the terms of the last Will or by the default tax apportionment provisions under state law – out of
the particular charitable bequest or legacy, then Section 2055(c) requires that the amount deductible
is limited to the net amount of such bequest or legacy (i.e. the legacy minus the tax).

Charitable Organizations. This list of organization to which a contribution will qualify for the es-
tate tax charitable deduction is very similar – but not the same as – the list of qualifying organiza-
tions permitted under the income tax. Section 170(c). For example, in the case of the income tax,
the fifth category of allowable donee organizations is a “cemetery company owned and operated ex-
clusively for the benefit of its members…” However, for estate taxes, the fifth category is not ceme-
tery companies, but rather employee stock ownership plans.

Another major difference from the income tax charitable donation section is that for purposes of the
estate tax, the deduction is not limited to United States domestic organizations.

Disallowances. Like Section 170, Section 2055 also states when the IRS will disallow certain con-
tributions. The most important of these disallowances – and the exceptions to each – are:

   No deduction is allowed for a charity’s remainder interest in trust unless the trust is a charitable
    remainder annuity trust, charitable remainder unitrust, or pooled income fund. Section
    2055(e)(2)(A).

   No deduction is allowed for the value of any charity’s income interest in trust unless the trust is a
    charitable lead trust. Section 2055(e)(2)(B).

A Qualified Conservation Easement. Section 2055(f) establishes the rules – added in 1997 – in
which an estate can claim an estate tax charitable contribution deduction for a qualified conservation
easement.

Reformation. Section 2055(e)(3) contains rules, which govern how, or even if, a defective charita-
ble remainder trusts or charitable lead trust can be reformed in order to qualify for the income, estate
and gift tax deductions.

IMPORTANCE
We have a choice as to the transfer of our social capital – the IRS or our favorite charities.

The importance of Section 2055 cannot be overstated. This statute governs if and how an estate can
claim a deduction for bequests or devices for charitable contributions. Estate planners must refer to

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Section 2055 to (1) determine which organizations will qualify as qualified organizations for purpos-
es of the estate tax deduction, (2) how to structure the gifts in a qualifying fashion, and (3) how to
successfully apportion taxes so as to avoid reduction of the deductible amount.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Taxes
          Subchapter C – Deductions
               §2522 – Charitable and Similar Gifts

Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter B – Computation of Taxable Income
               Part VI – Itemized Deductions for Individuals and Corporations
                    §170 – Charitable, Etc., Contributions and Gifts

          Subchapter F – Exempt Organizations
              Part I – General Rule
                   §501 – Exemptions from Tax on Corporations, Certain Trusts, Etc.
                   §501(c) – List of Exempt Organizations
                   §501(c)(3) – Corporations, Etc.

               Part II – Private Foundations
                    §507-§509

          Subchapter J – Estates, Trust, Beneficiaries, and Decedents
              Part I – Estates, Trusts, and Beneficiaries
                   Subpart A – General Rules for Taxation of Estates and Trusts
                        §642 – Special Rules for Credits and Deductions
                        §642(c) – Deductions for Amounts Paid or Permanently Set Aside for a
                                   Charitable Purpose


§2056           BEQUESTS, ETC., TO SURVIVING SPOUSE

OVERVIEW
(a) Subject to the limitation of §2056(b), the value of the taxable estate shall be determined by de-
    ducting from the value of the gross estate an amount equal to the value of any interest in property
    which passes or has passed from the decedent to a surviving spouse, but only to the extent that
    such interest is included in determining the value of the gross estate.

(b)(1) Life estates and terminal interests do not qualify for the marital deduction (M/D) (unless it is a
Qualified Terminal Interest Property (QTIP) Trust.

(b)(2) The M/D is reduced by the value of disqualified assets.
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(b)(3) Survival provision not in excess of 6 months is permissible.

(b)(4) The M/D will be reduced if the assets used to satisfy the M/D have to be used to pay death
taxes or have to be used by the surviving spouse to pay any obligation imposed on such assets by the
decedent or where the asset is encumbered.

(b)(5) Life estates with a GP of A qualify if the surviving spouse is the sole life tenant and gets all
income at least annually.

(b)(6) Life insurance, endowments, and annuities payable in annual installments, plus interest, that
start no later than 13 months from decedent’s death, payable solely to the surviving spouse and pro-
vided that solely the surviving spouse has a GP of A will qualify for the M/D.

(b)(7) Qualified Terminal Interest Property Trust (QTIP) qualifies if the surviving spouse is the sole
beneficiary; gets all income at least annually for life; has the power to demand unproductive assets be
converted to income producing assets; and no one else has a power of appointment during the surviv-
ing spouse’s life; and the executor makes the QTIP election on the estate tax return of the deceased
spouse.

(b)(8) A Qualified Charitable Remainder Trust where the surviving spouse is the sole non-charitable
beneficiary also qualifies for the M/D.

IMPORTANCE
Full deductions for the value of property given to spouse outright or as “qualified terminal interest
property” ‘QTIP’ are critical in interspousal testamentary planning.



CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Taxes
          Subchapter C - Deductions
               §2523 – Gifts to Spouse


§2056A          QUALIFIED DOMESTIC TRUST

OVERVIEW
To permit a non-citizen surviving spouse to avoid or post-pone the immediate estate taxation on the
value of assets received from a deceased spouse a “QDOT” trust must be established by will or trust
or by an executor after decedent’s death. Unlike property received by a citizen spouse outright or un-
der a Section 2056(b)(7) QTIP trust, any principal when withdrawn from the QDOT, except for hard-
ship, for the benefit of a surviving non-citizen spouse during life, is subject to immediate estate taxa-
tion.
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HR 1836 RELIEF Act of 2001 – There will continue to be an estate tax imposed on (1) any distribu-
tion prior to January 1, 2021before the date of the death of the non-citizen surviving spouse and (2)
the value of the property remaining in a QDOT if the non-citizen surviving spouse dies before Janu-
ary 1, 2010.

IMPORTANCE
Similar to a QTIP trust, this section provides a mechanism to provide for the postponement of estate
tax for property from which a non-citizen surviving spouse may receive income. Unlike a QTIP trust,
the non-citizen surviving spouse may receive no principal without a qualified U.S. Trustee withhold-
ing and becoming “personally liable for the amount of tax imposed.” Prior to §2056A a non-citizen
surviving spouse could leave the United States along with assets in which estate taxes had been post-
poned under the marital deduction, and as a result the US Treasury was unable to collect these post-
poned estate taxes upon the death of these non-resident non-citizens spouses. §2056A simply denies
a marital deduction unless a QDOT is established upon the deceased spouse’s death.

CROSS REFERENCE:

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter C – Miscellaneous
               §2210 - Termination


§2057          FAMILY-OWNED BUSINESS INTEREST

OVERVIEW
The value of the taxable estate shall be determined by deductions from the value of the gross estate
the adjusted value of a qualified family-owned business interest (Q-FOBI) of a decedent which is
described in §2057(b)(2).

The deduction allowed shall not exceed $675,000 and the §2010 applicable exclusion amount may
not exceed $625,000 unless the §2057 deduction allowed is less than $675,000, as long as when the
two are combined they do not exceed $1,300,000.

Requirements: (1) Decedent was a US citizen or resident; (2) The executor elects on the 706 and
files a 2057 Agreement with the IRS; (3) The value of the Q-FOBI plus §2503(b) gifts exceeds 50%
of the adjusted gross estate; and (4) There was §2032A material participation for 5 out of the last 8
years before the decedent’s death.

HR 1836 RELIEF Act of 2001 - §2057 is repealed after 2003, but fully reinstated after 2012 when
repeal of Chapter 11 sunsets on December 31, 2012.




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IMPORTANCE
This is another “Half-Baked” example of the congresses attempt to preserve the family-owned farm,
ranch, or business.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estates of Citizens and Residents
               Part III – Gross Estate
§2032A – Valuation of Certain Farm, Etc., Real Property (Special Use Valuation)


§2058           STATE DEATH TAXES

OVERVIEW
HR 1836 RELIEF Act of 2001

(a) Allowance of Deduction – For the years 2005 through 2012 the value of the “Taxable Estate”
will be determined by deducting from the value of the “Gross Estate” the amount of any state or
D.C. death taxes (estate, inheritance, legacy or succession taxes) paid respect to any property includ-
able in the gross estate.

(b) Period of Limitation – The state death tax deduction is limited to only the taxes actually paid
and deductions claims before the later of: (1) four years after the filing of the estate tax return; or (2)
(a) 60 days after a decision of the U.S. Tax Court determining the estate tax liability becomes final,
(b) the expiration of the period of extension to pay estate taxes over time under sections 6161 or
6166, or (c) the expiration of 60 days after the IRS sends notice of disallowance of a claim for re-
fund, or 60 days after a decision of a court in which such refund suit has become final, or 2 years af-
ter notice of waiver of disallowance is filed under section 6532(a)(3).

IMPORTANCE
After 2004 there will no longer be a dollar for dollar reduction of the estate tax for death taxes paid
to a state or the District of Columbia. States that pickup or sponge up the §2011 credit will have to
decouple from the §2011 credit and adopt a separate state death tax for the years 2005 through 2012.




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SUBCHAPTER B                           ESTATES OF NONRESIDENTS AND NOT CITIZENS
§2101          TAX IMPOSED

OVERVIEW
Imposes the IRC §2001(c) estate tax rates upon estates of non-residents who are not citizens
(NRNC).

IMPORTANCE
Non-residents non-citizens will pay US estate taxes upon death on the value of their property within
the US.


§2102          CREDITS AGAINST TAX

OVERVIEW
(a) The following credits may be allowed for estates of non-residents who are not citizens:

   IRC §2011 – Credit for State Death Taxes
   IRC §2012 – Credit for Gift Tax
   IRC §2013 –Credit for Tax on Prior Transfers

(b) Unified Credit – A unified credit of $13,000 is allowed against the tax imposed by IRC §2101.
 This provides a $60,000 exclusion amount.

However, there is a special unified credit for residents of US possession who are considered to be a
non-resident who is not a citizen. The unified credit is the greater of –
     (A) $13,000, or
     (B) That proportions of $46,800, which the value of that part of the decedent’s gross estate,
         which at the time of his death is situated in the US bears to the value of his entire gross es-
         tate wherever, situated.

Special Treaties can cause the full US citizen applicable credit amount of IRC §2010(c) to apply.

The total of all credits are limited to the amount of the tax.

IMPORTANCE
Non-residents non-citizens usually are not entitled to a full §2010(c) unified credit.




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§2103           DEFINITION OF GROSS ESTATE

OVERVIEW
The value of the gross estate of every decedent non-resident not a citizen of the US is that part of his
gross estate which at the time of his death is situated in the US.

IMPORTANCE
The US estate of a non-resident non-citizen only includes assets situated in the US.


§2104           PROPERTY WITHIN THE UNITED STATES

OVERVIEW
Property within the US includes:

     (A) Stock in a US domestic corporation
     (B) Revocable transfers – the value of all property brought back into the gross estate under IRC
         §2035-§2038.
     (C) Debt Obligations of –
         (1) A US person
         (2) The USA, a State or political subdivision or the District of Columbia
         (3) Deposit with a US branch of a foreign bank
         (4) Any other asset other than a property that is without the USA

IMPORTANCE
The value of all property within the US with certain exceptions is included in the gross estate of a
NRNC.


§2105           PROPERTY WITHOUT THE UNITED STATES

OVERVIEW
The following items are not included in the gross estate of a NRNC:

     (a) Proceeds of life insurance
     (b) Bank deposits
            (1) In US banks within the US
            (2) In foreign branch of a US bank
     (c) Works of art on loan for exhibition
     (d)     Money Market Mutual Funds




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IMPORTANCE
In order to attract foreign deposits in US banks, the gross estate excludes these deposits. Likewise,
to encourage the purchase of life insurance from a US life insurance company the proceeds are estate
tax free.


