FEDERAL ESTATE AND GIFT TAX OUTLINE Professor Popovich – Fall 2007 GIFT TAX GROSS GIFT Fair Market Value of Property Transferred by Gift Issues: Receipt of adequate and full consideration in “money or money’s worth” What constitutes “property?” “Complete” and “Incomplete” transfers Disclaimers Minus EXCLUSIONS § 2503(b) – Annual exclusion § 2503(e) – Certain educational and medical expenses paid by donor § 2518 – Disclaimers (see above) Minus DEDUCTIONS §2522 – Charitable gifts §2523 – Gifts to spouse (Marital deduction) Equals TAXABLE GIFTS Apply Rates For Computation in § 2502 using rates in § 2001 (new rate schedule in § 2502 starting in Tentative Gift Tax 2010) -Computation is more complex if donor made taxable gifts in prior years. Minus TAX CREDITS § 2505 – Unified credit (see handout chart) Equals GIFT TAX LIABILITY Gross Gift -§ 2512(b) GIFT is “where property is transferred for less than adequate and full consideration in money or money’s worth. -§ 2511 Gift tax only applies to transfers of property (not services), direct or indirect, tangible or intangible (stocks). -For Split Gifts (Life Estate/Remainder) use table to determine value at time gift is completed. -Someone doing my taxes for me would not be gift (more of a service)…actual document still not gift. -Child support is a legal obligation so not gift. You have a legal obligation to provide support for your child until he turns 18. No obligation to provide support for adult offspring. o IRS often doesn’t involve themselves in family matters like adult son living at home. o What about extravagant gifts to child? -A loan without repayment at FMV interest rate is a gift. If paying less than market rate, the deficiency is a gift. Completeness of Gift Gift is complete when Grantor relinquishes sufficient DOMINION and CONTROL over its disposition. Powers of Dominion and Control Affecting Completeness: RETAINED POWER COMPLETENESS of GIFT ARTIFICIAL INCLUSION in ESTATE Power to Revoke Incomplete Included Power to Change Beneficiaries Incomplete Included Power to Allocate Among Named Beneficiaries Incomplete Included Power to Make Changes in Conjunction w/3rd Party W/OUT Adverse Interest Incomplete Included (Adv. Interest N/A) Power to Affect Time and Manner of Enjoyment Complete Included Power to Administer/Manage Trust Complete Not Included Power to Make Changes in Conjunction w/3rd Party WITH Adverse Interest Complete Included (Adv. Interest N/A) -Split in JXD’s: GR is permissible beneficiary (TE has discretion to make payments to GR) o AND State allows creditors access to trust to the extent accessible to GR. -Power to Revoke o MAJ (incl. CA): Trust (∆) is silent as to Power to Revoke = Revocable ∆ (incomplete gift). o MIN: ∆ is silent as to Power to Revoke = Irrevocable ∆ (complete gift). On EXAM, if terms are silent as to Power to Revoke, discuss both approaches! -Checks from Donor. o General RULE: Mere delivery of check not sufficient for complete gift. It can still be revoked or cancelled and is complete when it clears. EXCEPTIONS: • Charitable Donations • Gifts given after Jan. 1 relate back to previous year if: o Check was given w/intent to give gift in previous year, o Unconditional delivery to donee, o Donee deposited check within previous calendar year, o Within reasonable time of issuance. -Power Retained by Independent 3rd Party – Discretionary ∆ o Normally as long as TE is independent and not under control of GR, gift is complete. EXCEPTION: Under CA law (and some other states) creditors of GR who has established discretionary ∆ in which payments can be made back to GR, have rights, not to force distribution of funds back to GR, but to go after ∆ Corpus and get to any funds that TE can distribute to GR in order to satisfy debts. -GR retains power to replace TE w/anyone other than GR? o Complete Gift as long as there is no chance GR can obtain prohibitive power. TE shopping OK. -GR Retains Prohibitive Power w/Ascertainable Standard – Completed Gift. EXCLUSIONS § 2503 – Annual Exclusion -$12K per year, per donee. o Can be cash, stamps, real estate shares o Married couple could be $24K (splitting the gift) o No limit to the number of people o MUST be an unrestricted right to IMMEDIATE USE AND ENJOYMENT. Income Interest in the form of a Life Interest or Term of Years Interest is considered a present interest if interest starts immediately upon completion of gift. • Crummie Powers – Creating a window in time (ex. 60 days) starting upon deposit in trust in which each donee has present use and enjoyment of up to amount