Estate and Gift Tax OutlineI. Introduction

A. In General 1. Estate tax was designed to break up large estates. (Inherited economical power is

like inherited political power.)2. Who pays the estate tax?

a. 24 billion was paid in estate tax, more than half of which came from 3600 estates (smallest being 5 million). This is a tax being paid by the wealthiest individuals.

b. The 3600 was .0015% of the people who died in 2000.c. 52,000 were required to file estate taxes.d. This truly applies to only a small amount of tax payers.

3. Promotes Charitable Givinga. One of the good things about the estate tax is that it forces the wealthy to decide if

they are going to give their estate to the government or to a charity. b. When we repeal this tax will they still leave their money to charities? Many who

have done this in the past were motivated by this tax. c. These charities may provide jobs for their families, but the IRS watches these

carefully to ensure that there are a requisite disbursements madeB. Nature of the Tax We Have

1. Estate Taxa. this is imposed on the decedent’s estate (as opposed to an inheritance tax imposed

on the heir)b. This must be paid before there can be a distributionc. Before 1981, only 50% of what was left to a spouse was exempt. This changed in

two ways: i It is unlimitedii before you had to give it outright or you had to put it into a trust (power of

appointment) in which the spouse had the general power of appointment – We created the Q-Tip trust – property will qualify for the marital

exclusion if it is left in a trust such that the surviving spouse receives all of the income from the estate and then dictate where it goes at the time of the surviving spouses death. We can make provisions to this such that the trustee can go into the principle of the trust when it is needed for health, maintenance, etc.

d. Gross Estatei Property owned at time of death passing through the will. ii Testamentary Substitutes

Life Insurance Pension/Retirement

iii Trusts – we will spend a lot of time on this (§§ 2036, 2037, 2038) Raise questions of a gift being given in the lifetime of the decedent Raise questions of whether or not this is part of the estate Will there be a double tax?

When the Grantor gives the right of the income of the trust it is a gift. § 2036 – estate will include the right that is transferred in the trust (all of the property is included in the estate).

This is not double taxation, it gives the government the opportunity to tax the appreciated value of the property. We back this out when we credit the Tentative Tax for all gift tax payable.

In the Estate Tax we are trying to tax the transmittal of wealth at death – so we do not want to limit to what the decedent leaves in his will. We will also tax the appreciation on the property you gifted previously.

e. Estate Tax is due 9 months after death and you can get an automatic 6 month extension (this does not extend the time for payment). There are some things that let you extend the payments over years – an estate with a closely held business. The interest rate on this payment schedule is as low as 2%.

2. Gift Taxa. Necessary back up to the estate tax (wealthier individuals were giving their assets

away to avoid the estate tax)b. This is imposed on the donor, the donee is secondarily liable if the donor does not

payc. Cumulative form of taxation – the calculation is a cumulative process, you have to

add all prior gifts when you calculate the current years tax rate (you credit what you pay by what you paid in previous years)

d. How do we get to taxable gifts?i What is subject to a gift tax?ii When is the Gift Tax applicable? Concept of completed gift – the gift tax is

imposed when the gift is complete. When is the gift complete for gift tax purposes? When has the transferor given up dominion and control over the property? Ex. Grantor puts property into a trust and provides that all of the income

will go to Y for Life and then to X. This is fine. (Note> there are two gifts in this situation: Gift of Income and Gift of Remainder. Each of these gifts would be taxed separately and can be completed and thus taxed at different stages.)

There are problems when there is a power to revoke. If there is a right to revoke, a gift will occur at the first distribution to Y. Then if he gives up his power to revoke, then the gift is complete.

What if the Grantor retains only the power to change who receives the income? The gift of the remainder will be complete, but the income gift will not be.

iii What is the value of the property transferred (we will spend very little time on this in this course, but know that this is very important in practice)? Do we have a transfer that is for less than adequate compensation? What

was the FMV of the amount transferred and what was given in exchange for this FMV? When we are dealing with third parties, there will be a tendency to find

that it is not a gift, but when it is a family member, there it will be more likely to be found a gift.

iv Exclusions Charitable Donations

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Marital Deductions – no gifts given from one spouse to another included Annual per Donee Exclusion - $11,000. This is available to us in the

computation of the taxable gift. ***You want to take this out when we compute taxable gifts**** If you use gift splitting between you and your spouse, then you can get

$22,000. Tuition or medical payments made on the behalf of another directly to the

institution providing the service. No Limit on this!!! (Note> this cannot be an exclusion if the child does not go to school there.)

ve. Gift Tax is filed with your income tax return. You do have to file a return if you

make gifts hire than the per donee exemption. If you do not do this then the SOL will not run. Note> Audits in estate and gift often take place when you have limited

partnerships and what not in the estate3. Generation Skipping Tax

a. Who pays this depends on the nature of the generation skipping transferi Tax Terminationii Taxable Distributioniii Direct Skip

Parent makes a gift directly to a grandchild or when the parent creates a trust when the first beneficiary is the grandchild – very costly because it causes 2 taxes – gift tax and generation skipping

tax That is why you want to have a trust that does not have a direct skip.

Added in 1986 because we did not want the grandparent could go ahead and just give the gift to the grandchild so that it would not be taxed twice

You want the timing of the tax to be as many years after the creation of the trust.

b. This first came along in 1976, but in 1986 it was substantially revised and the old one was repealed retroactively to its origin

c. Why do we need this – trusts. i A grandparent could place the property into a trust with the

child as the beneficiary. The child would get all of the income from the trust and then have the property itself pass to the grandchild. There should be a gift of right to income and gift of remainder.

ii We have adopted a system to ensure that some sort of federal tax will be applied as the property moves from one generation to another. In the trust example there is no opportunity for the property to be taxed as it moves

d. Fills in where property is transferred and the estate and gift taxes would not be applicable.

e. When the generation skipping tax applies, it is taxed at the highest possible estate tax rate for that year.

f. When you develop an exempt trust – and it goes to the grand kids, there is no GST.

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i Create the trust with 1.12mil (or whatever the applicable exclusionary amount is for that year) of corpus and the whole thing would be exempt from GST (it would be subject to gift tax).

ii When you file the gift tax you make your GST exclusion allocation. This will be exempt for the rest of its existence.

iii The exempt status will remain no matter what the appreciation of the property is – it can grow an unlimited amount. BUT you have to make sure you do not do anything that would disturb its exempt status.

iv Estate Planning with Exempt and Non-Exempt Trusts – you would want one of each. Exempt Trust

The exempt trust is the one that you really want to preserve for your skip generations – you want this to grow – so you want it invested in a way that would appreciate the assets.

You would provide that the child would receive distributions at the discretion of the trustee – that way the grandchild is not the first beneficiary.

The exempt trust is designed to maximize distributions to skip persons. Non-Exempt Trust

Then you can have a non-exempt trust – this is where you give the child money.

You can have this one distribute income and principle to the child. Then you would want to give the child some sort of interest in the trust so that it is included in his estate (because you know it won’t be taxed at a rate higher than the highest).

The non-exempt trust is going to be designed to maximize distributions to non-skips.

When you have a non-exempt trust, you have a special exclusion tuition and medical expenses for skip persons without being

subject to GST If the distribution would be exempt if paid by an individual by

paying it directly to the institution Never create a trust that has an inclusion ratio of anything besides 1 or 0.

You are better off having one that is totally exempt and another that is not at all exempt. You always want to have two separate trusts – one for current income (non-exempt) and one for growth (exempt).Note> Each spouse gets the exemption. So you could have two totally non-exempt trusts

g. Taxable termination is payable 9 months after death, Direct Skip and Taxable Distribution are both files with the income tax

C. Estate and Gift tax have an important connection (needed for the calculation of the estate tax)1. Up until the Tax reform of 1976 there was no connection between these two – but

then we adopted a unified system for the purpose of estate and gif tax

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2. If he makes any taxable gifts prior to 1976, we have to add to the estate all taxable gifts. The tax paid on the gifts will be credited to the amount you pay, this is just used to calculate the tax rate

3. Work off of the same rate schedule for gifts and estates4. Unified credit against the estate tax and Unified credit against gift tax (§ 2505) – this

can be applied to either gift tax liability or to estate tax liability. The code has kept the same credit for gifts taxes, but it has gone up on estate taxes.

