CHAPTER 18 -- FAMILY TAX PLANNING
Based on West Federal Taxation, Corporations, Partnerships, Estates, & Trusts, 2001 ed.
I. VALUATION CONCEPTS
A. VALUATION IN GENERAL p.18-2
1. Cash or equivalent - not a problem to determine value.
2. Stocks & securities when no sales price info is available – IRC says to use the value of stock or
securities of corporations engaged in the same or similar line of business which are listed on an
exchange. (This is risky.)
3. FMV is defined as the price a willing buyer would pay and a willing seller would accept for property
when neither is under compulsion to trade and both have relevant knowledge.
4. Sentiment is not important in determining value.
5. Also consider location and availability of asset.
B. VALUATION OF SPECIFIC ASSETS p.18-3
1. Stocks and Bonds – If that day’s info is not available, use the mean value between the closest prior
sale and the closest subsequent sale. (Careful – Use the inverse weighted average of sales price.)
2. Notes Receivable – FMV is the unpaid principal plus interest accrued to the valuation date. Some
wiggle room is available with distant maturity date or lower interest rate on note.
3. Insurance Policies and Annuity Contracts – Use when the decedent owns a life insurance policy on
someone else’s life. FMV is the cost of a comparable policy at the date of the decedent’s death.
4. Life Estates, Terms for Years, Reversions, and Remainders – Tables for life estates / remainder
interests change every 10 years.
PROBLEMS 32, 33
C. REAL ESTATE AND THE SPECIAL USE VALUATION METHOD p.18-6
1. Real estate must be valued at its most suitable (or highest) use.
2. Executors sometimes may elect the “special use value” (or current value) for farm land or land used in
a family business but cannot realize a benefit of more than $770,000 (for 2000) in reduced gross
3. Special use valuation election available if all these req’ts are met:
a. 50% or > of gross estate consists of real or personal property in qualifying use.
b. 25% or > of gross estate consists of real property in qualifying use (use most suitable use
c. Qualifying property must pass to a qualifying heir.
d. Real property owned by decedent or family 5 out of 8 years prior to death.
e. Decedent or member of family materially participated in operation during said 5 year period.
NOTE: If heir disposes of property within the next 10 years after death, recapture tax may be due.
D. VALUATION PROBLEMS WITH A CLOSELY HELD BUSINESS p.18-7
1. General Guidelines – Difficult to value closely held business interests. See list of factors on p. 18-7
2. Goodwill Aspects – If past years earnings are higher than usual, IRS will find goodwill as an asset.
Possible to argue for lower valuation amounts by focusing on:
a. Average profit is not typical – profit not likely to repeat itself in the future. Must give a
b. IRS is not using appropriate rate of return for this business.
c. Decedent was the key to the success of this organization.
3. Other Factors (that may lead to a discount of the value of the stock)
a. Minority interest owned by decedent? (Majority / controlling interest may mean a premium.)
b. Decedent own so much stock that he can’t find a buyer?
c. Poor-dividend paying record of corporation?
d. Lack of marketability of stock?
e. Will a large amount of income taxes be due on the sale of the stock?
4. Resolving the Valuation Problem for Stock in Closely Held Corporations – Big problem exists in
making a self determination on the value of stock for gift purposes to relatives and having the IRS
make a different determination on the value of that same stock. Taxpayer can sometimes use a hedge
by giving some of the stock to a charity and using the same valuation amount as used for the gift to
5. Buy-Sell Agreement and Valuation – Looking for certainty in transferring business interests. Two
a. Entity – Entity agrees to buy the shares of deceased or withdrawing shareholder at a
predetermined price per share. That price per share will control for estate tax purposes.
b. Cross-purchase – The surviving owners agree to buy out the withdrawing or deceased owner
at a predetermined price per share. That price per share will control for estate tax purposes.
NOTE: These options are available for unrelated parties and only when a formal written agreement
exists before the death or withdrawing occurs.
6. Estate Freezes -- Corporations – (closely held)
a. Taxpayer wants to transfer wealth to heirs but retain ownership of the asset while escaping
estate tax, gift tax, and income tax. One (highly flawed) method refers to conveying his
common stock to his heirs and retaining preferred stock. Problem: Transfer (while escaping
some estate tax) will incur gift tax on whole value of the business not just what is
b. “Estate freeze” means that the estate tax (or gift taxes) owed on the common stock is
determined at the time of the transfer. Any appreciation in the value of the stock is not
subject to estate or gift tax. PROBLEM: The value of the preferred stock (which has
already been subjected to gift tax at time of the transfer (i.e., whole business value is taxed)
is also subject to estate tax at the time of death.