of annual exclusion. o Lesser of amount of his portion deposited or of annual exclusion. o Must be FROM THE MOMENT IT IS DEPOSITED. o Cannot be illusory….Beneficiaries must have notice! o Must give them ample amount of time (30-45 days or so) to exercise withdrawal right…2 hours would be illusory! o If TE can accumulate income, then it’s a future interest and NOT present use and enjoyment. Donee must be guaranteed present enjoyment. o § 2503(c) – Statutory Provision Allowing Present Interest Ex.: Five year old child is beneficiary of ∆ (to accumulate until he reaches 21, then entire corpus is to be distributed to him). • This statute creates a complete gift w/a present interest (subject to annual exclusion). § 2503(e) – Educational & Medical Expenses -Tuition is excluded ONLY IF payments are made directly to “qualifying educational organization.” o DOES NOT include books, dorm fees, board, or other expenses. -Medical expenses MUST be made directly to medical care provider. -Cannot reimburse someone for tuition or medical expenses. o These do not apply to estate tax (so bequests in the form of tuition and medical still taxed) § 2518 – A DISCLAIMER is a refusal to accept a donative transfer of an interest in property. -Must be irrevocable, unconditional, -Made in writing, AND -No later than 9 months after either: (1) the transfer OR (2) the date the disclaimant reaches age 21. -Cannot redirect gift. (I don’t want it; but give it to Shannon.) o VERY STRICT that I am not entitled from any benefit from the property….even staying in it one night in gifted house would destroy my Qualified Disclaimer. I could disclaim it and simultaneously submit rental agreement to see if I like the house. o If it were money…even using money for collateral. Deductions § 2522 – Charitable Gifts – Must be to a qualified charity. § 2523 – Marital Deduction – Unlimited deduction for gifts to spouse. Calculating Gift Tax: Step #1: Determine Taxable Gifts for current year. Step #2: Total Taxable Gifts for all prior years. Step #3: Tax on sum of 1 and 2. Step #4: Figure out tax on all prior year’s gifts (tax on step 2 amount). Step #5: Step 3 (minus) Step 4 Step #6: Subtract any remaining unified tax credit. ESTATE TAX The Gross Estate (GE) is valued by taking a “snapshot” at death. See Goodman v. Granger. -§§ 2031, 2033 – At time of death, all property, tangible or intangible, wherever located. o State property law determines ownership of property but Feds assess estate tax. If State Supreme Court makes determination, Feds must comply. If lower state court makes determination, Feds will consider it but make their own determination using state law (as to whether or not it’s included in estate for tax). -Should contraband be included in estate? (see pg. 199 and note on pg. 204) o Stolen property included in GE but no deduction given for value of claims by rightful owners. o Illegal drugs were taxed but no deduction was given for confiscated property. Joint Interest -Community Property (CA) o Husband/wife each have undivided 50% interest. So if wife died estate would be valued at half of community property and 100% of her separate property. -Tenants in Common o Undivided co-ownership of property (FMV of interest owned at time of death included in estate). -Joint Tenancy o SPOUSAL -§ 2040(b) – If married person has JT at time of death, have of FMV of property will be included in his estate. (Of course, it will be cancelled out by the marital deduction.) o NON-SPOUSAL -§ 2040(a) – For non-married JT who dies, include 100% of FMV of property in his GE, except for any portion it can be shown a surviving JT furnished consideration for in the property. Tracing Principle: If decedent substantially contributed to the consideration provided by the surviving JT’s, then really no contribution on their part and the entire value of the property will be included in dededent’s estate. • If no evidence on who contributed what, then the entire amount is included in the estate. §2038 – REVOCABLE TRANSFERS -RULE: Where the decedent has made a transfer in which he still retained power (alone or in conjunction with others), at the time of his death, to alter, amend, revoke, or terminate then such transfer will be subject to inclusion in his gross estate. o Retained powers that result in inclusion in GE: Power of Revocation (FMV at time of death) Powers to Alter and Amend (change beneficiaries or allocate between named beneficiaries) Power to affect Time and Manner of Enjoyment o Retention of administrative powers does not result in