5. Estate Planning involves both gifts made prior to death and testamentary dispositionsa. Gift programs giving the exclusion of 11K per donee per year (this can avoid the

41% tax rate of the first taxable rate)b. Every person has an $1mil exemption – the husband and the wife. So with

spouses with at least $2mil you want to draft the will that will not waste the $1mil exemption for. So you would will $1 mil to someone else and then the rest going to the spouse.i Bypass trust – keeps the first mil out of the first spouse who dies out of the

estate of the other. (have to make sure the spouses keep separate accounts)c. Always preserve the exemptions of spouses in estate planning

6. The Unified Credit §§ 2010, 2505 – is available for either estate or gift tax computation.a. Why a credit instead of an exclusion – because the exclusion benefits the highest

tax brackets, the other takes it off at the lowerb. How is the credit computed? P. 93 of appendix. An estate has a credit equal to the

amount of the tentative tax from the applicable exclusion amount based on the applicable tax rate for that year.

c. For Gift taxes this is frozen at the $1,000,000 applicable exclusion.II. Estate Tax

A. § 2001 – Definition of the Gross Estate and Valuation1. § 2031 – Definition of Gross Estate

a. Includes the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.

b. Fair Market Value – the value spoken of in § 2031i FMV – the price at which the property would change hands between a willing

buyer and a willing seller, neither being under any compulsion to buy or sell and having reasonable knowledge of relevant facts.

ii Liquid assets – FMV can be determined by reference to comparable sales in the open market.

iii More problems when the item is not for sale in the open market: Only available on the black market – drugs have been advised by the

service to be valued at the price an ultimate consumer would pay in the open market.

Item is unique and irreplaceable in the market – rights to produce one play and two motion pictures.

iv Factors to consider when determining fair market value: Income yield Appraisal –

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Should represent the price that would be agreed upon between two hypothetical parties, not the price that the actual parties to a transfer would agree upon.

There must be a sound basis for the appraisal and the performing expert should be able to thoroughly explain it.

Courts will discredit experts when they are unfamiliar with aspects of the property or their analysis is poor or they contradict their own opinions from different cases.

Sales prices of similar property near the date of death Bids made for the asset General economic conditions.

v § 2032A Valuation of certain farm, etc., real property a special rule that allows us to alter the rule of 2031, to value property not

at its highest and best use, but to value it at its current use. This was designed to help family farms. There are a lot of requirements to use this special rule. This will ignore speculative value and development value

vi Valuation is usually at the moment of decedent’s death, BUT § 2032 Alternate Valuation Date

Allows us to elect to use a different date for valuation – 6 months after death.

This is an all or nothing thing – you cannot pick and choose assets to apply this alternate date.

This was enacted to prevent over taxation when the value takes a dive right after death. You cannot use this unless it lowers the tax

vii Valuation should not be effected by events that happen after death unless such events were known or reasonably foreseeable at the moment of death. The value of an illiquid asset can be determined with reference to an after

death sale of the asset, however the longer the period of time between the death and the sale, the less probative the sale is of the asset’s value.

2. § 2033 – Property in Which the Decedent Had an InterestThe 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. a. Beneficial Interest – The interest must be a beneficial interest; the burden is on the

estate to prove that it is not a beneficial interest. i State Law

State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.

State law would govern the relationship of the remainder person to the trust property; but whether the relationship fixed by local law amounted to an interest in the property would present a purely federal question.

ii State Decrees A federal court may decide whether the decedent had title to a property

only as a trustee or whether instead had a beneficial interest in the property. BUT it will apply state statutory and common law principles in the decision of that underlying issue.

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The beneficial interest question can be re-litigated in federal court → The Supreme Court said it will not give finality to a state court decision on an underlying state law issue, unless the local decision is by the state’s highest court. The fear here is that the decision will be made in non-adversarial conditions that are conducive to fraud and collusion.

Federal Courts are to give “proper regard” to state decisions not coming from the highest state court (this can be no regard if the decision was handed down in a non-adversarial suit).

b. Routine Inclusions i Real property solely owned by the decedentii Tangible personal property solely owned by the decedent

(factual issue of whether the item was actually owned by the decedent can be very troublesome)

iii Intangible items raising no questions such as: Currency in the decedent’s safe-deposit box Balance in decedent’s checking or savings account (this does not include

joint accounts) Any credit from one’s brokerage account Stocks, Bonds, CD’s owned solely by the decedent Amounts due to the decedent on notes arising out of the decedent’s

lifetime loans or deferred payment sales. c. Income Items

Income rights of the decedent at death must be treated as property in which decedent had an interest within the scope of § 2033. i Salary due at death (Note this will be taxed as income to the decedent’s estate

under § 691 but it is still includible in the estate under § 2033.)ii Bonuses payable to decedent at time of death

Bonuses which the decedent had no interest in at the time of death, but were awarded after death are not included in the gross estate even if they are paid to the decedent’s estate.

iii Compensation due for services other than as an employee are treated the same as salary

iv Rent accrued at death on real or personal property owned by decedentv Accrued interest at deathvi Dividends on shares of stock that are payable to the decedent at the time of

death – right does not arise until the record date of the dividend. d. Partial Interests in Property

i Shared Interest in Property – if the interest is one that the decedent can pass on to others, it is generally an interest in the scope of § 2033. Tenancy in common Community property

Note> These are shared interests that do not terminate at death, unlike joint tenancy with the right of survivorship.

ii Successive Interests in Property A owns Blackacre and leases it to B for 20 years. Both have interests that

may be taxed under § 2033.

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If B dies before the lease term is up he has an interest in the property for the next 10 years and his gross estate will include the value of the leasehold.

If A dies before the lease term is up, he has a reversionary interest that will be included in his estate.

The interest in the property can be based upon the happening of an event as well. Note> If the property is A’s for life and then to B or B’s estate. There will be nothing includible in A’s gross estate under § 2033, but if B were to die first, his estate would include the remainder interest in the property.

iii Cautions The only question that has been considered here is inclusion under § 2033

– these interests that may not be includible here, may be includible in the gross estate under another provision in the Code.

Be careful with life interest that are not includible in the decedent’s estate – these may give rise to generation skipping taxes.

e. Insurance Proceeds Under § 2033 i An insurance policy is property and the value of the decedent’s interest is

includable in his gross estate under § 2033 – this applies to the ownership of a policy on the life of another person. Note> § 2042 has special rules for insurance policies owned by the decedent on his own life.

ii If owner and insured die simultaneously: And the owner is the primary beneficiary, then the Simultaneous Death

Act applies. And the owner is not the primary beneficiary, then nothing is includable in

the gross estate under § 2033. (This does not mean that it is not included under another provision of the Code)

iii If the proceeds are those received before the death of the decedent, then it depends upon the nature of the proceeds as to whether or not they are included in the decedent’s estate. Annuity for life – nothing is included

iv Area of controversy → situation in which decedent is entitled only to interest on insurance proceeds for life and then they are to be paid to the decedent’s estate upon his death. These are not includible under § 2033.

f. Business Interests i Corporations and Proprietorships

Corporations – gross estate includes the value of decedent’s shares of stock

Sole Proprietorship – ownership of all of the various assets of the business is attributed to the decedent and included in gross estate under § 2033.

ii Partnership Interests Decedent’s share in the partnership is included in his gross estate under §

2033

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The decedent is not viewed as owning any specific assets of the partnership, but rather his proportionate share of each of the assets of the partnership.

It may be difficult to determine what the value of the partnership is if it is not terminated upon the death of the decedent.

Different partnership agreements may dictate how the partnership is to devise the partnership interest of a deceased partner to his estate, but this may not be determinative of its value if the Service thinks that it is below the market value of the partnership.

iii Limited Liability Companies – decedent’s share of the LLC is includible in his gross estate under § 2033.

g. Compensation for Death i “Survival” Statute – Recoveries under these acts for the decedent’s pain,

suffering, or related expenses during decedent’s lifetime are included in the decedent’s estate. Note> Survival statutes allow a claim brought by a decedent against a tortfeasor to survive his death.

ii Wrongful Death Acts – rights to recover under these acts do not constitute an interest in property owned by decedent to be included in his estate under § 2033.

3. §2034 – Dower or Curtesy Interestsa. Dower or Curtesy interests should be included in the estate of the deceased. b. Important thing here is that this provision forecloses the argument that a

decedent’s gross estate should be reduced by the surviving spouse’s dower or curtesy or similar interest in the decedent’s property.

B. §2035 – Adjustments for Gifts Made Within Three Years of Decedent’s Death1. Introduction

a. The Commissioner had little luck under the “contemplation of gift tax” so Congress expanded the rule to an automatic 3 year inclusion rule for all transfers in years after 1976.

b. Result → if a transfer was made that would be subject to the gift tax, it pushes increments of the estate into higher estate tax brackets, yielding a result much like an estate tax on at least the lifetime value of the gift, reduced by the credit for the earlier gift tax paid.

2. The First Pronga. §2035(a) Inclusion –

i §2035(a)(1) – requires property to be pulled back into the decedent’s gross estate if: there is a transfer if an interest in property or the relinquishment of a

power with respect to property inclusion AND the transfer or relinquishment is one that was made by the decedent within

3 years of death for less than adequate and full consideration in money or money’s worth. This section is not applicable to any transfers made outside of the three

years before death.