§2106          TAXABLE ESTATES

OVERVIEW
The following items may be deducted from the gross estate to arrive at the tax estate:

     (A) Expenses, losses, indebtedness and taxes deductible under IRC §2053 and §2054.
     (B) Transfers to charities allowed under IRC §2055
     (C) The marital deduction if the surviving spouse is a US citizen or if a Q-DOT is created for
         the non-citizen spouse


§2107          EXPATRIATION TO AVOID TAX

OVERVIEW
If a US citizen gives up his US citizenship to avoid the estate tax he must live 10 years. Otherwise,
if death occurs within the 10-year period, then his estate will only get a $13,000 unified credit and
the value of his gross estate shall be the same as determined under §2103 plus the value of certain
stock in certain foreign corporations.

IMPORTANCE
Even if death occurs within the 10 years expatriation can still save estate taxes.


§2108          APPLICATION OF PRE-1967 ESTATE TAX PROVISIONS

OVERVIEW
If the President finds that a foreign country imposes a more burdensome death tax on the foreign es-
tate of a US citizen who is not a resident then the tax imposed by subchapter B of Chapter 11, then
the US will impose the more burdensome pre-1967 estate tax provision upon the estates of the citi-
zens of that country who have property in the US and who are non-residents of the US.

IMPORTANCE
Turn around is fair play!




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SUBCHAPTER C                                                                   MISCELLANEOUS
§2201           COMBAT ZONE RELATED DEATHS OF MEMBERS OF THE ARMED FORCES,
                DEATHS OF ASTRONAUTS, AND DEATHS OF VICTIMS OF CERTAIN TERRORIST
                ATTACKS


OVERVIEW

(a) IN GENERAL

Unless the executor elects not to have this section apply, in applying sections 2001 and 2101 to the
estate of a qualified decedent, the rate schedule set forth in subsection (c) shall be deemed to be the
rate schedule set forth in section 2001(c).


(b) QUALIFIED DECEDENT

For purposes of this section, the term "qualified decedent" means:

(1) any citizen or resident of the United States dying while in active service of the Armed Forces of
the United States, if such decedent

was killed in action while serving in a combat zone, as determined under section 112(c), or

(B) died as a result of wounds, disease, or injury suffered while serving in a combat zone (as deter-
mined under section 112(c)), and while in the line of duty, by reason of a hazard to which such dece-
dent was subjected as an incident of such service,

2) any specified terrorist victim (as defined in section 692(d)(4)),
and

3) any astronaut whose death occurs in the line of duty.


(c) A SPECIAL TAX RATE SCHEDULE is contained in this Section.


(d) DETERMINATION OF UNIFIED CREDIT

In the case of an estate to which this section applies, subsection (a) shall not apply in determining the
credit under section 2010.

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IMPORTANCE

§2201 was amended by Public Law 107-134. The Victims of Terrorism Relief Act of 2001 and is
effective for estates of United States citizens or residents or non-resident non-citizens decedents dy-
ing as a result of certain terrorist attacks. Pamela Olson, Chief Tax Legislative Counsel to the US
Treasury re-wrote this entire bill, as the results of feedback that Peter J. Parenti gave her on the orig-
inal proposed bill.

Prior to Public Law 107-134 Sec. 2201 was not much of an estate tax break, but at least it was some-
thing. Now it is a great estate tax break! All the original §2201 did was to waive the Additional Es-
tate Tax of IRC §2011 (d).

Cross Reference:

Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part II – Income in Respect of Decedent
                    Section 692 – Income Taxes on Members of Armed Forces and Victims of
                                   Certain Terrorist Attacks on Death


§2203           DEFINITION OF EXECUTOR

OVERVIEW
The term “Executor” wherever used in Title 26 means the executor or administrator of the decedent’s
estate. Executor also means any person in actual or constructive receipt of any property of decedent
if no executor or administrator has been appointed, qualified or is acting within the United States.

IMPORTANCE
Broadly defines executor. If probate is totally avoided due to a fully funded living trust, the trustee
or trustees are the executors for Chapter 11 estate tax purposes.


§2204           DISCHARGE OF FIDUCIARY FROM PERSONAL LIABILITY

OVERVIEW
Allows executor to make written application for determination of estate tax and to receive discharge
from personal liability. Once application is made, the IRS has 6 months to notify the executor of any
estate tax deficiency and 9 months to notify the executor of any other tax deficiency.

IMPORTANCE
Fiduciaries operating in good faith and upon notice of and payment of tax assessment are entitled to
written notice of discharge. The executor upon payment of any tax as notified by the IRS, and upon

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furnishing any required bond will be discharged from any personal liability for any tax deficiency
letter found to be due.

CROSS REFERENCE:
Subtitle F – Procedure and Administration
     Chapter 71 – Transferees and Fiduciaries
          §6905 – Discharge of Executor For Personal Liability of Decedent’s Income and Gift
                   Taxes


§2205           REIMBURSEMENT OUT OF ESTATE

OVERVIEW
Direct recipient of property upon which estate tax has been paid is entitled to reimbursements from
either the undistributed amount of the estate or by equitable contribution from other noncontributing
recipients.

IMPORTANCE
This is an affirmation that estate taxes are expected to be paid from the estate prior to any distribu-
tion unless specifically directed by decedent’s estate plan. These code sections make clear the IRS is
not bound to collect tax from any particular property or person – this adds additional sources from
which payment may be received. IRS can collect the estate tax from any recipient, and if that recipi-
ent has paid more than his or her fair share they are in effect subrogated to the rights of IRS to collect
the fair share from other recipients.

§2206           LIABILITY OF LIFE INSURANCE BENEFICIARIES

OVERVIEW
Unless the decedent directs otherwise in his estate plan, the executor is entitled to recover from the
direct beneficiaries of life insurance proceeds, on the life of an insured decedent that was included in
the value the decedent’s gross estate, their proportionate share of estate taxes, or unless, and to the
extent, that the proceeds were deductible from the gross estate under §2056 (marital deduction).

IMPORTANCE
Establishes right of executor to enforce equitable distribution to all beneficiaries even those receiving
property never in the hands of the executor.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens and Residents
               Part III – Gross Estates
                    §2042 – Proceeds of Life Insurance
               Part IV – Taxable Estate
                    §2056 – Bequest to Surviving Spouse
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§2207          LIABILITY OF RECIPIENT OF PROPERTY OVER WHICH DECEDENT HAD POWER
               OF APPOINTMENT

OVERVIEW
Unless the decedent provided otherwise in his estate, if any part of the estate tax paid was due to the
inclusion under §2041 of power of appointment property, the executor may recover tax due from re-
cipient.

IMPORTANCE
Equitable contribution reaffirmed for estate and for the IRS.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part III – Gross Estate
                    §2041 - Powers of Appointment

§2207A         RIGHT OF RECOVERY IN THE CASE OF CERTAIN MARITAL DEDUCTION PROPERTY

OVERVIEW
If the estate of a decedent is increased in value due to the existence of a QTIP trust the executor is
allowed a right of recovery of the additional estate tax imposed from the recipients of the QTIP prop-
erty. The executor may recover the amount by which:
     (a) The total estate tax that has been paid exceeds.
     (b) The total estate, which would have been payable if the value of the QTIP trust, had not been
         included in the gross estate.

IMPORTANCE
If a surviving spouse has just an income interest on property left by a deceased spouse, the surviving
spouse’s estate is increased by the full amount of the property. This section allows that surviving
spouse’s estate to be only responsible for the correct amount of tax. If an executor does not recover
the tax due from the recipients, it will be a taxable gift to the recipients under Section 2511.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part III – Gross Estate
                    §2044 - Property for Which Marital Deduction was Previously Allowed
               Part IV – Taxable Estate
                    §2056 - Bequests to Surviving Spouse
          Subchapter B – Transfers
                    §2511 - Transfers in General (gift tax)
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§2207B         RIGHT OF RECOVERY WHERE DECEDENT RETAINED INTEREST

OVERVIEW
Unless the decedent’s estate plan provides otherwise, if any part of a decedent’s gross estate consists
of the value of property included in the gross estate by reason of IRC §2036 (relating to transfers
with retained life estate), the decedent’s estate is entitled to recover from the person receiving the
property the amount which bears the same ratio to the total estate tax (plus penalties and interest)
which has been paid as (a) the value of such property, bears to, (b) the taxable estate. Exception:
No person may recover estate from a qualified §664 Charitable Remainder Trust.

IMPORTANCE
The estate is subrogated to the rights of the IRS to recover. Notice §2035, 2037, and 2038 are not
included, however §2205 should apply.


§2208          CERTAIN RESIDENTS OF POSSESSIONS CONSIDERED CITIZENS OF THE UNITED
               STATES
§2209          CERTAIN RESIDENTS OF POSSESSIONS CONSIDERED NONRESIDENTS NOT CITI-
               ZENS OF THE UNITED STATES

OVERVIEW
The estate of a decedent who became a U.S. citizen by means of birth in a U.S. possession and died a
resident of a possession will be taxed as a non-resident, not a citizen under Section 2101. The estates
of all other decedent citizens dying in possessions as citizen residents are taxed under Section 2001.

IMPORTANCE
Most U.S. citizens who were born and died in U.S. possessions will avoid estate tax imposed under
Section 2001 and be taxed under Section 2101 on only his US estate which is not located in the US
possession. The portion of his estate that is located in the US possession is not estate taxable.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part I – Tax Imposed
                    §2001 - Imposed and Rate of Tax
          Subchapter B – Estate of Non-Resident, Not Citizens
                    §2101 - Tax Imposed (Non-Resident, Not Citizens)




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§2210          TERMINATION

OVERVIEW
HR 1836 RELIEF Act of 2001

(a) In General – Except as provided in subsection (b), this chapter shall not apply to the estates
of decedents dying after December 31, 2009.

(b) Certain Distributions From Qualified Domestic Trusts – In applying section 2056A with
respect to the surviving spouse of a decedent dying before January 1, 2010

      (1) section 2056A(b)(1)(A) shall not apply to distributions made after December 31, 2020,
and
      (2) section 2056A(b)(1)(B) shall not apply after December 31, 2009.


IMPORTANCE
HR 1836 RELIEF Act of 2001

(1) Chapter 11, Estate Tax, is repealed

(2) Distributions from Qualified Domestic Trusts (QDOT) made after December 31, 2020 are
not subject to estate tax

(3) There is no estate tax imposed on a QDOT for surviving spouses who die after December
31, 2009.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter B – Estates of Citizens or Residents
               Part IV – Taxable Estate
                    Section 2056A – Qualified Domestic Trusts
     Chapter 13 – Tax on Generation Skipping Transfers
          Subchapter G – Administration
                    Section 2210 – Termination


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CHAPTER 12                                                                              GIFT TAX
SUBCHAPTER A                                           DETERMINATION OF TAX LIABILITY
§2501          IMPOSITION OF TAX

OVERVIEW
(a) Taxable Transfers:

   (1) This section establishes a gift tax, computed as provided in section 2502, for each calendar
       year on the transfer of property by gift during any calendar year by any individual resident or
       nonresident.
   (2) Exception: Transfers of intangible property by a non-resident not a citizen is not subject to
       gift tax.
   (3) Exception to Exception: Gifts of intangibles by expatriates within 10 years of expatriation,
       unless the expatriate can prove that he or she did not have a tax avoidance motive in giving
       up his or her US citizenship.

(b) US Citizen who resides in US possessions are US citizens for gift tax purposes, unless he or she
    (1) became a US citizen by becoming a citizen of the US possession, or (2) was born there.

(c) Residents of US possession are considered non-resident not citizens for gift tax purposes if he or
    she (1) became a US citizen by becoming a citizen of the US possession, or (2) was born there.