inclusion in GE -Contingent Powers under § 2038 o If decedent dies holding a contingent power to alter, amend, revoke, or terminate, the property will NOT be included in the GE if the contingency has an “ascertainable” standard. Health, Education, Support, or Maintenance (of beneficiaries) Language such as “special emergency” or “for the best interest of the beneficiary” is NOT sufficient to constitute an ascertainable (determinable) standard. • If a ∆ is set up with such contingent power with an ascertainable standard, it will constitute a completed gift for gift tax purposes. o Also, any contingency out of the control of decedent that did not occur before his death is not subject to § 2038. (In other words, if ∆ said “TR retains power to revoke ∆ if the Miami Dolphins win the Superbowl” but Miami never wins and TR dies…then not subject to inclusion into TR’s GE. “Ascertainable Standards” is the more important of the two. Other sections (like 2036) do no consider whether or not contingency occurred, just that a possibility existed. -Powers Exercisable in Conjunction w/3rd Party o Doesn’t matter that consent of 3rd party is needed or whether or not their interest is adverse. o This is one of two exceptions in which § 2038 is not in pari materia with the Gift Tax Code. 1. TR retaining the power to alter the time and manner of enjoyment of the beneficiaries. This would still be considered a complete gift subject to gift tax AND subject to inclusion in the estate for estate tax purposes. 2. Requiring consent of 3rd party with adverse interest would make the transfer a completed gift AND be subject to inclusion in the GE under § 2038 -State Law -As long as TR does not enlarge his powers granted under state law (like powers of revocation or alteration with consent of all interested parties) then not subject to inclusion in GE under § 2038. -Trustees – It’s immaterial whether or not GR can or does become Trustee under § 2038. The only issue is whether or not GR can obtain prohibitive powers. o If such powers are placed in TE and it’s impossible for GR to become TE, then not incl. in GE. o GR can retain power to switch TE’s (Trustee-shop) but as long as prohibitive powers must stay with TE (not GR) then not subject to inclusion in GE. § 2035 – GIFTS MADE WITHIN 3 YEARS OF DEATH (Artificial Inclusion) -RULE: Gift tax paid on a gift given by decedent w/in 3 years of his death will be artificially included in his GE. o § 2035(a) – Relinquishment of prohibitive powers over certain gifts (linked to §§ 2036, 2038) within 3 years of death, triggers artificial inclusion of those gifts as if the GR had never relinquished the prohibitive power. §2036(a)(1) – TRANSFERS W/RETAINED LIFE ESTATE (Artificial Inclusion) -RULE: If GR makes a transfer during his lifetime and retains the possession or enjoyment of, or the right to income from the property for: (1) his life, (2) a period not ascertainable w/out reference to his death, OR (3) a period that does not in fact end before his death…then the entire FMV of the property is included in his GE at death. o Burden is on party trying to exclude from estate. o Must appear as bona-fide transaction. Beneficiaries should pay for maintenance, taxes, insurance, etc. If GR remains on property, he must pay FMV rent. If GR can enjoy for term of years, but dies within that term, he has effectively enjoyed a life interest and property will be included in his GE at FMV at time of his death. • If he outlives the term of years, no inclusion in his estate. If period of enjoyment not ascertainable w/out reference to GR’s death – Included in GE. o Support Trusts: GR receives “indirect” benefit. If child is minor when GR dies, property in ∆ for child’s welfare is included in GE. • GR has legal obligation to support minor children. ∆ is discharging that obligation. If ∆ has independent TE… • and ∆ states TE “must” support minor child, included in GE. • and ∆ states TE “may” support minor child, NOT included in GE. • and GR is TE or can become TE then included in GE. o See Gokie’s Estate Pg. 283 (holding that § 2036(a)(1) applied when ∆ stated income of ∆ “shall be used” for GR’s children. In this case, only 2 of the 3 kids were minors, so 2/3 of the value of the trust was artificially included.) §2036(a)(2) – VICARIOUS ENJOYMENT (GR retains right to determine WHO enjoys property) -RULE: If the decedent has retained the right, either alone or in conjunction with any person, to designate (or select) the persons who shall possess or enjoy the property of the income therefrom for: (1) his life, (2) a period not ascertainable w/out reference to his death, OR (3) a period that does not in fact end before his death…then the entire FMV of the property is included in his GE at death. o In ENGLISH: If GR makes a transfer but retains power to change beneficiaries of an income interest DURING GR’s life, he is considered to have vicarious enjoyment of the property. o This is as if he retained a life interest so the entire corpus is included in GR’s GE. o (This is much more expansive than § 2038, where only the life interest is included.) On EXAM, ALWAYS discuss both sections…as if you were IRS agent ☺ o The MAJ approach is that GR retaining power to affect time and manner of enjoyment/accumulate does not constitute vicarious enjoyment. MIN (at least one JXD) says that this would be prohibitive under § 2036. • Ex: GR sets up ∆ with income to A for 10 yrs and remainder to B. GR retains power to accumulate interest. o MAJ: Not prohibitive under § 2036 but § 2038 would apply and the value of the interest income at the time of GR’s death (chart) would be included in GR’s GE. o MIN: § 2036 would apply and the entire corpus would be included in GR’s GE (at least one JXD). o Also consider possibility of GR retaining right to change beneficiary of remainder interest. If it’s possible that could be realized during GR’s life, §2036(a)(2) would apply. Ex. To A for A’s life, remainder to B. GR reserves right to change B. -EXCEPTION: If power to change beneficiary is based on an Ascertainable Standard, then NO inclusion in GR’s GE. GR has no power, thus no vicarious enjoyment. o See § 2038 for definition of “Ascertainable Standard” HOWEVER, unlike § 2038 (which avoids inclusion by either (1) ascertainable standard or (2) contingency that hasn’t occurred), § 2036 doesn’t consider whether or not contingency has occurred…the mere possibility that it could occur triggers § 2036. o Grantor retaining power with consent of 3rd party changes nothing…still possibility he will effect who enjoys property. o Third Party Trustee (holding power to change beneficiaries): If GR and TE have no prohibitive powers, no inclusion in GE (even if GR is TE). If TE has prohibitive power (as long as GR can never become TE) no inclusion in GE. • Again, TE shopping is fine…but GR cannot become TE. o Look out for language in ∆ that allows GR to replace TE w/“anyone.” o Ex: “In the event TE dies or becomes unwilling, GR can appoint anyone he chooses to replace TE.” This is a contingency that opens door to possibility of GR appointing himself as TE (and obtaining prohibitive power). If GR dies and contingency never occurred, TE still serving: • § 2038 is not implicated because contingency never occurred. • § 2036 IS implicated because GR died holding contingent power (mere possibility) to decide who enjoys during GR’s life. The entire value of ∆ would come back into GE. §2042 – LIFE INSURANCE -RULE: Two ways Life Insurance Policy will be included into GE: o § 2042(1) – If decedenent’s estate is beneficiary, Full Face Value of policy included in his GE. o § 2042(2) – If decedent is OWNER of his own policy, Full Face Value of policy included in GE. If decedent is owner of someone else’s life insurance policy, it’s value is it’s Interpolated Terminal Reserve Value ITRV). Substance over form….doesn’t matter what it’s called, as long as it is effectively life insurance policy. See Comm’r v. Noel’s Est. (holding “flight insurance” as life policy). Who is the “owner?” Whoever policy designates as Owner. • “Any Incidents of Ownership” • Physical possession of policy has no effect on ownership. • Doesn’t matter who pays premiums (although payments likely “gifts”). Transfer of ownership of life insurance policy is a “gift” valued a IRTV. §2035(a)(2) still applies if owner of policy relinquishes prohibitive power w/in 3 years of his death…resulting in inclusion of GE at Full Face Value of Policy. • UNIQUE EXCEPTION: In rare cases where the ownership of the policy was transferred, a new owner took over premium payments, and insured dies w/in 3 years ownership will be allocated. o Ex: John takes out life insurance policy on himself and makes premium payments for 10 years. He gives ownership of policy to Bill (gift valued at IRTV). John then dies two years later. 