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The transfer date is the date when the gift is complete – look to local law to determine.

ii § 2035(a)(2) – The scope of this section is narrowed to apply only if the decedent transfers an interest or relinquishes a power over either an insurance policy that, without the transfer or relinquishment, would

have been included in the decedent’s gross estate under § 2042 OR The entire amount of the proceeds are included in the gross estate

because that is what would have been included under § 2042 If you own a policy on your own life, give it away before you are close

to death – give it away early. If you want to purchase more insurance, then you want to take the

money that you would buy the insurance with and put it in a trust and have the trust buy the insurance. (An irrevocable life insurance trust) – There is no way this will be

included in your account, because you never owned the policy. an interest in property or power over property that, if not transferred or

relinquished, would have required an amount to be included in the decedent’s gross estate under §§ 2036, 2037, or 2038.Note> This only applies to estates of decedents dying after 1981. Applies only if the interest transferred by the decedent was one that,

had it been retained by the decedent, would have enlarged the decedent’s gross estate under the above listed sections.

A transfer of property that, had it been retained until death, would have been included in decedent’s gross estate merely by reason of § 2033 escapes inclusion under § 2035.

We are targeting that their gift value is much lower than the value at the time of death.

b. Exceptions to the §2035 (a) Inclusion i §2035(d): bona fide sales

If, in connection with a transfer, the decedent receives full consideration in money or money’s worth, then the transfer amounts only to a substitution or exchange of assets, the gross estate is not reduced, and no estate tax is avoided.

The statute does not specify what constitutes “adequate” consideration – the statute also does not say for what the decedent must receive full consideration. When confronted with the problem of the interest transferred being ofa

different value than the estate tax inclusion amount, a court created an estate tax ownership concept requiring consideration equal in value to the potential estate tax inclusion.

Partial Consideration – when there is partial consideration that amount will reduce the value that is included under § 2035. With life insurance policies, if the transferee pays the premiums after

the transfer we would exclude the proportionate amount of those

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premiums to the total amount of premiums made from the proceeds when including them in the gross estate.

ii §2035(e): certain transfers from revocable trusts §2035 (and §2038) is inapplicable to “any transfer from any portion of a

trust during any period that such portion was treated under § 676 [the revocable grantor trust rule] as owned by the decedent by reason of a power in the grantor.”

c. Special Applications of the §2035(a) Rule i §2035(c)(1) sometimes makes §2035(a)(2) inoperative – it requires all

transfers within 3 years of death to be included in the gross estate under §2035(a) for purposes of applying § 303(b) (relating to stock exemptions), §2032A (relating to special use valuation), and §§ 6321-6326 (relating to liens for taxes).

ii §2035(c)(2) – imposes a dual test for purposes of meeting the 35% of the adjusted gross estate test of §6166(a)(1)

3. The Second Prong – §2035(b)a. The Gift Tax Gross Up Rule

i This provision requires the federal gift tax paid by the decedent or decedent’s estate on any transfers made after 1976 by the decedent or the decedent’s gross estate – this is a “gross up” of the gift tax. So – if a decedent makes a gift of 300K in cash, then pays a gift tax of

125K, the 125K will be pulled into his gross estate under this rule. This is because gift tax is exclusive and estate tax is inclusive – when a gift of 300K is made, the decedent is reducing the size of his estate by the full 425K (the gift plus the tax), but when a decedent has an estate of 2Mil then the estate is reduced by the estate tax amount before distribution to the beneficiaries.

It is still better to give the gift, because had we not the entire 425K would be included in the estate instead of just the 125K.

ii This section is operative whether the gift is subject to § 2035(a) or not. iii Gift Splitting –

if the spouse makes a gift and the spouses elect gift splitting, then the portion of the tax paid by the decedent will be included in his gross estate

If the decedent pays all of the gift tax on the gift split transfer made by the spouse, no gift to the decedent’s spouse results and the full gift tax is included in the decedent’s estate

If decedent makes a transfer and gift splitting is elected and decedent pays full amount of tax on the transfer, the full tax is again pulled into the decedent’s estate.

b. Gifts Made within 3 Years of Death – the transfer occurs when the gift is complete for gift tax purposes.

4. §2043 – Transfers for Partial Considerationa. The Affirmative Rule – the value of the consideration received by the decedent

can be subtracted from the applicable valuation date value of the property included in the gross estate.

b. Note – this has to be consideration for money or money’s worth!!

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C. §2036 – Transfers with Retained Life Estate1. Excluded Transfers

a. Sales for Full Consideration – this section is inapplicable to any transfers for adequate and full consideration. i In the case of a remainder interest, then it will be valued using the actuarial

tables in the back of the book. ii This can be paid with a note, but it has to be true debt:

b. Pre-March 4, 1931 Transfers 2. Period for which Interest is Retained

a. In order for § 2036 to apply, the decedent must have retained an interest in the property for a specified period.

b. Three-fold Test i For the decedent’s lifeii For a period not ascertainable without reference to the decedent’s death

Decedent is entitled to the income quarterly with the right to income ending in the quarter of decedent’s death → stays in the decedent’s estate

X for life, then to D for life, then to C → even if D predeceases X this will be included in his estate less the value of X’s outstanding life estate because the period for which D has a retained interest cannot be described without reference to D’s death.

iii For a period that does not in fact end before the decedent’s death A retained interest for a term of years – A has a retained interest for 10

years then to B. If A dies in that 10 year period, it remains in his estate. Have to reference § 2702 – grantor retained trust – where a grantor retains

the right to income for a term of years. This applies to grantor retained trusts to family members. If you have this kind of trust we do not apply the normal valuation

rules for this remainder interest. The remainder interest is valued at 100% of the value of the property

at the time of the gift. If it does not constitute ones family, then it is valued like normal. If we have a GRIT (fixed number of years) we pay gift tax at the

time we create the trust The good thing about doing this is that you at least get the appreciation

out of the estate, but you will pay more gift tax at origination. This is also applicable if there is a retained interest for life (but this

rarely happens because this will be included in the gift estate and we are trying to get stuff out of the gross estate.

3. Nature of Interest Retaineda. 2036(a)(1) – retained beneficial interests

i Invoked if the decedent retains “the possession or enjoyment of” or “the right to income from” the transferred property or property interest

ii Requires a retention of an interest in the very thing being transferred iii The decedent’s right to other property, such as an annuity, in return for the

transferred property does not trigger application of § 2036. (adequate and full consideration)

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b. 2036(a)(2) – retained control over other’s interests i Retention of the right for life to say who may enjoy transferred property or

income therefromii Does not have to be a power in which he can claim the enjoyment or interest

for himself4. Beneficial Interests in the Decedent

a. Possession or Enjoyment – ex. When one makes a gift of a valuable painting but reserves the right to keep it for life or a residence but retains the right to live in it for life.

b. Right to Income i Has to be more than a mere expectation – decedent has to have a right to itii Does not have to be received directly by the decedent to be a right to income.

If it is a trust with income to minor child, this is a discharge of a legal obligation. The legal obligation must still exist at the time of his death if it is to be included in the estate – so if Child reaches the age of majority, then this is no longer indirect income to the decedent and the property will not be included in the gross estate under § 2036 (like a trust for a term of years)

c. Enjoyment “Retained” – actual retention can turn into a rather pragmatic problem: i Implied Understanding – mere fact that the decedent continues to occupy the

house: Where the family member transferee does not co-occupy, it looks like

there has been retention by the transferor. Where the family member transferee does co-occupy, it looks less like it

was retained. ii Implied Agreement found where the transferor creates a FLP and transfers

interests in the partnership to other family members and, under the PA, the partnership or other family members have right to income, but the transferor diverts all of the partnership income for the transferor’s personal use.

iii Decedent has created a trust with income to X, but the trustee (not the transferor) has complete discretion to make income payments to the decedent.

5. Control Over Other’s Interesta. Right to Designate Retained Indirectly

i Transferor grants power to trustee to designate who shall enjoy the income and retains the right to discharge the trustee and name himself as the trustee with the same power When the grantor retains the right to remove the trustee (at any time and

without cause) and name himself trustee we have more concern – the powers held by the trustee will be attributed to the grantor. So we have to be careful about retention of powers removing the trustee.

ii Transferor’s reservation of the right to change trustees with a provision that it will not be the transferor will not be an indirect retention. When the grantor has the power to remove the trustee but can only do so

when they appoint another trustee – for years they said that just having this power was enough to include the property. BUT this was changed and the service now says that you can do this because there is no power given to the grantor to decide who gets income.

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There is an exception to this – when the list of trustees that could be chosen to replace the original trustee includes a related party (the service will raise this issue). No one thinks this is the right result because § 2036 allows the grantor to select this person in the first place.

b. Illusory “Control” – he will still retain the control sufficient to pull the property into the gross estate under this section when his right to designate an income beneficiary must be consented to by another person (under this section it does not matter if the person consenting has an adverse interest or not)

c. Right to Designate Who Benefits – i Mere right to direct the accumulation of trust income.