IMPORTANCE
This section establishes the general rules and exceptions for the imposition of gift tax and how it is
computed.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter O – Gain or Loss on Disposition of Property
               Part II – Basis Rules of General Application
                    §1015 – Basis of Property Acquired by Gift and Transfers in Trust

Subtitle B – Estate and Gift Taxes    Chapter 11- Estate Tax
     Subchapter A – Estates of Citizens or Residents
          Part I – Tax Imposed
§2001 – Imposition and Rate of Tax

     Subchapter C – Miscellaneous
              §2208 – Certain Residence of Possessions Considered Citizens of the US
              §2209 – Certain Residence of Possessions Considered Non-Residents Not Citizens
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                         of US
Subtitle F- Procedure and Administration
     Chapter 64- Collection
          Subchapter C- Lien for Taxes
               §6324- Special Liens for Estate and Gift Taxes


§2502           RATE OF TAX

OVERVIEW
This section establishes the computational guidelines for the imposition of gift tax by making refer-
ence to the unified tax on estate and gifts in §2001. This section also establishes the rule that gift tax
is paid by the donor.

HR 1836 RELIEF Act of 2001
Starting in 2002 to 2009 the maximum gift tax rate reduces to 50% and continues to reduce by 1%
for each year until 2007 when it levels off 45% at the same rate as §2001(c).
In 2010 the maximum gift tax rate is 35% and maximum gift tax applicable exclusion amount is
$1,000,000.
Starting in 2011 to 2012 the maximum gift tax rate is 35% and maximum gift tax applicable exclu-
sion amount is $5,000,000. For cumulative gifts over $500,000, the Gift Tax is $155,800, plus 35%
of the excess over $500,000. (However, the Applicable Credit Amount under §2505 is $1,730,800
which pays the Gift Tax on the first $5,000,000 of gifts).
After 2012, these changes are presently scheduled to sunset along with the rest of HR 1836.

IMPORTANCE
This section makes clear the relationship and unified nature of the transfer tax on estates and gifts.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Subchapter A – Estates of Citizens or Residents
          Part I – Tax Imposed
               §2001 – Imposition and Rate of Tax


§2503           TAXABLE GIFTS

OVERVIEW
This section does seven important things with regard to gift taxation: It
1. Defines what gifts are taxable in any given year as the total amount of gifts made during the cal-
   endar year, less the deduction provided in Subchapter C of Chapter 12, §2522-2524.
2. Establishes the concepts of present interest vs. future interest gifts
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3. Carves out an amount which is excluded from the definition of taxable gifts, and permits increas-
   es for cost-of-living factors (the $10,000 per donee annual exclusion)
4. Establishes an exception to taxable future gifts for certain transfers to donees under 21 years of
   age
5. Carves out specific exceptions for payments to educational and medical providers
6. Carves out exceptions for the waivers of any survivors benefit in a qualified retirement plan dur-
   ing the participants life
7. Carves out an exception for loans for qualified artworks

HR 1836 RELIEF Act of 2001

After 2009 transfers in trust will be treated as taxable gifts under §2503, unless the trust is treated as
wholly owned by the donor or the donor’s spouse under the grantor trust rules.

IMPORTANCE
The estate planning attorney needs to know the general rules and the exceptions for asset transfers by
gift.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part I – Estates, Trusts, and Beneficiaries
                    Subpart E – Grantors and Others Treated as Substantial Owners
                         §§671 – 679

          Subchapter O – Gain or Loss on Disposition of Property
              Part II – Basis Rules of General Application
                   §1015- Basis of Property Acquired by Gift

Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter B – Transfers
               §2511 – Transfers in General
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter B – Generation-Skipping Transfers


§2504           TAXABLE GIFTS FOR PRECEDING CALENDAR PERIODS

OVERVIEW
(a) In General – In computing taxable gifts for preceding periods for purposes of computing the gift
    tax for the current calendar year –

    (1) Look to prior year’s gift tax law for determining what is a gift.
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    (2) Look to the prior law for deductions.
    (3) Use the $30,000 exemption of §2521 for gifts made prior to January 1, 1977.

(b) Exclusions from prior periods still count.
(c) Lastly, this section tell us that if the time for assessing tax on a gift has expired ( i.e., three years
    after a return is filed disclosing the gift under §6501) the IRS cannot change the value as reported
    pursuant to §2001(f)(2), even if as a result of an increase in taxable gifts pursuant to a §2701
    transaction.

IMPORTANCE
Taxpayers and their attorneys need some certainty as to the taxation of gift transfers.


§2505           UNIFIED CREDIT AGAINST GIFT TAX

OVERVIEW
(a) §2505(a) applies to gift taxes imposed by §2501 the same credits against taxes available under
    §2010(c) for estate taxes. The credit is available for both US citizens and US residents.
(b) §2505(b): The applicable exclusion amount will be reduced by an amount equal to 20% of the
    aggregate amount allowed as specific exemptions under §2521 (the old Pre-Tax Reform Act of
    1976, $30,000 lifetime exemption) with respect to gifts made after September 8, 1976, and be-
    fore January 1, 1977.
(c) §2505(c) makes clear that total credit cannot exceed the total amount of taxes imposed by §2501
(d) Starting in the year 2002 to 2010, the applicable exclusion amount for gift taxes is $1,000,000
    and will stay at $1,000,000 despite the increases under §2010. For 2011 and 2012 the applicable
    exclusion amount for gift taxes is $5,000,000. For 2013 and thereafter the applicable exclusion
    amount for gift taxes drops to $1,000,000.

IMPORTANCE
Coordinating estate and gift taxes is a central theme of estate planning and this section announces
how the two forms of transfer tax work together.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part II – Credits Against the Tax
                    §2010 – Unified Credit Against Estate Taxes

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SUBCHAPTER B                                                                           TRANSFERS
§2511           TRANSFERS IN GENERAL

OVERVIEW
§2511(a) provides that gift taxes will apply on all gratuitous transfers, whether direct or in trust and
to all forms of property. If the donor is a non-citizen, non-resident of the US, tax will be imposed
only on transfers of US sited property.
§2511(b) provides that shares of stock in a US domestic corporation and debt obligations of a US
citizen or of a US governmental entity owned by a non-citizen, non-resident are deemed to be US
sited property for purposes of this section.

Sec. 2511(c) was REPEALED by the 2010 Tax Act.

HR 1836 RELIEF Act of 2001,
Transfers in trust shall be treated as a taxable gift under §2503, unless the trust is a grantor trust that
is wholly owned by the grantor or the grantor’s spouse under Subpart E of Part 1 of Subchapter J of
Chapter 1 – The Grantor Trust Rules(§§671-679).

IMPORTANCE
Recognizing the different rules for two classes of donors: non-citizen/non-residents and everyone
else, helps the estate planner appreciate the far-reaching effect on §2501.


§2512           VALUATION OF GIFTS

OVERVIEW
This section does two things:
(a) The value of a gift of property on the date of transfer is the value of the gift
(b) Applies gift taxation in any given year to any transfer for less than adequate and full considera-
    tion in money or money’s worth, valuing it as the excess above the date of transfer value and the
    actual consideration paid.

IMPORTANCE
This section clarifies the rules applicable to valuation of gifts and makes clear that “bargain sales”
will create gift tax liability.




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§2513          GIFT BY HUSBAND OR WIFE TO THIRD PARTY

OVERVIEW
(a) This section establishes the rule that permits gift splitting by spouses and the manner for a spouse
    to signifying assent to the gift made by the other spouse to a third party.
(b) The consent is signified by filing a Form 709 Gift Tax Return, and must be made on or before
    April 15th following the calendar year in which the gift was made.
(c) The consent may be revoked anytime on or before April 15th after the year of the gift.

IMPORTANCE
This rule permits the estate planner to carefully engineer gifts by spouses to third parties so as to
make maximum use of both spouses’ applicable credit available under §2505.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Subchapter A – Estates of Citizens or Residents
          Part I – Tax Imposed


§2514          POWERS OF APPOINTMENT

OVERVIEW
This section does several very important things:
(a) Provides that the exercise or release of a general power of appointment is a transfer for gift tax
    purposes.
(b) Defines general powers of appointment and how they may be exercised.
(c) Creates the “ascertainable” standard of health, education, support and maintenance as a limita-
    tion preventing a power to invade or appropriate property for the benefit of the possessor of a
    power from becoming a general power of appointment.
(d) Establishes what an exercise of a power means to the possessor of the power.
(e) Establishes the “5 and 5” rule for lapses of exercise of a power.

IMPORTANCE
Since general powers of appointment and the property subject to them are subject estate and gift tax,
the estate planning attorney must know these rules in order to effectively draft will and trust clauses
which achieve the desired tax results. The rules of IRC §2514 and IRC §2041 are virtually the same.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estates of Citizens or Residents
               Part III – Gross Estate
                    §2041 – Powers of Appointment


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§2515           TREATMENT OF GENERATION-SKIPPING TRANSFER TAX

OVERVIEW
This rule bulks up the value of a taxable gift which is also a generation skipping direct skip gift un-
der Chapter 13., by adding to the value of the gift the amount of any generation-skipping tax imposed
on the transfer.

IMPORTANCE
This rule creates an inter-related gift tax calculation.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Subchapter A – Estates of Citizens or Residents
          Part I – Tax Imposed
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
          Subchapter C – Taxable Amount
               Section 2623 – Taxable Amount in Case of Direct Skip

§2516           CERTAIN PROPERTY SETTLEMENTS

OVERVIEW
This section treats transfers between spouses pursuant to a marital property agreement when divorce
occurs within 3 years of the agreement as transfers paid for full and adequate consideration, and thus,
not a gift. The 3-year period can begin 1 year prior to the actual agreement. The agreement does not
have to be approved by the divorce decree.

IMPORTANCE
Divorce happens and the planner must be aware of the continued availability of tax-free marital tax
transfers of property pursuant to it.

§2518           DISCLAIMERS

OVERVIEW
Defines “qualified disclaimer” and states the rules on how one is made. The rule states that if a per-
son makes a qualified disclaimer the gift tax rules will apply as if the transfer had never been made
to the disclaiming person.
The requirements for a qualified disclaimer are that is must be in made in writing and delivered to
the transferor within 9 months after the transfer is made (or the disclaiming transferee attains age 21)
(or in the case of a decedent dying after December 31, 2009 and before 12/17/2010 disclaimers may be
made within 9 months after 12/17/2010), the transferee cannot have accepted the transferred interest
or any of its benefits. Lastly, the disclaimed interest must then pass without direction by the
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disclaimant to the decedent (transferors) spouse or any other person other than the disclaimant. A
power with respect to property is considered an interest, which can be disclaimed. A qualified dis-
claimer must also meet all of the requirements of the state disclaimer statute.
Undivided interests can also be disclaimed if the disclaimer otherwise meets the requirements of this
section.
Lastly, a written transfer of a transferors entire interest in property will be considered a qualified dis-
claimer if: it is made within 9 months after the interest is created (or the transferor attains age 21),
the transferor has accepted no benefit from the interest, and the transfer is to a person who would
have received the interest had the transferor made a qualified disclaimer.

IMPORTANCE
Thoughtful planning of disclaimers is a powerful tax saving technique to otherwise meet a client’s
objectives.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part III – Gross Estate
                    §2046 - Disclaimers

§2519           DISPOSITIONS OF CERTAIN LIFE ESTATES

OVERVIEW
This section makes clear that if a donee spouse disposes of all or any part of an income interest he or
she has under a transfer to him or her which qualified as a marital deduction gift, i.e., a QTIP interest
(under §2056(b)(7) or §2523(f)), the donee spouses gift of the income interest is a gift of the entire
property, not merely the income interest.

IMPORTANCE
If a trust permits a partial QTIP election, post mortem planners may be better advises to make a par-
tial election and disclaim the marital gift not subject to the election, rather than have the donee
spouse be deemed to make a gift of the entire marital gift property.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estate of Citizens and Residents
               Part IV – Taxable Estates
                    §2056 – Bequests, Etc., to Surviving Spouse
     Chapter 12 – Gift Tax
          Subchapter C – Deductions
                    §2523 – Gifts to Spouses
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SUBCHAPTER C                                                                        DEDUCTIONS
§2522           CHARITABLE AND SIMILAR GIFTS

OVERVIEW
This section establishes the rules for deductions by citizens and residents for gifts to specifically
enumerated types of qualified tax-exempt organizations. This section also establishes the rules for
deductions for gifts by nonresidents to specifically enumerated types of qualified tax-exempt organi-
zations. Additionally, this section establishes the allowance of deductions for remainder interest gifts
in qualifying charitable trusts and for special transfers of easements in qualified real property.