PROBLEMS 38, 39
7. Estate Freezes -- Partnerships
a. Taxpayer sets up a Family Limited Partnership (FLP) with himself as a general partner and
his heirs as limited partners.
b. Title to the property to be passed to the next generation must be conveyed to the FLP.
c. Taxpayer begins to make gifts of the partnership interests to his heirs.
d. Big benefit – The value of the interests he transfers are discounted because they represent a
minority interest and there is no one else wants to own them (lack of marketability).
e. FOCUS ON: Value of the partnership interest being transferred.
II. INCOME TAX CONCEPTS
A. BASIS OF PROPERTY ACQUIRED BY GIFT p.18-14
1. If given between 1920 and 1976, donee’s basis is the lesser of:
a. Donor’s basis plus gift tax paid on transfer OR
b. FMV on date of gift.
2. If given after 1976,
a. Donee’s GAIN basis is donor’s basis plus gift tax attributed to appreciation of property up
until gift is made.
b. Donee’s LOSS basis is the lesser of:
(1) Donee’s gain basis OR
(2) FMV of property on date of gift.
3. Holding period for donee includes donor’s holding period.
B. BASIS OF PROPERTY ACQUIRED BY DEATH p.18-15
1. General Rule – Basis for the beneficiary is the FMV of the property at date of death (or AVD if
a. Stepped-up basis – Any appreciation realized on asset escapes income tax for the beneficiary.
b. Stepped-down basis – Any loss realized on asset is not allowed a deduction on tax return.
c. Holding period for assets acquired due to a death is automatically long term.
2. Community Property – For separate property passing to the surviving spouse (SS), the SS’s ½ of the
community takes the same basis as ½ included in the deceased spouse’s gross estate. SS gets the
same result as if she received all the property through the estate in a community property state.
3. Step-up in Basis and the One-Year Rule – Normally, a beneficiary will receive the benefit of the
stepped-up basis for property received from decedent through his estate. Exception: Receipt of the
property is treated as a gift if:
a. Decedent owned the property less than one year from his date of death AND
b. Received the property from the now beneficiary or his spouse.
PROBLEMS 42, 43
4. Income in Respect of a Decedent (IRD) – Income earned by the decedent prior to death but not
reported on the estate’s final income tax return. Examples include: distributions from retirement
plans, IRAs, unpaid installment pymts, accumulated interest and dividends, lottery winnings, deferred
a. IRD included in gross estate at its FMV on either PVD or AVD.
b. Neither stepped-up or stepped-down basis is used.
c. Recipient of IRD must classify it the same way the decedent would if living.
5. How Conclusive is the Value Used for Estate Tax Purposes – Pretty conclusive.
III. GIFT PLANNING
A. MINIMIZING GIFT TAXES p.18-19
1. Start a lifetime giving program to reduce the estate by using the $10,000 annual exclusion. A
married taxpayer may also use a split-gift giving program.
2. If real estate is the subject of the gift, partial interests may be used to transfer the property out, but this
method may several years to complete depending on the property value and the number of donees.
3. If real estate is suspected of having a high value, obtain a written formal appraisal so that the values
used in the calculations will have supporting documentation.
B. MINIMIZING ESTATE TAXES p.18-20
As a general rule, no difference in taxes will be realized by transferring property before death versus after
death; however, pre-death transfers should be considered for the following reasons:
1. Avoiding a Transfer Tax on Future Appreciation – By giving property now, no estate tax will be owed
on the growth of the money or the asset’s worth.
2. Preparing for the Special Use Valuation Method – Pre-death gifts could reduce the size of
non-business assets so that the estate qualifies for the special use valuation. Must be outside the 3
year window to realize the benefits of a pre-death gift.
3. Avoiding State Transfer Taxes – Most states do not have a state gift tax. If property is given away
prior to death, then only federal gift taxes would be owed. If property is transferred after death, then
federal and state estate taxes may be due.