O’Malley – If the accumulation will eventually pass to a third person remainder person, then this is a retained right to designate who benefits.

Struthers – If the accumulation will eventually pass to the beneficiary or her estate, this court held that this is a retained right to designate who benefits. But really, this should only trigger the § 2038 power to alter the time of enjoyment.

ii Right to invade the corpus for another third party beneficiary G → X or X’s estate for G’s Life → remainder to Y or Y’s estate Retains power to invade corpus for Z – power that effects the enjoyment

all of the income of the property during his lifetime. We will include in the gross estate the entire trust.

If he had limited this power, the amount included in the gross estate would be limited as well (if he can only invade 50% of the corpus, then only 50% is included in the estate)

iii Right to invade corpus for the income beneficiary G → X or X’s estate for G’s Life → remainder to Y or Y’s estate The grantor retains the power to invade the corpus of the trust for X – The

corpus of the trust can be distributed to the income beneficiary of the trust. Is this a 2036 power? No this is not a 2036 power → Reg. 20.2036 – only

concerned with a power that will alter who receives the income or the benefit of the property. When G has the power to give the corpus to the income beneficiary it

does not change who gets the income. It changes how he gets it, but it does not alter the identity of who receives the property. Not included in the decedents gross estate under § 2036.

Caution> this will be included in his estate (though remainder interest only) under §2038. If §2036 were to apply, the entire value of the trust would be

included in the estate – but § 2038 would only include the remainder interest in the gross estate. You have to examine whose beneficiary interest would be altered and value of that interest is included in the estate.

6. Indirect Interests or Controlsa. Settlor Trustee

i It is possible for the settlor (transferor) to name himself trustee without invoking § 2036.

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ii The settlor must restrict his powers to compliance with a reasonable standard. The idea being that the trustee is not the innovator – he is simply carrying out directions from the trust instrument. Beneficiary’s accustomed manner of living For the beneficiary’s educational needs In case of sickness When you say “the comfort of the beneficiary” you are going to have

questions about this.iii Can the settlor freeze his tax liability to the value of the property at the time of

gift and yet work to enlarge his estate for life without estate tax attrition at the end? While this seems to be against the purpose of this section, read literally it

could work – the power to control investments is merely fiduciary and a restricted power over enjoyment meets the ascertainable standard.

iv G → X or X’s estate for G’s Life → remainder to Y or Y’s estate G names himself trustee (this always leads to problems – it could lead to

all kinds of violations – and we would only want to do this with the greatest of caution) but puts limitations on his power. He is required (note> this is not a right, but a requirement) every year to give Z the amount needed for his support and maintenance and the remainder of the income to go to X.

There is no discretion in this power as trustee – this is an enforceable distribution. This is not a § 2036 power and will not cause inclusion in the grantor’s gross estate. There must be ascertainable standards.

b. Enjoyment Retained in Commercial Transactions – where donor transfers property to another, but they agree that the donor will use the land rent free for his life, there is a retention of the enjoyment of the property.

c. Rent Paid by Transferor – a gratuitous transfer of real property coupled with a leaseback agreement under which the transferor pays rent for continued possession. i Business Setting – § 2036(a)(1) is inapplicable where the property is business

property that is leased back for its fair rental value. ii Non-business Setting – The service says they are not going to follow this rule

where it is a residence (this is a meaningless distinction and the service should not accept it)

iii Sale and Lease Back – will be included in the gross estate if it does not look like it is true debt and the lease back provisions appear to pay the note. You would want a loan with a fixed end date, amortizing over the life of

the debt, you would want to cut out any provision in the will forgiving the debt. You will have to enforce payment of the loan.

A loan that has payments of interest only, the parent paying rent close in value to the interest, the parent forgiving a portion of the principal each year equal to the annual exclusion amount and forgiving the balance as a provision in the will most likely will be seen as a gift – which is what it is.

Installment sales are good estate freeze devices – but you have to make sure it is pure debt.

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d. §2036(b) Transfer of Stock i Under 2036(b) the direct or indirect retention of voting rights in a “controlled

corporation” is “considered” a retention of the “enjoyment” of transferred property so as to trigger application of 2036(a)(1).

ii “Controlled Corporation” – one in which the decedent owns, either directly or by attribution under § 318, stock possessing at least 20% of the combined voting power of all classes of stock in the corporation. (This includes the mere ownership of the voting rights)

7. Transfer by the Decedent – 2036 does not apply to transfers by others creating rights in the decedent, except for others’ transfers imputed to the decedent, such as by way of reciprocal trust doctrine. a. Indirect Transfers

i D pays $10K to X to transfer real estate of like value into a trust – it is not unrealistic to treat D as the one who transferred the real estate into the trust even though he never owned it.

ii Where the beneficiaries in an executed will agreed in a settlement to a distribution plan specified in an unexecuted – the beneficiaries will be treated as having transferred the property.

b. Transfers by Election – ex. When you make an election on your insurance to not receive the proceeds but to have them accumulate for your life then pass to your children at death – this is a transfer.

c. Reciprocal Trusts i You have siblings who each create trusts for the other giving income for life

and remainder to his children. When S dies, he has no interest in the trust he created and the right to income he was not originally his property it just goes on to his children. The problem is that if either of the siblings had created the trust for themselves then they would have been subject to § 2036. So we treat him as if he created a life estate.

ii Application of the reciprocal trust doctrine requires only that the trusts be interrelated, and that the arrangement, to the extent of mutual value, leaves the settlors in approximately the same economic position as they would have been in had they created the trusts naming themselves as life beneficiaries.

iii If the amounts are different Rev. Ruling 74 – 533 → the amount that can be included in either grantor’s estate under § 2036 is no more than the smaller trust at the applicable estate valuation date.

8. Amount to be Included – the date of death value of the property interest transferred in the proscribed manner (the trust corpus)a. Accumulated Income – treated as if it was owned and transferred by the decedent

for purposes of measuring tax liability under 2036b. Lifetime Relinquishment of Prescribed Interests – if the decedent relinquishes his

retained interest then it will not be included in his estate – NOTE> 2035 does apply here, so if he relinquished his retained interest within 3 years of death then it will be pulled back in under that provision.

D. § 2037 – Transfers Taking Effect at Death1. Introduction

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a. § 2037 draws into the gross estate the value of some interests in property that the decedent has transferred conditionally during life.

b. The section applies only if: i The possession of enjoyment of the property is conditional upon surviving

the decedent ANDii The decedent has retained an interest in the property that may bring the

property back to the decedent or to the decedent’s estate or back into the decedent’s power of disposition. (Reversionary Interest)

2. Excluded Transfersa. Inapplicable to bona fide sale for an adequate and full consideration in money or

money’s worthb. Does not apply to transfers made before September 7, 1916.

3. The Survivorship Requirementa. Can possession be obtained without surviving the decedent?

i If yes, then 2037 will not applyii If no, then it will apply

b. If there is an alternative contingency by which the interest can be obtained, then it will not be included under 2037, but if the alternative contingency is unreal – will never happen – then it will be knocked back into 2037.

c. When there is more than one interest in the property transferred, as there often is in these situations, we need to be careful to find the interest that is contingent on decedent’s death and only that interest is falling under 2037/

4. Retention of Reversionary Interesta. Definition of “Reversionary Interest”

i The term is defined to include the possibility that the property may return to the decedent transferor, as well as the possibility that it may return to the decedent’s estate.

ii Even if the possibility ends with the decedent’s death, the decedent has retained the requisite interest long enough within the statutory concept

iii Does not include a possibility merely that the income from property or the power to designate who shall have the income may return to the decedent (these would fall under 2036)

b. How the Interest is Retained i Pre 1949 – only reversionary interests that arise “out of the express terms of

the instrument of the transfer” ii Post 1949 – both the reversionary interests arising out of express terms and by

operation of lawc. Negligible Reversionary Interests – the reversionary interest must exceed 5% of

the value of the transferred property (its value immediately preceding death.d. Mortality Tables and Actuarial Principles – the fact of the decedent’s death is to

be disregarded and the usual valuation methods are to be employed, including the use of gender-neutral mortality tables and actuarial principles.

e. Decedent’s Physical Condition – taking this into account would largely nullify this provision, so it is not taken into account.

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f. Application of the 5% Test – this becomes primarily a determination of the decedent’s mathematical chances, on the basis of age just prior to death, of surviving some contingency(ies).

g. Base for the 5% Test – in determining whether the value of the reversionary interest exceeds 5%, it is to be compared with the entire value of the transferred property, including the interests that are not dependent upon survivorship of the decedent.

5. Pre-Death Termination of Reversion – if the reversion is terminated before death then its value would be zero and would not be included in the gross estate under 2037. Note> it can still be pulled in under 2035.