This section allows an unlimited deduction to taxpayers for inter vivos gifts to charitable organiza-
tions described in §2522(a). The types of organizations are specifically enumerated and are generally
those that are exempt from taxation under Code Section 501. Non-citizen, nonresident aliens are al-
so permitted an unlimited charitable deduction for gift tax purposes, but generally, their contributions
are limited to US based organizations. Section 2522(b).

Special rules apply for charitable deductions when the donor transfers a partial interest in property to
or for the use of a charitable recipient and either retains an interest in the same property or transfers
an interest in the property to non-charitable beneficiaries for less than adequate and full considera-
tion. Section 2522(c)(2). Under such circumstances, the charitable interest must be one of the fol-
lowing:

   An undivided portion, not in trust, of the donor’s entire interest in the property.

   An irrevocable remainder interest, not in trust, in a personal residence or farm.

   A qualified conservation contribution.

   A remainder interest in a trust that is a charitable remainder annuity trust, a charitable remainder
    unitrust, or a pooled income fund.

   A guaranteed annuity or unitrust interest (i.e., a charitable lead trust).

IMPORTANCE
The estate planner must be aware of the statutory source for charitable gift tax deductions.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter B – Computation of Taxable Income

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               Part VI – Itemized Deductions for Individuals and Corporations
                    §170 – Charitable, Etc. Contributions and Gifts

Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter F – Exempt Organizations
               §501-530

Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Taxes
          Subchapter A – Estates of Citizens or Residents
               Part IV – Taxable Estate
                    §2055 – Transfers for Public, Charitable, and Religious Uses


§2523          GIFT TO SPOUSE

OVERVIEW
This is an extremely ambitious and complex section. It does several things:
(a) Establishes an unlimited deduction for gifts made to a spouse, and
(b) Denies the marital deduction to a transfer to a spouse if the interest transferred terminates as a
    result of the transferee/spouses death and the donor spouse retains or transfers the retained inter-
    est (a life estate), or if the donor spouse has the power to appoint the failed interest
(c) Denies a deduction for gifts to a spouse of property which does not qualify for the marital deduc-
    tion
(d) Excepts from this rule a transfer which creates a joint tenancy or tenancy by the entirety;
(e) Excepts from this rule a transfer to a donee spouse who has a power to appoint the entire interest
    (even to the donor spouse or his/her estate)
(f) Establishes the concept of “qualified terminable interest property” and “qualifying income inter-
    est”
(g) Applies the “qualifying income interest” concept to joint and survivor annuities
(h) Excepts from the life interest rule denying a deduction, an income interest from a qualified chari-
    table remainder trust
(i) Denies the marital deduction where the donee spouse is not a US citizen, modifies §2503(b) to
    permit an annual exclusion of $100,000 to non-citizen spouses – Rev. Proc 2001-13, provides
    that for calendar year 2001 this amount has been adjusted for inflation to $106,000. Rev. Proc
    2007-66, provides that for calendar year 2008 this amount has been adjusted for inflation to
    $128,000.

IMPORTANCE
These complex rules provide the backbone concepts for martial gift and estate tax planning.

CROSS REFERENCE:
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes
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          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
              Part I – Estates, Trusts, and Beneficiaries
                   Subpart A – General Rules for Taxation of Estates and Trusts
          Subchapter O – Gain or Loss on Disposition of Property
              Part II – Basis Rules of General Application
                   §1015 Basis of Property Acquired by Gift and Transfers in Trust
              Part III – Common Non-Taxable Exchanges
                   §1041 – Transfers of Property Between Spouses or Incident of Divorce

Subtitle B – Estate and Gift Taxes
     Subchapter A – Estates of Citizens or Residents
          Part IV – Taxable Estate
               §2056 – Bequests, Etc., to Surviving Spouse
               §2056A – Qualified Domestic Trust


§2524           EXTENT OF DEDUCTIONS

OVERVIEW
This is one of those little obtuse sections of the Code that seeks to make clear that charitable gifts
under section 2522 and gifts to spouses under section 2523 are only eligible for deductions to the ex-
tent they are included in the total amount of gifts made for which a deduction is claimed. In other
words, it is not possible to exclude a gift or a portion of a gift and not utilize an available deduction
to achieve some other tax- planning objective.


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CHAPTER 13                                     TAX ON GENERATION-SKIPPING TRANSFERS
SUBCHAPTER A                                                           TAX IMPOSED
§2601           TAX IMPOSED

OVERVIEW
Imposes a tax on every generation-skipping transfer. This section imposes a tax on transfers to
beneficiaries who are more than one generation below the transferor’s generation. There are three
types of “generation-skipping” transfers: taxable terminations, taxable distributions and direct skips.
 The HR 1836 RELIEF Act of 2001 added a sub-category of transfer called an “Indirect Skip”


IMPORTANCE
When considering lifetime or testamentary transfers to grandchildren or other subsequent genera-
tions, it is very important to understand the impact of the generation-skipping tax. It is also important
to consider those situations where an unintended generation-skipping transfer might occur, i.e.,
where a child is living at a parent’s death but dies before the distribution to the child and such child’s
children become the beneficiaries.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2602, 2603

Subchapter B – Generation-Skipping Transfers
    §2611-2613


§2602           AMOUNT OF TAX

OVERVIEW
This section defines the amount of generation skipping transfers tax imposed as the taxable amount
multiplied by the applicable rate.

The taxable amount depends on whether the transfer is a taxable distribution, taxable termination or
direct skip.

The applicable rate is the maximum federal estate tax rate imposed by §2001 at the time of the trans-
fer (currently 35%) multiplied by the inclusion ratio with respect to such transfer.



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The inclusion ratio is determined by subtracting the applicable fraction from one; the applicable frac-
tion being that fraction, the numerator of which is the amount of generation-skipping transfer exemp-
tion allocated to a trust or to property transferred in a direct skip over the value of the property trans-
ferred to the trust or involved in a direct skip, reduced by the sum of federal estate and state estate
death tax attributable to such property and any estate or gift tax charitable deduction allowed with
respect to such property.

HR 1836 RELIEF Act of 2001
As the Applicable Estate Tax Rate (§2001) starts to decline in 2002 to 50% and then by 1% per year
thereafter until 2007 when it will have declined to 45%, the Applicable GST Tax Rate will also de-
cline at the same rate. The Applicable (GSTT) Rate for 2010 is ZERO. The Applicable (GSTT)
Rate for 2011 and 2012 is the same as highest Applicable Estate Tax Rate (§2001) which is cur-
rently 35%.

IMPORTANCE
This section is the basis for determining the amount of GST tax on a generation-skipping transfer.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part I – Tax Imposed
                    §2001 – Imposition and Rate of Tax
     Chapter 13 – Tax on Generation-Skipping Transfer
          Subchapter B – Generation-Skipping Transfers
               §2611-2613

          Subchapter C – Taxable Amount
              §2621-2623


§2603           LIABILITY OF TAX

OVERVIEW
This section sets forth the party or entity responsible for the payment of a generation-skipping tax. In
the case of taxable distributions, the transferee pays the GST tax. In the case of taxable terminations,
the trustee pays the GST tax. In the case of direct skips, the tax is paid by the transferor. The source
from which the tax is to be paid is the property, which is the subject of the GST transfer, unless oth-
erwise provided in the governing instrument by specific reference to the GST tax.

IMPORTANCE
The estate planner needs to know which party or entity will be responsible for any tax which may be
imposed on a generation-skipping transfer in order to property plan for and deal with the impact of
such tax.
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CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 12 – Gift Tax
          Subchapter B – Transfers
               §2515 – Treatment of Generation-Skipping Transfer Tax
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter B – Generation-Skipping Transfers
               §2611-2613


§2604          CREDIT FOR CERTAIN STATE TAXES

OVERVIEW
This section provides a credit against the federal generation-skipping transfer tax imposed (not to
exceed 5% of such tax) for generation-skipping transfer taxes actually paid to any state with respect
to such generation-skipping transfers as a result of the death of an individual (other than a direct
skip).

HR 1836 RELIEF Act of 2001

New Subsection (c) “Termination” provides that: “This Section shall not apply to generation skip-
ping transfers after December 31, 2004”.

IMPORTANCE
This section permits a limited credit against the GST for state GST taxes.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 11 – Estate Tax
          Part II – Credits Against the Tax
               §2011 – Credit for State Death Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2601


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SUBCHAPTER B                                          GENERATION-SKIPPING TRANSFERS
§2611          GENERATION-SKIPPING TRANSFER DEFINED

OVERVIEW
(a) This section defines those transfers, which are generation skipping transfers. There are three
types of transfers –

     Taxable termination                  the termination (by death, lapse of time, release of a
                                    power, or otherwise) of an interest in property held in a
                                    trust, unless immediately after such termination a non-
                                    skip person has an interest in such trust, or unless at no
                                    time after such termination may a distribution is made
                                    from such trust to a skip person. A skip person is defined
                                    under Section 2613 as a person who is two or more gen-
                                    erations below that of the transferor.

     Direct skip                    a transfer, which is subject to a gift or estate tax, of an in-
                                    terest in property to a skip person

     Taxable distribution                any distribution from a trust to a skip person other
                                    than a taxable termination or a direct skips. (The “Catch
                                    All”)

(b) Excludes any IRC §2503(e) Educational or Medical Gifts. Also excluded are prior GST transfers
where the new transferee is in the same generation as the prior transferee whose transfer had been
GST taxed.

IMPORTANCE
When preparing a trust, it is very important to identify, in your clients’ estate plans, the different
types of transfers that may trigger the generation-skipping transfer tax, including unintended skips.
Also, the actual generation skipping tax is very different in amount, depending which type of transfer
triggered the GST.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter A – Determination of Tax Liability
               §2503 – Taxable Gifts
               §2503(e) – Exclusion for Certain Transfers for Educational Expenses or Medical
                              Expenses
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     Chapter 13 – Tax on Generation-Skipping Transfers
         Subchapter B – Generation-Skipping Transfers
              §2612, 2613
         Subchapter C – Taxable Amount
              §2621-2624


§2612          TAXABLE TERMINATION; TAXABLE DISTRIBUTION; DIRECT SKIP

OVERVIEW
This section defines taxable terminations and taxable distributions and direct skips.

(a) Taxable termination is the termination of an interest in property held in a trust, unless immedi-
ately after such termination a non-skip person has an interest in such trust, or at no time after such
termination may a distribution be made from such trust to a skip person. Skip person is defined un-
der §2613 as a person who is two or more generations below that of the transferor.

(b) A “direct skip” is a transfer of an interest in property to a skip person that is subject to gift or
estate tax. Sole for purposes of determining whether any transfer to a trust is a direct skip the look-
thru rules of §2651(f)(2) shall not apply.

(c) A taxable distribution is any distribution from a trust to a skip person other than a taxable ter-
mination or a direct skip.

IMPORTANCE
When preparing a trust, it is very important to understand the different types of transfers that may
trigger generation-skipping transfer tax, including how they occur in an unintended manner. Also,
the actual generation-skipping tax is very different in amount, depending which type of transfer trig-
gered the GST.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2601-2603
          Subchapter B – Generation-Skipping Transfers
               §2611, 2613
          Subchapter C – Taxable Amount
               §2621-2624
          Subchapter F – Other Definitions and Special Rules
               §2651 – Generation Assignment




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§2613           SKIP PERSON AND NON-SKIP PERSON DEFINED

OVERVIEW
A skip person is a natural person two or more generations younger than the transferor. A nonskip
person is anyone who is not a skip person. A trust can also be skip person if only skip person holds
all beneficiary interests in such trust.

IMPORTANCE
The first step in any multigenerational estate plan is to identify all beneficiaries and contingent bene-
ficiaries who are skip persons, since transfers to them must be protected from the GST tax.