4. Effect of Gift Taxes Paid – Must consider if the donor may need the assets prior to death to maintain
his lifestyle or for his care.
C. INCOME TAX CONSIDERATIONS p.18-22
1. Income Shifting – To shift the income to the donee, the donor must give a complete gift and must give
the donee some economic benefit not merely liability.
2. Income Tax Consequences to the Donor – Generally, a gift of property results in no income tax
consequences to the donor. Two exceptions:
a. Gift of an installment note receivable
(1) Donor is treated as having sold the note at its FMV; therefore, he must recognize a
gain on the gift.
(2) If note passed at death, collector of note is charged with the income (estate or heirs).
b. Gift of a U. S. Savings Bond
(1) Must be re-registered in donee’s name which means that donor must recognize any
deferred income from bond (cannot postpone recognition until bond matures).
3. Carryover Basis Situations
a. With appreciated property, preferable to inherit instead of receiving by gift.
b. With depreciated property, preferable to sell first then give the proceeds so as to retain the
capital loss to offset capital gains and ordinary income up to $3,000 per year.
IV. ESTATE PLANNING
A. PROBATE COSTS p.18-24
1. Probate estate -- All property subject to administration by the estate executor.
2. Probate costs -- Include attorney's & accountant's fees, appraisal and inventory fees, court cots, and
expenses due to disposing of assets and paying debts.
3. Problem with probate is the length of time before an heir can be assured of ownership of the property,
taking from 6 months to several years. To reduce probate estate and costs, take these steps before
a. Sell any real estate located outside home state (otherwise must probate twice)
b. Own property with a right of survivorship
c. Make life insurance, IRAs, & retirement plans payable to a beneficiary
d. Use a revocable trust (I suggest this option as a last resort.)
B. CONTROLLING THE AMOUNT OF THE GROSS ESTATE p.18-25
1. Gross estate determines whether any estate taxes will be owed.
2. Consider using the special use valuation method if family business or farm is involved.
3. Consider using the alternative valuation date if property declines in value after death.
C. PROPER HANDLING OF ESTATE TAX DEDUCTIONS p.18-25
To pay as little in taxes as possible, taxpayer must reduce his assets and / or increase his possible deductions.
1. Approaches to the Marital Deduction -- Two major goals in planning:
a. Equalization -- Adjust the value of each spouse's estate to maximize their lifetime credit.
b. Deferral -- Postpone estate taxation as long as possible.
2. The Marital Deduction -- Sophistication of the Deferral Approach
A good estate plan is likely to have both an equalization and a deferral approach to eliminate estate
taxes. Disclaimers are also options in dealing with marital deductions.
3. Effectively Working with the Charitable Deduction -- More benefits are usually available with
lifetime charitable contributions as opposed to testamentary bequests.
a. Lifetime giving -- Allows taxpayer to take an income tax deduction for the amount of the
contribution, shrink his gross estate by the contribution amount, and reduce potential estate
b. Testamentary bequest -- Taxpayer includes the bequest in his gross estate but receives an
offsetting charitable deduction. Taxpayer's estate receives no income tax deduction for
c. In order for the estate to receive a charitable deduction, the designated recipient must meet
the guidelines for a charity at the time of death. If a will designates a charity as a
(1) Build in a safety net which conditions the receipt of funds on its having a charitable
status at the time of death.
(2) Give executor authority to substitute a qualified beneficiary for a non-qualified one.
4. Proper Handling of Other Deductions and Lossess Under §§2053 and 2054 -- With certain limits,
taxpayer can use an income tax deduction or an estate tax deduction or a combination of the two.
D. PROVIDING ESTATE LIQUIDITY p. 18-29
1. Recognizing the Problem -- Must have sufficient cash or cash equivalents to pay taxes and make
a. Analyze the assets of an estate.
b. Should life insurance be purchased to provide extra cash.
c. Have a will.
d. Consider negotiating with IRS for extension of time to pay tax.
2. Discretionary Extension of Time to Pay Estate Taxes -- §6161
Executor may receive an extension of up to 10 years to pay taxes if he receives approval from the IRS
based upon "reasonable cause."
3. Extension of Time When the Estate Consists Largely of an Interest in a Closely Held Business §6166
a. IRS is required to accept a 15 payment plan beginning before the fifth anniversary of death.
b. Gross estate must consist of 35% value from closely held business.