6. Amount to be Included – the gross estate shall include the value at the date of death of any interest in property that has been transferred in such a way as to take effect in possession or enjoyment at or after the decedent’s death

E. §2038 – Revocable Trusts 1. Introduction

a. It might be better named “alterable transfers” because all it takes is the power to change the enjoyment of transferred interests to invoke the section

b. The transfer sections overlap quite a bit (esp. 2036 & 2038) – When two or more of the transfer sections are applicable, obviously the Commissioner quite properly will apply that section or combination of sections requiring the maximum inclusion in the decedent’s gross estate.

2. Excluded Transfersa. A bona fide sale for an adequate and full consideration in money or money’s

worth. b. Transfers made before June 22, 1936

3. Any Change in Enjoymenta. Whether the enjoyment of an interest in property transferred by the decedent

during life is subject to “any change” at the decedent’s death. i If the decedent kept a hand on the property until death, even by a right to

accelerate the interest, it is so much akin to a testamentary disposition that the affected interest should be subject to estate tax.

ii Ex – Where income beneficiary and remainder-man are the same person, the right to terminate the trust and turn corpus over to him immediately.

b. Whether the possible change may be brought about by the decedent through the decedent’s exercise of power. i This would include any right to invasion of the corpus for the benefit of

another. ii This also includes any right that would merely change the timing of when a

beneficiary received their interest. 4. Power in the Decedent – any of these powers will invoke 2038

a. Power to Revoke i If decedent retains the right to get the property backii If state law provides that a particular transfer is revocable if not specifically

made irrevocable, then unless the transferor expressly makes the trust irrevocable, 2038 will apply

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iii If creditors of the transferor, under local law, can reach the corpus of the trust, then it is revocable and caught in 2038

b. Power to Alter or Amend i Power generally to name new beneficiaries of a trustii Mere Power to change beneficial interests among a limited group of persons

already enjoying rights as beneficiariesiii Sufficient even if the power can only be exercised by will and there is no right

during life to make the adjustment.c. Administrative Powers

i Mere administrative or managerial powers over trust assets do not constitute powers to alter beneficial interests in the trust within 2038.

ii What is considered to be an administrative or managerial power? Trustee Grantor has discretion to allocate stock dividends to principal or

income – administrative power Non-Trustee – Grantor has reserved complete allocation discretion with no

judicial restraint – not an administrative power (looking at unbridled discretion)

Allocation powers as trustee, if they are validly expressed in such a way as to foreclose restraint by a court of equity, they go beyond the needed flexibility, involve affirmative authority to tamper with beneficial interests – not an administrative power.

iii 2038 does little more than require attention to be focused on any power to determine whether under its terms and applicable law, it is properly considered a fiduciary power or whether it really amounts to a power to change beneficial interests.

d. Powers of Investment – any uncontrolled power over trust investments such that the remainder person’s interests could be changed at decedent’s will or lifetime interest beneficiary’s interest could be changed at his will, then it is a power within 2038

e. Power to Terminate – expressly proscribed in 2038 and taxed as to the interest that is subject to termination.

f. Gifts to Minors – a transfer to a minor with the decedent named as custodian will result in inclusion under 2038 if decedent dies before child reaches majority.

g. Power in “Whatever Capacity” – this brings in the power to remove or discharge a trustee at any time and to appoint the decedent as trustee

5. Powers Restricted by Standardsa. A power to change enjoyment only in stated circumstances does not invoke 2038. b. Ascertainable Standard – a power that is restricted by an objective standard is not

a power within the meaning of 2038.i Decedent’s power as trustee to give income to child “in accordance with the

station in life to which he belongs.”ii Medical expenses, support, education,

c. The rationale is that such a power involves the authority to execute rather than to determine or to change the terms of the transfer.

6. Power Exercisable Only With Another

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a. It does not matter who the other person is, the decedent’s power to alter or revoke will still invoke 2038 when it must be consented to by another person (even if the other person has an interest adverse to the exercise of that authority)

b. One exceptional case – if the decedent holds a power that is exercisable only with the consent of all persons having an interest, vested or contingent, in the property subject to the power and if the power adds nothing to the rights of the parties under local law (i.e., a provision of local law that would allow such person to alter the terms of the trust in any event), the power is ignored.

7. Source of the Powera. It makes no difference “when or from what source” the decedent acquired the

power. However, there should be some linkage between the required transfer by the decedent and the decedent’s power.

b. 2038 should be held inapplicable in situations where the decedent makes a complete, absolute transfer and, by totally unrelated conveyance, the decedent has some fiduciary power or control at death.

8. When Power Must Exista. At date of deathb. Will be considered to be there at date of death even when there is a requirement of

notice before the exercise, despite no noticec. Deferred effective date for the amendment, revocation, or termination from the

date of exercised. However, if there are other contingencies, 2038 will not applye. Relinquishment of the Power – if within 3 years of death then it will be included

in the gross estate (2038(a)(1) & 2035)9. Amount to be Included – Any interest in the property transferred by the decedent if

the enjoyment of such interest was subject at the date of decedent’s death to change through one of the proscribed powers. a. Interests Subject to Change

i Only the interests that the power effects will be included in the gross estate

ii Requirement of giving notice makes this subject to adjustment – the adjustment excludes the value of the interest that could not have been effected by an exercise of the power if the decedent had lived.

b. §§ 2036 and 2038 Comparedi § 2036 – includes the value of the entire propertyii § 2038 – only includes the value of the effected interest

F. §2039 – Annuities1. General Rule

a. The value of amounts received by beneficiaries by reason of their surviving the decedent is to be included in the decedent’s estate.

b. Three Requirements: i Under any form of contract or agreementii If under such contract

An annuity or other payment was payable to the decedent Decedent possessed a right to receive such annuity or payment for

His life

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Any period of time not ascertainable without reference to his death or For any period of time which does not in fact end before his death

iii Receivable by the beneficiary by reason of surviving the decedent2. Exceptions Expressed in §2039(a)

a. Life Insurance Policies – expressly inapplicable to life insurance policies (2042 controls). In the combination policies, the regulations say that “if the decedent dies after the reserve value equals the death benefit, there is no longer an insurance element under the contract” and 2039 will control.

b. Pre-1931 Contracts – limited to estates where decedent dies after August 16, 1954 and then only to contracts entered into after March 3, 1931.

3. Qualificationsa. Contract or Agreement

i There must be a contract or agreement → includes understandings, arrangements or plans or combinations of arrangements, understandings, or plans arising by reason of decedent’s employment

ii Does not include → benefit payments paid under public laws where decedent has no voice in the designation of beneficiaries; where beneficiaries have only a mere expectancy; salary payments to which decedent had a right to (these are included on the decedent’s final income tax return)

b. Period for which Interest is Retained – the question is whether the decedent had a specified right or interesti For his lifeii For a period not ascertainable without reference to his deathiii For a period that did not in fact end before his death.

c. Nature of Decedent’s Interest i Payable to the decedent – where the decedent at death was actually receiving

payments without regard to the question whether the decedent could require their continuation

ii Possessed the right to receive – if the decedent had an enforceable right to receive payments at some point in the future, whether or not, at the time of his death, he had a present right to retain payments, i.e., it is not necessary that he have met the conditions at the time of his death

iii If the payments to the decedent have not commenced at the decedent’s death, 2039 will not apply unless, at death, the decedent’s rights to future payments are non-forfeitable.

d. Nature of Beneficiary’s Interest i same as the decedent’s ii Right to payment is by reason of surviving the decedent

4. Amount to be Included – the value of the amounts receivable by beneficiaries “by reason of surviving the decedent.”a. Valuation

i Annuities under contracts issued by companies regularly engaged in their issuance – cost of comparable contracts issued by the company What it would cost at the date of death to acquire a policy for the survivor

with benefits such as exist under the contract in question.

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ii When it is not issued by a company engaged in issuing these contracts – value is determined in accordance with appropriate valuation tables.

b. Percentage Restriction – i the amount actually includable in the decedent’s gross estate under 2039 is to

be determined by reference to the following 2 factors: The value of what is payable to the survivors The portion of the purchase price of the annuity or other contracts that was

paid by the decedentii The amount to be included is only such part of the value of the annuity or

other payment receivable by beneficiary as is proportionate to the part of the purchase price contributed by the decedent. Portions paid by the decedent’s employer will be considered as paid by the

decedent. 5. Private Annuities

a. Not an annuity in the context of employment or bought from a company in the business of selling annuities. This is a related party selling the property in exchange for an annuity.

b. The FMV of the annuity must equal the FMV of the property.i Usually when you are trying to make sure that this is adequate consideration it

is unworkable because the payment is too large.ii A lot of times there are not other sources of income with which to make the

annuity payments so you have to rely on the income of the property that was exchanged for the annuity.

c. A better plan would be to give away portions of the property on a year by year basis. These are discounted in their value. So you give a 20% interest to your child and it will be discounted because it is not worth as much as just a portion – you could work it so that each gift equal in value to the annual exclusion.