CROSS REFERENCE:
Subtitle B – Estate and Gift Tax
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2602, 2603
          Subchapter B – Generation-Skipping Transfers
               §2611-2612


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SUBCHAPTER C                                                               TAXABLE AMOUNT
§2621          TAXABLE AMOUNT IN CASE OF TAXABLE DISTRIBUTION

OVERVIEW
This section provides that the taxable amount in the case of a taxable distribution is the value of the
property received by the transferee reduced by any expenses incurred by the transferee in connection
with the determination, collection or refund of the GST tax with respect to the distribution. If the
GST tax is paid out of the trust, the portion so paid is treated as an additional taxable distribution
subject to GST. The transferee pays the GST tax.

IMPORTANCE
Chapter 13, Generation Skipping Tax treats taxable distributions, taxable terminations and direct
skips differently.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2603
          Subchapter B – Generation-Skipping Transfers
               §2611-2613
          Subchapter C – Taxable Amount
          §2621-2624


§2622          TAXABLE AMOUNT IN CASE OF TAXABLE TERMINATION

OVERVIEW
This section provides that the taxable amount in the case of a taxable termination is the value of all
property with respect to which the taxable termination has occurred, reduced by any §2053 expens-
es, indebtedness and taxes attributable to the property with respect to the taxable termination. The
Trustee pays the GST tax.

IMPORTANCE
Chapter 13, Generation Skipping Tax treats taxable distributions, taxable terminations and direct
skips differently.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part IV – Taxable Estate
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                   §2053 – Expenses, Indebtedness, and Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
         Subchapter A – Tax Imposed
              §2603
         Subchapter B – Generation-Skipping Transfers
              §2611-2613
         Subchapter C – Taxable Amount
              §2621-2624


§2623           TAXABLE AMOUNT IN CASE OF DIRECT SKIP

OVERVIEW
This section provides that the taxable amount in the case of a direct skip is the value of the property
received by the Transferee. The transferor pays the GST tax.

IMPORTANCE
Chapter 13, Generation Skipping Tax treats taxable distributions, taxable terminations and direct
skips differently.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter B – Transfers
               §2515 – Treatment of Generation Skipping Transfer Tax
     Chapter 13 – Tax on Generation-Skipping Transfer
          Subchapter A – Tax Imposed
               §2603
          Subchapter B – Generation-Skipping Transfers
               §2611-2613
          Subchapter C – Taxable Amount
               §2621-2624


§2624           VALUATION

OVERVIEW
This section provides that generally, for generation-skipping transfer tax purposes, a property subject
to such transfer is valued as of the time of the transfer. However, in the case of direct skips and tax-
able terminations, if the alternate valuation date is selected for estate tax purposes, it shall apply for
GST purposes. In the case of direct skips, if the decedent’s estate elected special use valuation under
§2032A, then such value shall also be used for GST tax purposes. The value of property transferred
shall also be reduced by the amount of any consideration provided by the transferee.


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Importance
An estate planner must understand that the value of the property involved in a generation-skipping
transfer is the value on the date the transfer occurs.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter A – Tax Imposed
               §2601-2603
          Subchapter B – Generation-Skipping Transfers
               §2611, 2613
          Subchapter C – Taxable Amount
               §2621-2623


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SUBCHAPTER D                                                                 GST EXEMPTION
§2631          GST EXEMPTION

OVERVIEW
This section allows every transferor a $5 million GST exemption. A transferor may al-
locate the exemption against gifts during life, bequests upon death, or both. The allocation is irrevo-
cable, once made. The exemption is inflation-adjusted. For 1999 the GST exemption is $1,010,000.
For 2000 the GST exemption is $1,030,000. For 2001 the GST exemption is $1,060,000.

HR 1836 RELIEF Act of 2001

         (a) General rule.
        For purposes of determining the inclusion ratio, every individual shall be allowed a GST
        exemption amount which may be allocated by such individual (or his executor) to any
        property with respect to which such individual is the transferor.
        (b) Allocations irrevocable.
        Any allocation under subsection (a) , once made, shall be irrevocable.
        (c) GST exemption amount.
        For purposes of subsection (a) , the GST exemption amount for any calendar year shall
        be equal to the basic exclusion amount under section 2010(c) for such calendar year.

After 2003 the GST exemption will be the same as the §2010(c) estate tax applicable exclusion
amount. After the year 2012, the GST exemption amount will go back to being $1,000,000 adjusted
by inflation.

IMPORTANCE
Multigenerational wealth planning focuses on how best to use this GST Exemption to protect as
much of a transferor’s estate as possible from taxation in the estates of generations of beneficiaries.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter D – GST Exemption
               §2632




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§2632          SPECIAL RULES FOR ALLOCATION OF GST EXEMPTION

OVERVIEW
(a) Time and Manner of Allocation
    (1) Time – Any time on or before the date prescribed for filing the estate tax return (or gift tax
        return), regardless if it is required to be filed.
    (2) Manner – Prescribe by forms or regulations

(b) Deemed Allocation to Certain Lifetime Direct Skips
    (1) In General – Direct skip during lifetime shall be allocated to the extent necessary to make
        the inclusion ratio zero. The unused portion shall be allocated to the property transferred.
    (2) Unused Portion – That portion of such exemption, which has not previously been allocat-
        ed.
    (3) Subsection Not to Apply in Certain Cases – An individual may elect not to allocate GST
        exemption.

(c) Deemed Allocation to Certain Lifetime Transfers to GST Trusts (Indirect Skips)
    (1) In General – If an indirect skip is made during lifetime, the unused portion is allocated to
        the property transferred to the extent necessary to make the inclusion ratio zero. The entire
        unused portion shall be allocated to the property transferred.
    (2) Unused Portion – The portion of such exemption, which has not previously been -
        (A) allocated by such individual
        (B) treated as allocated with respect to a direct skip
        (C) treated as allocated with respect to a prior indirect skip
    (3) Definitions
        (A) Indirect Skip – Means any transfer of property (other than a direct skip) subject to the
             GST tax made to a GST trust.
        (B) GST Trust – A trust that could have a generation-skipping transfer unless
             (i) the trust instrument provides that more than 25 percent of the trust corpus must
                   be distributed to or may be withdrawn by one or more non-skip persons
                   (I) before age 46
                (II)     on or before dates specified that will occur before age 46
                (III) occurrence of an event that may reasonably be expected to occur before age
                         46
             (ii) the trust instrument provides more than 25 percent must be distributed to or may
             be withdrawn by non-skip persons living on the date of death of another person more
             than 10 years older
             (iii) the trust instrument provides if one or more non-skip persons die on or before a
             date or event described in clause (i) or (ii), more than 25 percent must be distributed
             to the estate or estates or is subject to a general power of appointment exercisable by
             non-skip persons
             (iv) the trust is any portion of which would be included in the gross estate of a non-
             skip person

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               (v) the trust is a charitable lead annuity trust or a charitable remainder annuity trust
               or a charitable remainder unitrust
               (vi) a trust with respect to which a deduction was allowed under section 2522 for the
               right to receive annual payments of a fixed percentage and which is required to pay
               principal to a non-skip person who is alive when payments terminate

     For purposes of this subparagraph, the value of transferred property shall not be considered to
     be includible in the gross estate of a non-skip person subject to a right of withdrawal in section
     2503(b) annual exclusion property.

   (4) Automatic Allocations to Certain GST Trusts – an indirect skip to which section 2642(f) ap-
       plies shall be deemed to have been made only at the close of the estate tax inclusion period.
   (5) Applicability and effect
       (A)     In General – An individual
               (i) may elect to have this subsection not apply to
                    (I) an indirect skip, or
                    (II) any or all transfers made to a particular trust, and
               (ii) may elect to treat any trust as a GST trust
          (B) Elections
               (i) Election With Respect to Indirect Skips – shall be deemed to be timely if filed
                    on a timely filed gift tax return or on such later date or dates as may be pre-
                    scribed by the Secretary
               (ii) Other Elections – an election under clause (i)(II) or (ii) of subparagraph (A) may
                    be made on a timely filed gift tax return
(d) Retroactive Allocations
    (1) In General -
        (A) a non-skip person has an interest in a trust
        (B) such person
              (i) is a lineal descendant of a grandparent of (1) the transferor, or (2) the transferor’s
              spouse or former spouse;
              (ii) is assigned to a generation below the transferor, and
        (C) such person predeceases the transferor, then the transferor may make an allocation of
              any unused GST exemption to any previous transfer to the trust on a chronological
              basis
    (2) Special Rules – If the allocation is made on a gift tax return filed within the calendar year
        which the non-skip person’s death occurred
        (A) the value of such transfer shall be determined as if such allocation had been made on
              a timely filed gift tax return for calendar year within which transfer was made.
(e) Allocation of Unused GST Exemption
    (1) In General – GST exemption which has not been allocated shall be deemed to be allocated
        as follows -
        (A) first, a direct skip occurring at death


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         (B) second, to trusts with respect which a taxable distribution or a taxable termination
             might occur at or after death
     (2) Allocation Within Categories
         (A) In General – shall be made among the properties in proportion to the respective
             amounts of the nonexempt portions
         (B) Nonexempt Portion – means the value of the property or trust, multiplied by the in-
             clusion ratio

IMPORTANCE
Transferors must proactively make allocations to maximize the amount of wealth that they can trans-
fer for many generations’ estate- and gift-tax-free. If a transferor has never made allocations, the de-
fault allocation rules will many times protect the transferor’s wealth from the generation-skipping
transfer tax.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter D – GST Exemption
               §2631


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SUBCHAPTER E                                       APPLICABLE RATE, INCLUSION RATIO
§2641          APPLICABLE RATE

OVERVIEW
The GST tax-rate adjusts to reflect the percentage of each taxable transfer that is not exempt from
the GST. This “Applicable Rate” equals the maximum federal estate tax rate (§2001)-- 55% --
times the nonexempt percentage of assets transferred – the “inclusion ratio” (§2642). The 2005
Applicable Rate is 47%, the 2006 Applicable Rate is 46%, the 2007 to 2009 Applicable Rate is 45%,
the 2010 Applicable Rate is 0%, the 2011 to 2012 Applicable Rate is 35% and for 2013 and thereaf-
ter the Applicable Rate is 55%.

HR 1836 RELIEF Act of 2001

As the applicable estate tax rate (§2001) starts to decline in 2002, the applicable GST rule will also
decline at the same rate.