10/12th of the face value of the policy would be included in John’s GE. • On EXAM, look for scenario where decedent transfers the “ownership” of his life policy (gift – valued at IRTV…don’t forget about annual exclusion…donee has present use and enjoyment of policy) within 3 years of his death…policy then comes back into estate at Full Face Value. §2041 – GENERAL POWERS OF APPOINTMENTS (Artificial Inclusion) -RULE: A person who dies holding General Power of Appointment (GPA) (either inter vivos or testamentary) must include value of any property they have power over in their GE. o GPA: Power is considered “General” if permissive appointees include ANY of the following: decedent, his estate, his creditors, or the creditors of his estate. If someone has power to appoint “anyone” as beneficiary (including themselves), they have a GPA. This is not good for the power holder (for estate tax purposes). o Donor – Party giving up power (Usually GR giving TE power over trust). o Donee – Person receiving power. o Permissive Appointee – Anyone who power holder ca give property to (potential beneficiaries). o Takers in Default – Whoever would get property if power holder does nothing (named bene’s). o Special/Limited Power of Appointment – If permissive appointees do not include decedent (power holder), his estate, his creditors, or their estates. CRITICAL to distinguish between GPA and Limited Power of Appointment. • See Jenkins v. U.S. Pg. 407 o Ascertainable Standard applies – So if decedent (power holder) can appoint himself only if necessary for health, maintenance, education, or support of beneficiaries, not GPA. o TRICKY HYPO (Problem Set #14, Question #3): TE has GPA over ∆ (with dispositive provisions: Income to A for life, Rem. To B). TE exercises her GPA and appoints entire property to a new trust, that provides for income to TE for life w/remainder to TE’s sister. TE dies. What’s in her estate? • Well, § 2036 doesn’t apply because she isn’t the Transferor. • BUT see § 2041(a)(2): TE exercised a power which “is of such nature” that if she had owned the property, would have been included in her GE per §§ 2036, 2038. o Look for something like this on the EXAM. It would not fall under § 2036 but instead under § 2041. It would also require potential discussion of §§ 2035-2038…a lot of material for an essay question. • On EXAM, don’t focus on what things are called (ex. GPA) but instead what powers they grant in SUBSTANCE. § 2032 – ALTERNATE VALUATION -RULE: If the entire estate is valued less at six months after date of death than it was worth at death, you can elect to value the estate at the later date. o Entire estate is valued (Can’t pick and choose). o Must be exactly six months…you can’t elect to pick the date. o Ex. If I died with a bunch of stock and property that was worth $5M but it depreciated to $4M over the following six months, my estate could use the $4M figure for estate tax valuation. ESTATE DEDUCTIONS: § 2053 – CLAIMS, DEBTS, and EXPENSES -Mortgage, money owed, etc. come out of gross estate. -Includes expenses of the Estate o Funeral Expenses Including transport of the body, plot, party/reception at funeral, etc. o Administrative Expenses Probate costs, attorney’s fees, executor fees and commissions, storage, etc. § 2054 – CASUALTY LOSSES -Even after decedent’s death but within a specific period of time, if there is a loss based on casualty, there can be a deduction. § 2055 – CHARITABLE BEQUESTS § 2056 – MARITABLE DEDUCTIONS -RULE: As long as things stay within the marital unit, transfers will not be subject to tax. o MUST be spouse, and must be surviving. o When couple transfers something out of unit, then taxed. Ex. Husband dies and is owner of life insurance….named beneficiary is wife. It passes to spouse so falls under maritable deduction. If husband retains prohibitive power but property goes to spouse, still ok. § 2056(b)(1) – Terminable Interest/Maritable Deduction -RULE: No marital deduction given where the spouse’s interest is contingent or may lapse w/time. o This will not be tested heavily on EXAM. o Ex. H died and his will provided all of his property goes into ∆, income to W for her life and remainder to their children upon her death. This would get maritable deduction if remainder interest was to be distributed to wife’s estate upon her death. § 2056(b)(5) Life – Estate with Power of Appointment in Surviving Spouse/Maritable Deduction -Requirements: o Wife gets all the income for her life, o Paid at least annually, o Power to appoint to either herself OR her estate (surviving spouse). (not necessarily a true GPA) o Power in surviving spouse must be exerciseable by HER ALONE and exercisable in all events (without contingency). ** Sadly, we never made it to computation of the Estate Tax so this will not be included on FINAL.