6. Exempt Annuities – the exclusions under this section were repealed under Tax Return Act of 1984 for all estates of decedents dying after 1984.

G. §2040 – Joint Interests1. Introduction

a. There are four possible rulesi If decedent’s interest and that of the other co-owners was acquired

gratuitously – each co-owner will be taxed at death for his ratable shareii If the decedent’s wealth created all of the joint interests – the entire value of

the property is included in the decedent’s gross estateiii If the decedent’s interest was created gratuitously by the other co-owner –

there is nothing from this property included in the gross estate of the decedentiv If the both the decedent and the co-owner contributed to the acquisition of the

property – the portion of the property equal to the decedent’s share of the cost of acquisition is included in his estate

b. Special Rule in 2040(b) for joint tenancies in which the co-owners are spouses2. Forms of Ownership Covered

a. Joint Tenancies – property is held by decedent and another or others with a right of survivorship

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b. Tenancies by the Entirety – joint tenancy where the only tenants are husband and wife

c. Joint Bank Accounts – specifically included in the statute where the deposit is payable to either co-owner or the survivor

3. Some §2040 Misconceptions must be set aside:a. It is immaterial that jointly owned property is not part if a decedent’s estate for

purposes of probate or administration. b. The value of the decedent’s interest in the jointly held property prior to the

decedent’s death is by no means the measure of what is to be included in the decedent’s gross estate.

c. The estate tax treatment of property owned by the decedent and another as joint tenants is not affected by the fact that the creation of the tenancy was treated as a gift for gift tax purposes, except with regard to the possible availability of a credit for gift tax paid.

4. Amount to be Included – the value of the jointly held property, except to the extent that the surviving tenant(s) contributed to the cost of the property.

5. Survivor’s Contribution – a. the amount to be excluded as the survivor’s contribution bears the same ratio to

the entire value of the property as the consideration furnished by the survivor bears to the entire consideration paid for the property

b. Amount Excluded = (survivor’s consideration/entire consideration paid) * entire value of the property

6. Property Acquired by Gift From Others – upon the death of one of the owners, the property is treated for estate tax purposes just as if each owner had contributed an equal part of the purchase price (value included = value of property/# of owners)

7. Property Paid for by Co-ownersa. The Tracing Requirement

i Only contributions from separate funds of the survivor are taken into account under the exclusionary rules.

ii A contribution originating as income from property acquired gratuitously from the decedent constitutes contribution from the survivors separate funds. What is income for these purposes? Dividends from stock, rent from property – clearly income when

contributing to the acquisition of a separate property Gains from the sale of property used to purchase jointly held property –

income constituting separate funds Appreciated property used as contribution – not income and will be

considered contributed wholly by the decedentb. Additions and Improvements –

i The regulations state that the total cost of acquisition included the cost of “capital additions.”

ii Three approaches Application of the regulations literally – the exact dollar amount actually

contributed Allocation to each of the co-owners a part of the appreciation

commensurate with the co-owners contributions prior to the appreciation.

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Reduction of the cash contribution made by the surviving owner from the total value of the property to arrive at the value to be included in decedent’s gross estate

iii The first and third approaches should both be rejected and the second one should be applied.

8. Burden of Proofa. The burden of showing original ownership or contribution to the purchase price

by the survivor falls upon the estate. b. In the case of a bank account – you have to show contribution by the survivor and

no subsequent withdrawals.9. Termination Prior to Death

a. Creation of a tenancy in common near death – only half of the property would be included in the decedent’s estate.

b. If the decedent and the surviving co-owner transfer the entire property to a 3rd party, then none of it will be included in the gross estate – regardless of whether or not he lives for 3 years after (gift of property not an interest in property so not includable under 2035, but the gift tax associated with decedent’s portion of the gift will be included)

c. If decedent and co-owner transfer to trust and retain a life interest – half of the property will be included in his gross estate. Rationale – at the time of the transfer the decedent had only one half interest in the property under local law, which is all the decedent could have transferred.

10. The § 2040(b) Exceptiona. General Rule

i (b)(1) provides a flat rule that ½ of the property jointly owned is included in the estate of the predeceasing tenant in the case of a “qualified joint interest”

ii (b)(2) “qualified joint interest” – the co-owners are husband and wifeb. Exceptions:

i Inapplicable to qualified joint interests created prior to 1977ii Inapplicable where the surviving spouse is not a U.S. citizen

If non-citizen becomes a citizen prior to the filing of the decedent’s tax return and is a U.S. resident at all times after decedent’s death and prior to becoming a citizen then (b)(1) will apply

To the extent it is included in the estate the spouse can transfer the property to a QDOT and it will qualify for the marital deduction and QDOT treatment resulting in the postponement of decedent spouse’s estate tax.

c. One thing to be concerned with here is that you do not want to have too much property to be held jointly because then there may not be enough to fund the credit shelter trust – all jointly held property will go to the spouse qualifying for the marital deduction. You want to make sure that each spouse owns enough property individually to fund the credit shelter trust.

H. §2041 – Powers of Appointment1. Introduction

a. Never applies to a retained power – this is reserved for 2036, 2038

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b. Only applies to a power conferred to the owner by another person or group of persons.

c. There is a comparable provision in the gift tax area – see §25162. Powers within §2041 – a right that may be exercised either during life or by will, not

necessarily both, to direct who shall become owner of the property subject to the power. Includes:- right to consume the principal of the trust- unrestricted right to substitute oneself for the existing trustee of a trust, if the

trustee has a power of appointmentb. Relationship to Other Sections

i §2041 never operates to exclude from a decedent’s gross estate the value of property that is includable under other sections

ii Does not apply to powers “reserved by the decedent to himself” which are within the scope of other sections

c. Powers that Overlap Interests – If decedent had an actual ownership interest in the property it will be included in the gross estate under 2033.

3. Definition of a General Power – a power is general if it “is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate.” (one that can be exercised directly or indirectly in favor of one’s own benefit)

4. Exceptions to General Definitiona. Power Limited by a Standard

i 2041(b)(1)(A) – if a power may be exercised only in accordance with an ascertainable standard relating to the decedent’s health, education, support, or maintenance, it is not treated as a general power of appointment. If it is an ascertainable standard not related to one of the above, then it is

not sufficient to limit the powerii Critical Question – whether the power is limited by an ascertainable standard.

b. Post 1942 Powers with Another Person i Power held with the creator of the power – the property will be brought into

the creator’s estate under 2036 or 2038ii Power held with an adverse party – someone who has a substantial interest in

the appointive property, which interest will be adversely affected by an exercise of the power in favor of the decedent

iii Power held with an equally interested party – if a decedent’s power to appoint for his benefit can be exercised only in conjunction with one other person in whose favor the power may also be exercised, only ½ of the property will be treated as subject to a general power of appointment in the decedent.

c. Judicious Use of Powers – congress has left considerable room for the judicious use of powers of appointment in planning at substantial tax savings.

5. Treatment of Pre-1942 Powers – gives rise to estate tax inclusion only if the power is a general power and the decedent exercises the power.a. Exercise of Power

i Non-exercise of a pre-1942 power is not taxableii The power must be exercised by will or in some other manner akin to

testamentary disposition in order to cause estate tax liability

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iii If a pre-1942 power is exercised by a disposition of a type that would be caught by 2035-2038 if an actual transfer of property were involved, estate tax liability results.

b. Failure to Exercise – the statute explicitly states that failure to exercise shall not be deemed an exercise

c. Complete Release i A complete release shall not be deemed an exerciseii What constitutes a complete release?