IMPORTANCE
Partially exempt transfers will always require payment of a generation-skipping tax. It is best to
avoid holding assets that are only partially exempt and to hold assets that are either completely ex-
empt or completely nonexempt. You can then focus on conserving and growing exempt assets while
making distributions (especially to non-skip persons) solely from non-exempt assets.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter A – Estates of Citizens or Residents
               Part I – Tax Imposed
                    §2001 – Imposition and Rate of Tax
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter E – Applicable Rate, Inclusion Ratio
                    §2642


§2642          INCLUSION RATIO

OVERVIEW
(a) Inclusion Ratio Defined
 (1) In General – The inclusion ratio shall be the excess (if any) of 1 over -
         (A) the applicable fraction for the trust, or
         (B) in the case of a direct skip, the applicable fraction for such skip
(2) Applicable Fraction
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        (A) the numerator is the amount of the GST exemption allocated to the trust (or in the
             case of a direct skip, allocated to the property), and
        (B) the denominator is –
             (i) the value of the property transferred, reduced by
             (ii) the sum of -
                   (I) any Federal or State death tax, and
                   (II) any charitable deduction allowed
(3) Severing of Trusts
        (A) In General – The trusts resulting shall be treated as separate trusts thereafter.
        (B) Qualified Severance
             (i) In General – means the division of a single trust and the creation of two or more
                   trusts if -
                   (I) divided on a fractional basis
                (II)     the new trusts provide for the same succession of interests of beneficiaries
             (ii) Trusts With Inclusion Ratio Greater than Zero – if less than 1, the trust receiving
                   such fractional share shall have an inclusion ratio of zero and the other trust
                   shall have an inclusion ratio of 1
             (iii) Regulations – “qualified severance” includes any other severance permitted un-
                   der regulations
        (C) Timing and Manner of Severances – A severance may be made at any time. The IRS
             shall prescribe by forms or regulations for reporting
(b) Valuation Rules, Etc.
    (1) Gifts for Which Gift Tax Return Filed or Deemed Allocation Made
        (A) the value of such property for purposes of subsection (a) shall be its value as finally
             determined for gift tax purposes, or its value at the time of the close of the estate tax
             inclusion period
    (2) Transfers and Allocation At or After Death
        (A) Transfers at Death – the value of such property shall be its value as finally determined
             for estate tax purposes
    (3) Allocations to Inter Vivos Transfers Not Made on Timely Filed Gift Tax Return
        (A) the value of such property shall be determined as of the time such allocation is filed
            with the IRS.
    (4) QTIP Trusts – the value of such property shall be its value for estate tax purposes

(c) Treatment of Certain Direct Skips , which are Nontaxable Gifts
    (1) In General – the inclusion ratio shall be zero
    (2) Exception for Certain Transfers in Trust – unless -
        (A) no portion of the corpus or income of the trust may be distributed to any other person
        (B) the assets will be includible in the gross estate
    (3) Nontaxable Gift
        (A) section 2503(b) ($10,000 annual exclusion)
        (B) section 2503(e) (tuition and medical exclusion)

(d) Special Rules Where More Than 1 Transfer Made to Trust

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     (1) In General – the applicable fraction for such trust shall be recomputed as of the time of
         such transfer
     (2) Applicable Fraction – the recomputed applicable fraction is a fraction
         (A) the numerator of which is the sum of –
              (i) GST exemption allocated to property, plus
              (ii) the non-tax portion, and
         (B) The denominator of which is the sum of -
              (i) the value of the property involved reduced by the sum of -
                   (I) any Federal estate tax or State death tax, and
                   (II) any charitable deduction allowed, and
              (ii) the value of all of the property in the trust (immediately before such transfer)
     (3) Non-tax portion – means the product of -
         (A) the value of all of the property in the trust, and
         (B) the applicable fraction in effect for such trust
     (4) Similar Recomputation in Case of Certain Late Allocations

The applicable fraction for such trust shall be computed as of the time of such allocation.

(e) Special Rules for Charitable Lead Annuity Trusts
    (1) In General – The applicable fraction shall be a fraction -
        (A) the numerator of which is the adjusted GST exemption, and
        (B) the denominator of which is the value of all of the property in such trust immediately
              after the termination of the charitable lead annuity.
    (2) Adjusted GST Exemption – Is an amount equal to the GST exemption allocated to the
        trust increased by interest determined -
        (A) at the interest rate used in determining the amount of the deduction under section
              2055 or 2522 for the charitable lead annuity
        (B) for the actual period of the charitable lead annuity
    (3) Definitions
        (A) Charitable Lead Annuity Trust – means any trust in which there is a charitable lead
              annuity
        (B) Charitable Lead Annuity – means any interest in the form of a guaranteed annuity
              with respect to which a deduction was allowed under section 2055 or 2522

(f) Special Rules for Certain Inter Vivos Transfers
    (1) In General – For purposes of determining the inclusion ratio,
        (A) an individual makes an inter vivos transfer of property, and
        (B) the value of such property would be includible in the gross estate of such individual,
             any allocation of GST exemption to such property shall not be made before the close
             of the estate tax inclusion period. If such transfer is a direct skip, such skip shall be
             treated as occurring as of the close of the estate tax inclusion period.
    (2) Valuation – The value of such property shall be -
        (A) if such property is includible in the gross estate of the transferor, its value for estate
             tax purposes, or

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          (B) its value as of the close of the estate tax inclusion period
     (3) Estate Tax Inclusion Period – means any period after the transfer during which the value of
     the property would be includible in the gross estate of the transferor. Such period shall in no
     event extend beyond the earlier of -
          (A) the date on which there is a generation-skipping transfer, or
          (B) the date of the death of the transferor

(g) Relief Provisions
    (1) Relief From Late Elections
         (A) In General – The IRS shall prescribe regulations under which extensions of time will
               be granted to make
               (i) an allocation of GST exemption, and
               (ii) an election under subsection (b)(3) or (c)(5) of section 2632
         (B) Basis for Determination – The IRS shall take into account all relevant circumstances
    (2) Substantial Compliance – An allocation of GST exemption that demonstrates an intent to
         have the lowest possible inclusion ratio shall be deemed to be an allocation of so much of
         the transferor’s unused exemption as produces the lowest possible inclusion ratio.

IMPORTANCE
Knowing when and how your clients must allocate the GST Exemption allows you to get the maxi-
mum leverage from the GST Exemption.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 12 – Gift Tax
          Subchapter A – Determination of Tax Liability
               §2503 – Taxable Gifts
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter E – Applicable Rate, Inclusion Ratio
               §2641


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SUBCHAPTER F                                    OTHER DEFINITIONS AND SPECIAL RULES
§2651           GENERATION ASSIGNMENT

OVERVIEW
Family transferees or beneficiaries are assigned to generations in relation to the transferor by their
relative degree of descent from the transferor’s grandparents. In-laws are assigned to generations in
relation to their relative degrees of descent from the grandparents of the transferor’s spouse. Spous-
es are automatically in the same generation as transferors. A spouse of a descendant is always as-
signed to the same generation as the descendant.

Non-family transferees or beneficiaries are assigned to generations lower than the transferor by
age relative to the transferor:

                        0 - 12.5 years younger............same generation as the transferor
                    12.5 – 37.5 years younger............1 generation younger than the transferor
                    37.5 – 62.5 years younger............2 generations younger than the transferor
                    62.5 – 87.5 years younger............3 generations younger than the transferor
                    87.5 – 112.5 year younger............4 generations younger than the transferor

The Predeceased Ancestor Rule allows family members to move up one generation with respect to
the transferor if their parent dies before the date of the transfer, so long as they are a lineal descend-
ant of the transferor (or the transferor’s spouse or former spouse).

IMPORTANCE
The first step in GST planning is to determine which of your clients’ beneficiaries are two or more
generations younger than your clients. Only transfers to these beneficiaries need protection from the
GST tax. You need not be concerned about the GST tax for transfers to anyone in your clients’ gen-
erations or one generation younger.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter F – Other Definitions and Special Rules
               §2652


§2652           OTHER DEFINITIONS

OVERVIEW
(a) Transferors are persons whose are the last persons to whom property has been includable for gift
or estate tax purposes. Except under §2652(a)(3) a Reverse QTIP election may be made to treat the
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deceased spouse as the transferor of a §2056(b)(7) or §2523(f) QTIP Trust. If a spouse elects to gift-
split under §2513, each spouse is a transferor of his or her respective share of the gift.

(b) Trust and Trustee – Life estates and remainders, estates for years, insurance and annuity con-
tracts are treated as trust arrangements and the person in constructive possession is treated as a trus-
tee.

(c) Interest - A person has an interest in property held in a trust if such person -

     (1) has a right to receive income or corpus from the trust, or
     (2) is a permissible current recipient of income or corpus, or
     (3) the trust is a CRT or pooled income fund.

The fact that a discretionary trust or UGMA or UTMA could be used to relieve a person of a support
obligation is disregarded in determining if such person has in interest in a trust.

(d) Executor – has the same meaning as §2203.

IMPORTANCE
All GST analysis begins by identifying the transferor. The transferor with respect to an asset can
change over time, thereby creating a new transferor for GST planning purposes (i.e., RQTP election
§2652(a)(3)).

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter E – Other Definitions and Special Rules
               §2651


§2653          TAXATION OF MULTIPLE SKIPS

OVERVIEW
Whenever a GST tax applies to a trust, the transferor moves down in generation-level to one genera-
tion older than the oldest trust beneficiary. Therefore, distributions to members of that oldest benefi-
ciary’s generation will not be subject to the GST tax again. The inclusion ratio of the trust will not
change unless a GST tax is paid.

IMPORTANCE
The GST Tax is imposed no more than once per generation. Section 2652 changes generation-
assignments to ensure that the tax does not apply more often than once per generation.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers

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          Subchapter E – Other Definitions and Special Rules
              §2651, 2652


§2654          SPECIAL RULES

OVERVIEW
(a) Basis Adjustments
    (1) A GST Step-Up in Basis occurs for that portion of transferred property subject to the GST
        tax (but not above the fair market value of such property).
    (2) Certain transfers (taxable terminations) at death get a §1014(a) basis adjustment multiplied
        by the inclusion ratio.

(b) The Separate Share Rule. A single trust is treated for tax purposes as separate trusts when the
trust has separate transferors or separate and independent beneficiary shares. Under no other cir-
cumstances can a single trust be divided into separate share trusts.

(c) Disclaimers: the rules of §2518 apply

(d) Special rules for limitations on personal liability of a trustee if GST tax is increased

IMPORTANCE
Trusts must be divided into separate shares before the GST Exemption is allocated to them to create
trusts with inclusion ratios of zero or one. After an allocation has been made to a partially GST-
exempt trust, it cannot later be divided into fully exempt and a fully nonexempt trusts.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter D – GST Exemption
               §2631, 2632


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SUBCHAPTER G                                                                 ADMINISTRATION
§2661               ADMINISTRATION

OVERVIEW
In general, all subtitle F gift tax rules of administration apply to inter vivos generation-skipping
transfers and all subtitle F estate tax rules apply to all testamentary generation-skipping transfers.

IMPORTANCE
In general, the same forms (706 & 709), filing deadlines, interest on underpayment, and penalties
apply to reporting GST tax liability that apply to gift or estate tax liabilities.

CROSS REFERENCE:
Subtitle F – Procedure and Administration
     Chapter 61 – Information and Returns
     Chapter 62 – Time and Place for Paying Tax
     Chapter 67 – Interest
     Chapter 68 - Penalties
§6001-6101, 6151-6161, 6601-6631, 6651-6751


§2662          RETURN REQUIREMENTS

OVERVIEW
Direct skips must be reported on or before the gift or estate tax return deadline. Taxable termina-
tions and distributions must be reported by April 15 of the year following the transfer. For Direct
Skips made in 2010 the report is due on or before 9 months after 12/17/2010.

IMPORTANCE
Reporting deadlines must be met to ensure timely allocation of the GST Exemption and to preclude
interest or penalties.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter F – Administration
               §2661




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§2663          REGULATIONS

OVERVIEW
Congress authorizes the IRS (“Secretary”) to promulgate rules to coordinate with chapter 11 and 12,
and to recapture generation-skipping transfer taxes under §2032A(c), and, among other things, non-
resident noncitizen transferors.

IMPORTANCE
You must look to Treasury regulations to know how transfers by nonresident, noncitizen transferors
are taxed (as well as farm valuation-reduction recaptures and the taxation of trust-equivalent ar-
rangements under §2032A(c)).

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 13 – Tax on Generation-Skipping Transfers
          Subchapter F – Administration
               §2661-2663


§2664          TERMINATION

OVERVIEW
HR 1836 RELIEF Act of 2001

This chapter shall not apply to generation-skipping transfers made after December 31, 2009.

IMPORTANCE
Chapter 13 Generation-Skipping Transfer Tax is repealed after 2009, but is reinstated after 2010 by
the sunset provision.

CROSS REFERENCE:
Subtitle B – Estate and Gift Taxes
     Chapter 11 – Estate Tax
          Subchapter C – Miscellaneous
               §2210 – Termination


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CHAPTER 14                                                       SPECIAL VALUATION RULES
§2701          SPECIAL VALUATION RULES IN CASE OF TRANSFERS OF CERTAIN INTERESTS TO
               CORPORATIONS OR PARTNERSHIPS

OVERVIEW
§2701 applies SOLELY for purposes of determining:

     (1) whether a transfer of an interest in a corporation or a partnership to or for the benefit of a
         member of transferors family is a gift;
     (2) the value of the transfer; and
     (3) the value of any applicable retained interest in a controlled entity with respect to any distri-
         bution rights, liquidation, put, call or conversion rights, retained by the transferor.

When the transfer of an interest in a controlled corporation or a controlled partnership is made to or
for the benefit of a lineal member of the transferor’s family, and the transferor has retained a pre-
ferred interest with income rights that are not determined by a fixed formula, the retained preferred
rights, although usually deductible from the value of the transfer in a non-familial setting, are valued
at zero.

IMPORTANCE
Despite the fact that the donor has retained valuable distribution or liquidation rights in the applica-
ble retained interests, the applicable retained interests are presumed to have no value and the interest
transferred is valued without regard to the applicable retained interest. Examples of preferred rights
or payments valued at zero are distribution rights puts, calls, conversion rights, and liquidation
rights. §2701 does not affect retained rights to common stock dividends or a junior class of equity.
This section effectively abolished family partnership and family corporation “freeze” strategies ac-
complished by recapitalizations establishing senior and junior classes of equity.

CROSS REFERENCE:
§2701 – Special Valuation of Transfers in Trusts
§2703 – Certain Rights and Restrictions Disregarded
§2704 – Treatment of Certain Lapsing Rights and Restrictions
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§2702           SPECIAL VALUATION RULES IN CASE OF TRANSFERS OF INTERESTS IN TRUSTS

OVERVIEW
(a) §2702 is applicable SOLELY for the purpose of determining:
    (1) whether a transfer of an interest in trust to or for the benefit of a member of the transferor’s
    family is a gift;
    (2) the value of such transfer; and
    (3) the value of any interest in such trust retained by the transferor or any applicable family
    member.
The value of any retained interest which:
     (1) is not a qualified interest shall be treated as zero
     (2) is a qualified interest shall be determined under IRC §7520
Exceptions:
     (1) incomplete gifts (i.e. revocable living trusts)
     (2) personal resident trust and qualified personal residence trusts
     (3) other transfers permitted by Treasury Regulations promulgated under §2702 (i.e. a tangible
         non-depreciable property GRIT)
(b) A Qualified Interest means:
    (1)   A GRAT (grantor retained annuity trust)
    (2)   A GRUT (grantor retained unitrust)
    (3)   A non-contingent remainder interest in a GRAT or GRUT
    (4)   QPRTs and PRTs, and
    (5)   Tangible Property Grantor Retained Income Trust (TP GRITs)

IMPORTANCE
Transfers to family members of common law, grantor retained income trusts (GRITS) were made
unattractive, but not illegal. Fixed payment retained annuity trusts and transfers of personal residenc-
es in trust with retained rights to live in the home for a period of years were granted. Specific statuto-
ry valuation discounts thereby made those transfers very attractive.

CROSS REFERENCE:
Subtitle A – Income Tax
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter J – Estates, Trusts, Beneficiaries, and Decedents
               Part E - Grantor
                    §673 – Reversionary Interests
                    §677 – Income for the Benefit of
Subtitle D – Miscellaneous Excise Taxes
     Chapter 77 – Miscellaneous Provisions        §7520 Valuation Tables

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§2703           CERTAIN RIGHTS AND RESTRICTIONS DISREGARDED

OVERVIEW
(a) For purposes of Subtitle B (Estate and Gift Taxes) – The value of property shall be determined
    without regards to:

    (1) Any option, agreement, or other right to acquire or use “The Property” for a price, which is
        less than FMV.
    (2) Any restriction on the right to sell or use “The Property.”

(b) Exceptions: Any option, right or agreement right or restriction which is:

    (1) a bona-fide business arrangement
    (2) is not a device to transfer property to a member of the decedent’s family for less than full
        and adequate consideration in money or money’s worth
    (3) under terms which are comparable to similar arrangements entered into by unrelated persons
        in arms length transactions

Property transferred between family members is to be valued without regard to options or agreements
to acquire at less than full, fair market value or restrictions on rights to sell. The purpose of this sec-
tion is to revalue at full value transfers among family members where restrictions on the property
would otherwise reduce the value unless it is a bona fide arrangement, not a mere device or is com-
parable to arms length transactions.

IMPORTANCE
The IRS has traditionally objected to valuation discounts for restricted intra-family buy-sell agree-
ments. This section permits discounts for such buy-sell agreements as long as all the exceptions stat-
ed in § 2703(b) are independently satisfied – Regulation 25. 2703 – (1)(b)(2) and the traditional buy-
sell requirements established by case law is present:

     (1) transfers during life are restricted;
     (2) the estate is obligated to sell at a pre-determined price; and
     (3) the pre-determined price is ascertainable from the written agreement.

CROSS REFERENCE:
§2701 – Special Valuation Rules in Transfers
§2704 – Certain Lapsing Rights and Restrictions

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§2704           TREATMENT OF CERTAIN LAPSING RIGHTS AND RESTRICTIONS

OVERVIEW
§2704(a)(1) – Creates a deemed transfer for Subtitle B Estate, Gift and GST Tax purposes; where
there is a lapse of voting rights or liquidation rights in a corporation or partnership, and the individu-
al who held the voting or liquidation rights that lapsed and members of his or her family control the
entity both before and after the lapse.

§2704(a)(2) – Fixes the value of the deemed transfer as the difference between the before and after
values i.e. value before the lapse (as if non-lapsing) minus the value after the lapse equal the value of
the deemed transfer.

§2704(b)(1) – Disregards “Applicable Restrictions” on liquidation of an entity for Subtitle B Estate,
Gift and GST Tax valuation purposes if:

     (1) there is a transfer of an interest in an entity to or for the benefit of a member of the transfer-
         ors family, and
     (2) the transferor and members of his or her family hold control of the entity before the transfer.

§2704(b)(2) – Defines the term “Applicable Restriction” on liquidation as any restrictions:

     (1) which effectively limits the ability of the entity to liquidate, and
     (2) which either (i) lapses, in whole or in part after the transfer to a family member, or (ii) the
         transferor or family member either alone or collectively has the right after the transfer to
         remove, in whole or in part the restriction.

§2704(b)(3) – Provides several exceptions to the term “Applicable Restriction.”

     (1) commercially reasonable restrictions under a financing arrangement with unrelated parties
     (2) restrictions imposed by any federal or state law

IMPORTANCE
§2704(a) - Is also knick-named the “Anti-Harrison Rule.” In the Harrison case, Mr. Harrison pos-
sessed certain voting rights that allowed him to cause his family limited partnership to liquidate.
Upon his death the rights had lapsed. As a result his estate qualified for almost a 50% discount in
valuing his limited partnership interest. §2704(a) was intended to eliminate this result.

§2704(b) – The majority of states that have adopted the Revised Uniform Limited Partnership Act
have adopted the provision that requires the affirmation vote of 100% of all partners to liquidate the
partnership. If a limited partnership is formed in any of these states that require a unanimous vote to
liquidate, adopts a provision in its partnership agreement that requires unanimous voting to liquidate,
such a provision is not an “Applicable Restriction,” because this restriction on liquidation is re-
quired by state law. On the other hand, if a limited partnership is formed in a state that requires a
majority vote to liquidate adopts a unanimous vote to liquidate provisions in its partnership agree-

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ment, this is an “Applicable Restriction” because this restriction goes beyond the restrictions re-
quired by state law. §2704(b) does not prohibit this restriction, it only says for valuation purposes
the evaluator must ignore this “Applicable Restriction” on liquidation and value the partnership as if
the agreement only provided for majority voting to liquidate.

CROSS REFERENCE:
§2701 – Special Valuation Rules in Transfers
§2703 – Certain Rights and Restrictions Disregarded
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CHAPTER 79                                                                           DEFINITIONS
§7701         DEFINITIONS

OVERVIEW
(a) When used in this title (Title 26 Internal Revenue Code), where not otherwise distinctly ex-
    pressed or manifestly incompatible with the intent thereof –

   (1) Person – The term “person” shall be construed to mean and include an individual, a trust, es-
       tate, partnership, association, company or corporation.

   (2) Partnership and Partner – The term ”partnership” includes a syndicate, group, pool, joint ven-
       ture, or other unincorporated organization, through or by means of which any business, fi-
       nancial operation, or venture is carried on, and which is not, within the meaning of this title,
       a trust or estate or a corporation; and the term “partner” includes a member in such a syndi-
       cate, group, pool, joint venture, or organization. (Cross Reference to §761)

   (3) Corporation – The term “corporation” includes associations, joint-stock companies, and in-
       surance companies.

   (4) Domestic – The term “domestic” when applied to a corporation or partnership means created
       or organized in the United States or under the law of the United States or of any State unless,
       in the case of a partnership, the Secretary provides otherwise by regulations.

   (5) Foreign – The term “foreign” when applied to a corporation or partnership means a corpora-
       tions or partnership which is not domestic.

   (6) Fiduciary – The term “fiduciary” means a guardian, trustee, executor, administrator, receiver,
       conservator, or any person acting in any fiduciary capacity for any person.

   (7) Stock – The term “stock” includes shares in an association, joint-stock company, or insur-
       ance company.

   (8) Shareholder – The term “shareholder” includes a member in an association, joint-stock com-
       pany, or insurance company.

   (9) United States – The term “United States” when used in a geographical sense includes only
       the States and the District of Columbia.

   (10) State – The term “State” shall be construed to include the District of Columbia, where

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   such construction is necessary to carry out provisions of this title.

(11) Secretary of the Treasury and Secretary –
     (A) Secretary of the Treasury – The term “Secretary of the Treasury” means the Secretary
         of the Treasury, personally, and shall not include any delegate of his.
     (B) Secretary – The term “Secretary” means the Secretary of the Treasury or his delegate.

(12) Delegate –
     (A) In General – The term “or his delegate” –
       (i) means any officer, employee, or agency of the Treasury Department duly authorized
           by the Secretary of the Treasury directly, or indirectly by one or more redelegations
           of authority, to perform the function mentioned or described in the context.

(13) Commissioner – The term “Commissioner” means the Commissioner of Internal Revenue.

(14) Taxpayer – The term “taxpayer” means any person subject to any internal revenue tax.

(15) Military and Navel Forces

(16) WITHHOLDING AGENT - The term "withholding agent" means any person required to deduct and with-
    hold any tax under the provisions of section 1441, 1442, 1443, or 1461.

(17) Husband and Wife – If the husband and wife therein referred to are divorced, wherever ap-
    propriate to the meaning of such sections, the term “wife” shall be read “former wife” and
    the term “husband” shall be read “former husband”; and, if the payments described in such
    section are made by or on behalf of the wife or former wife to the husband or former hus-
    band instead of vice versa, wherever appropriate to the meaning of such sections, the term
    “husband” shall be read “wife” and the term “wife” shall be read “husband.”

(18) Employee – For the purpose of applying the provisions of section 79 with respect to group-
    term life insurance purchased for employees, for the purpose of applying the provisions of
    sections 104, 105, and 106 with respect to accident and health insurance or accident and
    health plans, and for the purpose of applying the provisions of subtitle A with respect to con-
    tributions to or under a stock bonus, pension, profit-sharing, or annuity plan, and with re-
    spect to distributions under such a plan, or by a trust forming part of such a plan, and for
    purposes of applying section 125 with respect to cafeteria plans, the term “employee” shall
    include a full-time life insurance salesman who is considered an employee for the purpose of
    chapter 21, or in the case of services performed before January 1, 1951, who would be con-
    sidered an employee of his services were performed during 1951.

(19) Levy – The term “levy” includes the power of distraint and seizure by any means.

(20) Attorney General – The term “Attorney General” means the Attorney General of the Unit-
    ed States.

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(21) Taxable Year – The term “taxable year” means the calendar year, or the fiscal year ending
    during such calendar year, upon the basis of which the taxable income is computed under
    subtitle A. “Taxable year”, means, in the case of a return made for a fractional part of a year
    under the provisions of subtitle A or under regulations prescribed by the Secretary, the peri-
    od for which such return is made.

(22) Fiscal Year – The term “fiscal year” means an accounting period of 12 months ending on
    the last day of any month other than December.