There are no good guidelines in the regulations so inaction seems to be the safest route

d. Partial Release of Pre-1942 Powers – when a general power is partially released such that it is now a limited power, the exercise of the limited power will be considered an exercise of a general power

6. Treatment of Post-1942 Powers – several tests determine whether the value of property subject to post-1942 general power of appointment in the decedent must be included in his gross estate: a. Possession

i Did he have possession of the power at the time of his death? ii It is irrelevant that he was under legal disability to exercise it at all times after

the power was created – mere possession. iii Conditional power of appointment – triggering event:

Decedent has no power over the triggering event – no possession of the power at death

Decedent has power over the occurrence of the triggering event – possession of the power at death

iv Giving Notice as a Requirement of Exercise – value of the property to be included in the gross estate will be discounted for the period required to elapse between the time of the decedent’s death and the time the power could have been exercised.

b. Exercise i A pre-death exercise of the general power in a testamentary fashion requires

inclusion of the value of the property subject to the power in the gross estateii If the power is exercised through the will – inclusion of the value of the

property subject to the poweriii Exercise that involves a disposition that would be covered by 2035-2038 if it

were transferred in the traditional wayc. Release – a lifetime release of the power will be equivalent to an exercise of the

power d. Disclaimer or Renunciation – 2518 provides a rule for disclaimers that allows an

individual who is given a post-1942 general power of appointment to avoid any tax consequences with respect to the power.

e. Lapse – release of a general power includes the lapse of the power during the donee’s lifetime, subject to some important exceptions

f. The Five or Five Rule – the exception to the general rule that a lapse = releasei The general rule is inapplicable if the power that lapsed was such that during

any calendar year its exercise was limited to $5K or to 5% of the value of the

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property out of which the exercise of the power could have been satisfied, whichever is greater. If the lapse exceeds these amounts, it is to be treated as a release only to

the extent of the excess 5% of the value at the time of the lapse If the decedent’s power is limited to only part of the property, then only

that part is used to measure the 5% exclusion. ii The failure to exercise the power that fits within this exception would have no

resulting estate tax consequence. iii You would want to make sure that the power expires in a short time because if

the decedent died while the power was unexercised and the lapse had not occurred then it would be included in his estate.

iv One way to set up one of these trusts: We have a list of beneficiaries who may make annual non-cumulative

withdrawals of the greater of 5K or 5%, BUT we never expect them to make any of these withdrawals.

This way we are passing wealth using the annual exclusion, and building up the trust to pass to future generations. You can make the gift up to the amount of the annual exclusion for each of the beneficiaries

7. Amount to be Included – it is the value of the property that the decedent could or did appoint that is brought into the decedent’s gross estate

I. §2042 – Insurance1. Introduction

a. Two Basic Inclusionary Rules → The proceeds of insurance policies on a decedent’s life are to be included in the insured’s gross estate if they are:i Receivable by the executor ORii Receivable by other beneficiaries and the decedent had any incidents of

ownership in the policy at death. b. This section only applies to decedent’s ownership of a life insurance policy on his

own life.c. This section is not necessarily exclusive.

2. What is Insurance? a. In order to be insurance the policy must include the distribution or shifting of the

risk of premature death. b. Conventional policies which guard against death (accidental or not) and a double

indemnity of a life contract. c. Death benefits paid by fraternal beneficial societies operating under a lodge

system. 3. Amounts Receivable by or for the Estate

a. Meaning of Executori “receivable by the executor” – they are part of decedent’s gross estate for tax

purposes. “receivable by or for the benefit of the estate” when nominally payable to another beneficiary who is legally bound to

use the proceeds to discharge the estate’s obligations, such as taxes, debt, or other charges.

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ii “executor” – the executor or administer of the estate or, if none is appointed, “then any person in actual or constructive possession of any property of the decedent.”

b. Simultaneous Death – If the primary beneficiary dies at the same time, then it will go to the secondary beneficiary and whether or not it is included will depend upon who is the secondary beneficiary.

c. Is Insured’s Wealth Transmitted – yes, it is something that is owned by the decedent that happens to increase in value on the date of his death

4. Amounts Receivable by Other Beneficiaries a. Incidents of ownership

i Full ownership is not requiredii House Ways & Means listed some incidents (not exhaustive):

The right of the insured or his estate to the economic benefit of the insurance

The power to change the beneficiary The power to surrender or cancel the policy The power to assign it The power to revoke an assignment The power to pledge the policy for a loan The power to gain from the insurer a loan against the surrender value of

the policyb. Reversionary Interest – this is an incident of ownership only if the value of the

reversionary interest exceeds 5% of the value of the policy immediately before the decedent’s death i Includes “a possibility that the policy, or the proceeds of the policy, may

return to the decedent or his estate, or may be subject to a power of disposition by him.

ii Be careful of ultimate and indefeasible rights conferred by the policy on the decedent and any remainder interest in the policy.

c. Effect of Policy Termsi The express terms of the policy generally determine the incidents of

ownership, but where these are unclear, the courts will look to the substance of the transaction.

ii The burden of proof is on the estate of the decedent to show that there are no incidents of ownership when the terms indicate that there are.

d. Buy-and-Sell Agreements – usually these collateral agreements will provide a surrender of all rights by the decedent and thus no inclusion under 2042i When a transfer for value is made, the buyer loses the exemption for income

tax purposes – for example if X had an insurance policy on his life with ‘s estate as the beneficiary and Y bought the policy such that he would become the beneficiary, he would not have the income tax exemption.

ii 4 Exceptions: transfers to the insured transfers to a partner of the insured transfers to a partnership of which the insured is a member transfers to a corporation in which the insured is a key shareholder.

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iii Note> in order to purchase life insurance on a person you must have a relationship with that person rendering an insurable interest.

e. “Incidents” in Contexti if the origin of the insurance is such that some form of wealth transfer by the

decedent is evident, very slender 2036-2038 rights should be regarded as incidents of ownership, but

ii if the policy is not generated at all by the decedent’s wealth or is disassociated from the decedent by a prior outright gift, then the stronger 2041 type rights should be recognized as incidents of ownership.

f. Economic Benefit – courts use this to narrow the meaning of “incidents of ownership”

5. Incidents Incidentally Helda. Shareholder in a Corporation

i Where corporation is the beneficiary and the decedent is a controlling shareholder, then the incidents of ownership will be attributed to the corporation

ii Where the Corporation is not the beneficiary and the decedent as legal or equitable ownership of more than 50% of the combined voting power of the stock of the corporation, the corporation’s ownership attributes will be attributed to the decedent.

b. Partnership’s Insurance on Partneri Incidents attributable to the Partnership

When the proceeds are payable to the partnershipii Incidents attributable to the Partner

When the proceeds are payable to a third person (partner’s spouse) If under the policy the decedent has the right to change beneficiaries

6. Assignment of Group Term Insurancea. An employee may effectively assign a nonconvertible group policy if the

employee assigns all of his rights. b. No incident of ownership in the employee’s conversion privilege at employment

termination. 7. Amount to be Included

a. In General – the full amount receivable under the policyb. Inclusion of Only a Portion of Proceeds – to the portion of the policy over which

incidents of ownership extend8. Policy Purchased with Community Property Funds

a. Only ½ of the proceeds are to be included in the decedent’s estate (the surviving spouse owns the other half.

b. Where the surviving spouse is not the beneficiary, ½ will be in the decedent’s estate and the surviving spouse will have made a gift of ½

9. Relation of §2042 to Other Sections Defining “Gross Estate”a. The Transfer Sections Generally

i §2037 – might be applicable if there is a lifetime interest in the policy transferred, but it is difficult to see how this would produce a more onerous tax result than 2042, so the government usually does not resort to this

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ii §2036 – not likely to be resorted to because rarely will decedent even want a lifetime interest in life insurance

iii §2038 – this would satisfy the incidents of ownership requirement iv §2039 – this is expressly inoperable to insurancev §2041 – this will be treated as an incident of ownership

b. Near-Death Transfersi §2035(a) applies only where decedent actually held an transferred 2042

incidents of ownership.ii 4 possibilities:

Transfers more than 3 years Beneficiary pays all premiums post transfer – nothing included in

decedent’s estate Decedent continues to pay all premiums – nothing included in

decedent’s estate Transfers within 3 years

Beneficiary pays all post transfer premiums – the pro rata amount of the proceeds attributable by the decedent’s payments

Decedent pays all post transfer premiums – all of it would be included 10. Planning Aspects:

a. This is an asset that we typically want to divest our client of incidents of ownership. We should be able to do this without any federal estate taxes. It has a much higher value on the date of his death than it does when he is alive. You can give it as a gift at a lower value when he is alive, but upon death, if it is still owned, then it is included in his estate at face value.

b. Irrevocable Life Insurance Trust – we will use this trust to keep it out of the estate of the insured, the insured’s spouse, and maybe the children of the insured.i He would transfer any life insurance policies that he owns to the trust – whole

life, term, even group. ii He makes the policies payable to the trust – but there are still risks of

inclusion under §2035 – the 3 year time frame we are concerned with. If the transfer was within three years of his death, then if they would have been included under §2042.

iii There will be a gift tax on the transfer of the policy – policy valued at CSVJ. Valuation

1. General Methodsa. Income Approachb. Market Approachc. Asset-based Approachd. Combinations

2. Valuation Determined by Agreement – §2703a. We do not take account of buy sell agreements when we value the business for

estate tax purposes – they will be binding on the members only.b. Courts will usually give deference to the agreement if – bona fide business

transfer agreement AND the terms of this agreement are comparable to other arrangements between 3rd parties.

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c. The failure to use a formula will lead to the belief that this will not be an excepted agreement.