(23) Paid or Incurred, Paid or Accrued – The terms “paid or incurred” and “paid or accrued”
    shall be construed according to the method of accounting upon the basis of which the taxable
    income is computed under subtitle A.

(24) Trade or Business – The term “trade or business” includes the performance of the func-
    tions of a public office.

(25) Tax Court – The term “Tax Court” means the United States Tax Court.

(26) Other Terms – Any term used in this subtitle with respect to the application of, or in con-
    nection with, the provisions of any other subtitle of this title shall have the same meaning as
    in such provisions.

(27) Internal Revenue Code – The term “Internal Revenue Code of 1986” means this title, and
    the term “Internal Revenue Code of 1939” means the Internal Revenue Code enacted Febru-
    ary 10, 1939, as amended.

(28) United States Person – The term “United States person” means –
     (A) a citizen or resident of the United States,
     (B) a domestic partnership,
     (C) a domestic corporation,
     (D) any estate (other than a foreign estate, within the meaning of paragraph (31)), and
     (E) any trust if –
          (i) a court within the United States is able to exercise primary supervision over the
               administration of the trust, and
          (ii)    one or more United States persons have the authority to control all substantial
                  decisions of the trust.

(29) Foreign Estate or Trust –
     (A) Foreign Estate – the term “foreign estate” means an estate the income of which, from
         sources without the United States which is not effectively connected with the conduct
         of a trade or business within the United States, is not includible in gross income under
         subtitle A.
     (B) Foreign Trust – The term “foreign trust” means any trust other than a trust described in
         paragraph (E) of paragraph (30).

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     (28) Individual Retirement Plan – The term “individual retirement plan” means –
          (A) an individual retirement account described in section 408(a), and
          (B) an individual retirement annuity described in section 408(b)

     (29)Joint Return – The term “joint return” means a single return made jointly under section
         6013 by a husband and wife.

     (30)Persons Residing Outside United States – If any citizen or resident of the United States
         does not reside in (and is not found in) any United States judicial district, such citizen or
         resident shall be treated as residing in the District of Columbia for purposes of any provi-
         sion of this title relating to –
         (A) Jurisdiction of courts, or
         (B) enforcement of summons

     (31) Indian Tribal Government -
          (A) Special rule for Alaska Natives – No determination under subparagraph (A) with re-
              spect to Alaska Natives shall grant or defer any status or powers other than those
              enumerated under section 7871. Nothing in the Indian Tribal Governmental Tax
              Status Act of 1982, or in the amendments made thereby, shall validate or invalidate
              any claim by Alaska Natives of sovereign authority over lands or people.

    (32)     TIN – The term “TIN” means the identifying number assigned to a person under section

    (33)     Substituted Basis Property – The term “substituted basis property” means property is –
           (A) transferred basis property, or
           (B) exchanged basis property

     (47) Executor – The term “executor” means the executor or administrator of the decedent, or,
         if there is no executor or administrator appointed, qualified, and acting within the United
         States, then any person in actual or constructive possession of any property of the dece-
         dent. (Cross Reference to § 2203)

(b) Definition of Resident Alien and Nonresident Alien -

   (A) Resident Alien – An alien individual shall be treated as a resident of the United States with
       respect to any calendar year if (and only if) such individual meets the requirements of clause
       (i), (ii), or (iii):
             (i) Lawfully Admitted for Permanent Residence – Such individual is a lawful perma-
                       nent resident of the United States at any time during such calendar year.
             (ii) Substantial Presence Test – Such individual meets the substantial presence test of
                       paragraph (3).
             (iii) First Year Election – Such individual makes the election provided in paragraph (4).


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   (B) Nonresident Alien – An individual is a nonresident alien if such individual is neither a citizen
       of the United States nor a resident of the United States (within the meaning of subparagraph
       (A)).

IMPORTANCE
It is important for an estate planner to know how certain terms are defined in the Internal Revenue
Code. Chapter 79 is the Internal Revenue Code dictionary.

By understanding these special IRC terms, one can better understand the individual code sections.

CROSS REFERENCE:


§7702           LIFE INSURANCE CONTRACT DEFINED

OVERVIEW
(a) General Rule – For purposes of this title, the term “life insurance contract” means any contract
    which is a life insurance contract under the applicable law, but only if such contract –
    (1) meets the cash value accumulation test of subsection (b), or
    (2A) meets the guideline premium requirements of subsection (c), and
    (2B) falls within the cash value corridor of subsection (d).

IMPORTANCE
Informational


§7702A          MODIFIED ENDOWMENT CONTRACT DEFINED

OVERVIEW
(a) General Rule – For purposes of section 72, the term “modified endowment contract” means any
    contract meeting the requirements of section 7702 –
      (1) which –
            (A) is entered into on or after June 21, 1988, and
            (B) fails to meet the 7-pay test of subsection (b), or
      (2) which is received in exchange for a contract described in paragraph (1) of this paragraph.

(b) 7-Pay Test – For purposes of subsection (a), a contract fails to meet the 7-pay test of this subsec-
    tion if the accumulated amount paid under the contract at any time during the 1st 7 contract years
    exceeds the sum of the net level premiums which would have been paid on or before such time if
    the contract provided for paid-up future benefits after the payment of 7 level annual premiums.

IMPORTANCE
Informational



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§7703           DETERMINATION OF MARITAL STATUS

OVERVIEW
(a) General Rule – For purposes of part v of subchapter B of chapter 1 and those provisions of this
    title which refer to this subsection –
       (1) the determination of whether an individual is married shall be made as of the close of his
           taxable year; except that if his spouse dies during his taxable year such determination shall
           be made as of the time of such death; and
       (2) an individual legally separated from his spouse under a decree of divorce or of separate
           maintenance shall be not considered as married.

(b) CERTAIN MARRIED INDIVIDUALS LIVING APART

For purposes of those provisions of this title which refer to this subsection,
if--
     (1) an individual who is married (within the meaning of subsection (a)) and who files a
        separate return maintains as his home a household which constitutes for more than
        one-half of the taxable year the principal place of abode of a child (within the mean-
        ing of section 151(f)(1)) with respect to whom such individual is entitled to a deduc-
        tion for the taxable year under section 151 (or would be so entitled but for section
        152(e)),

     (2) such individual furnishes over one-half of the cost of maintaining such household
        during the taxable year, and

     (3) during the last 6 months of the taxable year, such individual's spouse is not a mem-
        ber of such household,


     such individual shall not be considered as married.


IMPORTANCE
Informational


§7704           CERTAIN PUBLICLY TRADED PARTNERSHIPS TREATED AS CORPORATIONS

OVERVIEW
(a) General Rule – For purposes of this title, except as provided in subsection (c), a publicly traded
    partnership shall be treated as a corporation.

(b) Publicly Traded Partnership – For purposes of this section, the term “publicly traded partnership’
    means any partnership if –
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   (1) interests in such partnership are traded on an established securities market, or
   (2) interests in such partnership are readily tradable on a secondary market (or the substantial
       equivalent thereof).

(c) Exception for Partnerships with Passive-Type Income

(d) Qualifying Income –

     (1) In General – The term “qualifying income” means –
           (A) interest,
           (B) dividends,
           (C) real property rents,
           (D) gain from the sale or other disposition of real property (including property described
               in section 1221(1)).

IMPORTANCE
Informational


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CHAPTER 80                                                          GENERAL RULES
SUBCHAPTER A                                APPLICATION OF INTERNAL REVENUE LAWS
§7801           AUTHORITY OF DEPARTMENT OF THE TREASURY

OVERVIEW
(a) (1)      Powers and Duties of Secretary – Except as otherwise expressly provided by law, the
       administration and enforcement of this title shall be performed by or under the supervision of
       the Secretary of the Treasury.

(2) ADMINISTRATION AND ENFORCEMENT OF CERTAIN PROVISIONS BYTHE AT-
    TORNEY GENERAL

[(b) Repealed.]

(c)   Functions of Department of Justice Unaffected – Nothing in this section or section 301(f) of
      title 31 shall be considered to affect the duties, powers, or functions imposed upon, or vested
      in, the Department of Justice, or any officer thereof, by law existing on May 10, 1934.

IMPORTANCE
Informational


§7805           RULES AND REGULATIONS

OVERVIEW
(a) Authorization – Except where such authority is expressly given by this title to any person other
than an officer or employee of the Treasury Department, the Secretary shall prescribe all needful
rules and regulations for the enforcement of this title, including all rules and regulations as may be
necessary by reason of any alteration of law in relation to internal revenue.

(b)    Retroactivity of Regulations -
       (1) In General – Except as otherwise provided in this subsection, no temporary, proposed, or
final regulation relating to the internal revenue laws shall apply to any taxable period ending before
the earliest of the following dates:
             (A) The date on which such regulation is filed with the Federal Register.
             (B) In the case of any final regulation, the date on which any proposed or temporary
regulation to which such final regulation relates was filed with the Federal Register.
             (C) The date on which any notice substantially describing the expected contents of any
temporary, proposed, or final regulation is issued to the public.
       (2) Exception for Promptly Issued Regulations – Paragraph (1) shall not apply to regulations

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filed or issued within 18 months of the date of the enactment of the statutory provision to which the
regulation relates.
       (3) Prevention of Abuse -
       (4) Correction of Procedural Defects -
       (5) Internal Regulations -
       (6) Congressional Authorization -
       (7) Election to Apply Retroactively –The Secretary may provide for any taxpayer to elect to
apply any regulation before the dates specified in paragraph (1).
       (8) Application to Rulings – The Secretary may prescribe the extent, if any, to which any
ruling (including any judicial decision or any administrative determination other than by regulation)
relating to the internal revenue laws shall be applied without retroactive effect.

(c)   Preparation and Distribution of Regulations, Forms, Stamps, and Other Matters -

(d)   Manner of Making Elections Prescribed by Secretary -

(e)   Temporary Regulations -
      (1) Issuance -
      (2) 3-year Duration -

(f)   Review of Impact of Regulations on Small Business -
      (1) Submissions to Small Business Administration -
      (2) Consideration of Comments -
      (3) Submission of Certain Final Regulations -


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SUBCHAPTER C                     PROVISIONS AFFECTING MORE THAN ONE SUBTITLE
§7872          TREATMENT OF LOANS WITH BELOW-MARKET INTEREST RATES

OVERVIEW
(a) Treatment of Gift Loans and Demand Loans
    (1) For purposes of Title 26 IRC, in the case of any below-market loan which is a gift loan or a
        demand loan, the forgone interest shall be treated as –
        (A) Transferred from the lender to the borrower, and
        (B) Retransferred by the borrower back to the lender as interest paid on the last day of the
            calendar year.

A gift loan is any below-market loan where the foregoing of interest is in the nature of a gift.

A below-market rate of interest is an interest rate that is below the Applicable Federal Rate (AFR)
depending upon the type of loan made:

Term Loans – Term loans must use the IRC §1274(d) AFR, for the appropriate term, in effect as of
the day the loan was made, compounded semi-annually.

Demand Loans – Demand loans must use the IRC §1274(d) short-term AFR for the period for which
the loan was made, compounded semi-annually.

§7872(c)(2) contains an exception for deminimis loans where all loans from one individual to anoth-
er total less than $10,000.

§7872(d) contains some special rules for loans, which are over $10,000 but less than $100,000.

§7872(i) authorizes IRS to promulgate regulations.

Reg. §1.7872-5T contains some special rules for “Exempt Loans” which do not have a significant
effect on the federal tax liability of the borrower or the lender.




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IMPORTANCE
Estate planners need to know the special imputed interest rate rules for our clients who loan money
to family members and friends.

CROSS REFERENCE
Subtitle A – Income Taxes
     Chapter 1 – Normal Taxes & Surtaxes
          Subchapter P – Capital Gains and Losses
               Part V – Special Rules for Bonds and Other Debt Instruments
                    §1274 – Determining the Issue Price in Case of Certain Debt Instrument Issued
                             for Property
                    §1274(d) – Determination of Applicable Federal Rate




                                               164                      ©2008 WealthCounsel, LLC

				
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