3. Adjustments for Discounta. Discount for Minority Interestb. Discount for Lack of Marketability – This can be argued whether or not you have

control of the company. If you have 51% there still may be a discount because there is no market for the percentage share

Note> There is a wide range for the discounts to be applied. There is a requirement of an appraisal of the interest of the entity – we need a valuation of the partnership interest in the business. - This takes account of any and all restrictions that may be in the partnership

agreement.- The service does not like these discounts – and they have tried to get legislation to

limit the discounts.c. Other Significant Discounts

i Fractional interest discount – this can be in percentage shares of commercial property, timberland, etc. This works well the practice of asset protection

ii Blockage and market absorption discountsiii Capital gains discountiv Securities law discountv Environmental hazards discountvi Key person discountvii Litigation discount

d. Combination of Premiums and Discounts e. Nonbusiness Assets held in FLPS and FLLC’s

i A FLLP or FLLC can be used to shelter some of the property that would not necessarily fall into discounts by forcing them to be discounted. These entities will restrict the rights regarding the property.

ii Use of this can reduce the size of the estate by about 40%. Some people raise the question of whether or not the formation of the partnership itself creates a gift to someone – but who???

iii When you put this property into one of these entities, then you have to value the entity, not the particular property. You have to be careful on how you do this – you have to respect the partnership form. All of the assets need to be titled to the partnership and the income should

go to the partnership as opposed to the partner.iv The service does not like these and has made it clear that certain FLLP’s had

to go to the national office for auditing: Substantial amount of marketable securities (we all know what these are

worth, by putting them in these entities the decedent is just trying the avoid estate tax),

Partnerships created within a short time before death makes it look like this is just a device to mitigate the estate tax they are trying to argue that the partnership agreement itself is a buy

sell agreement that should not be used in the valuation of the property, Powers of attorney

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v Any of these will generate more difficulty in an IRS audit. The service has not had a lot of luck with arguing these cases. (Case in Texas about a partnership formed VERY close to death – the court found that this was okay)

4. §2701 – Certain kinds of interests in partnerships and corporationsa. Corporations

i A person who owns 100% of corporation – you would recapitalize with common and preferred and we would create a class of preferred stock that has a value of 100,000. Then we would give away the common stock to the younger family members. The older family member would retain the frozen capital and give away the growth portion of the corporation.

ii These transactions are no longer worthwhile under this code section.iii The valuation principle that is applied is that

The common stock will never be worth less than 10% of the corporation and

The preferred will not be worth the entire amount.iv The statute makes you guarantee a regular right to payment.v These are not worth doing any more – too costly.vi Only apply this section if the transferor retains the frozen interest and gives

away the part that grows.b. So what we set up is a partnership that has a corp as a GP and all of the members

of the LP have the same interest in the partnership. And this rule has no application.

5. §2704 – Treatment of Certain Lapsing Rights and Restrictionsa. Ex: Contributed 50M of oil and gas property in an LP and took back an LP

interest with certain restrictions. The LP rights allowed him to force the LP to give back the property, but upon death this right terminated. What was included in the estate – the LP interest, but how should it be valued? And should be look at the moment before death or the value at the moment of death. The court said that the value that passes is that value right before death.

b. In valuing partnership interests, we ignore restrictions that lapse upon the death. This increases the value of the property at the time of the gift of the property.

6. §2032. Alternate Valuation Datea. We are given an alternate valuation date – this is an elective provision b. Provides for an alternative valuation date of 6 months after the date of deathc. We can only do this to reduce estate tax liability – this cannot be used to try to get

a higher basis in the property.7. §2032A. Valuation of Certain Farm, Etc., Real Property

a. Introduction i Normal valuation says that we use the best use for the value of the property.

But, this provision allows us to value the property at its current use instead of its highest and best use.

ii This provision was brought in the 70’s to help the estates of persons who own family farms (there was a lot of speculation in land during this time and the values were sky-rocketing)

b. Qualifications for Special Use Valuation in General

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i an active business – the decedent was a material participant in at least five of eight years prior to his death

ii it is passing on to a qualified heir and that party is going to be a material participant in the active business.

iii Only allowed to use this if it is a substantial portion of the estate: 50% of the value of the gross estate real property itself has to constitute at least 25% of the gross estate

iv This is limited to a reduction of 850K. So, when you value the property at its highest and best use and then its current use is valued more than 850K less than that, you are limited to the 850.

c. Election and Agreement i This is an elective provision – you have to remember to make this election. ii You have to comply with all of the requirements for the valuation, now it is

more like substantial compliance. There are certain statute authorized methods of valuation.

d. Recapture i The Ten Year Period

You are at risk (for 10 yr period) that the tax will be recaptured if certain things occur and the service will impose the valuation that would have been applied if this election was not applied.

ii Measuring the Recapture Taxiii Liability for Additional Taxiv Basis Adjustment for Additional Tax

8. §6166 Deferment of Estate Taxesa. You can elect § 6166(only estate tax attributable to business value included in the

estate) to defer the payment of estate tax for about 15 years – then you will only pay interest on the estate tax, then you pay the estate tax in installments for the next 10 years. The interest rate is fixed at 2% plus 45% of the current market rates

b. The purpose of this is to not put too much burden on the estate when the decedent dies.

c. This section also has provisions that if you dispose of the property then the tax payable will be accelerated. This applies to the entire value of the business – not just the real estate portion.

K. §2053 Expenses, Indebtedness and Taxes1. Introduction

a. We take these deductions to get down to the value of the estate that is really available for distribution. This gets us down to the taxable estate. (also §§ 2055, 2056)

b. § 2053 this is about the expenses necessary in carrying out the distribution of the estate.

c. We would look at all of the debts that he owed at the time of his death wanting those to be appropriately taken care of. Ultimately we will be distributing assets.

d. We want to identify claims of the estate and total amount of debt. e. Technically allows the expenses outlined under (a). The language after that talks

about expenses allowable under state law.

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i Critical Question: Is the executor authorized to pay these things out of the estate? He can only use the probate estate to pay these expenses.

ii All of the items that pass out of the probate estate will have some administrative expenses – it may be necessary that some of these expenses be paid from other parts of the gross estate.

f. But, (b) makes it clear that if we have similar kinds of expenses that would be deductible if they related to probate assets, we will be able to take the deductions for the expenses relating to the non-probate assets.

g. Limitation – Amounts actually expendedi There will often be expenses well beyond the filing – we can estimate these

executor fees, accounting fees, attorney fees, etc. ii If you never paid the estimated amounts you are obligated to go back and

amend.2. Funeral Expenses - very liberally, includes sending someone and the body to the

burial plot. It does have a reasonableness limitation for some items – silver casket example from the book.

3. Administrative Expenses – The collection of the decedent’s assets, determining what other claims exists, paying off those claims, and distributing the assets of the estate. This raises several questions as to the scope of what is necessary.a. We have to draw the line with what is necessary and what is not – if the will is

ambiguous there may be more expenses that are deductible. There is a prohibition of paying attorney fees for the benefit of the beneficiary, but when there is a disagreement or ambiguity in the will, then this might be necessary and thus included.

b. The service says that cannot deduct all the administrative expenses arbitrarily because they are in effect increasing the value of the marital deduction with property acquired after death. i The deductible administrative expenses are limited to the value of the

“property subject to claims.” That part of the gross estate that under local law will bear the burden of

such expenses, claims, and charges, reduced, however, by any casualty loss deduction allowed under 2054.

ii The administrative expenses relate to the assets of the estate such that it should be deductible on the income tax purposes.

c. Expenses associated with selling certain assets of the estate – is this necessary for the proper distribution of the estate.

d. Interest for borrowing for the estate – is this necessary for the proper distribution of the estates – i Where we have highly liquid assets available, then you probably should not

borrow and the interest expense would not be deductible. ii Where you have a business interest included in the estate or illiquid assets –

then borrowing might be necessary. iii The payment of the interest is a proper payment for the estate to make and can

be deducted. BUT remember – this is an interest expense deduction as well. You have to make a choice as to which deduction you want – estate tax or

income tax.

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The logical thing to do when you have an estate that will not have any estate tax – you have a reduced to zero estate tax plan, then you will want to use these deductions for income tax purposes.

.iv

e. Investment Expenses – there are arguments for and against these being deductible expenses.

f. Expenses to maintain property – maintenance of the property for preservation until the date of distribution is deductible – but you could not deduct development expenses.

4. Debts and Claims Against the Property – a. It must be a filed claim in order for there to be a §2053 deduction. b. The Service’ position is that this is not something that the executor should pay – it

can only be claims for which a proper claim has been filed.c. Revenue Ruling 60-47 – you cannot deduct a claim that will not be paid because

the creditor failed to file.d. 2053(c)(1)(a) – Consideration for claims - Any claim must be supported by

consideration for money or money’s worth.i A separation agreement with a spouse – the giving up of rights of support is

adequate consideration or if it is based on judgment or order of the court then it is sufficient.

iie. When a claim is uncertain you can probably get an extension for the estate tax

filing because the amount could be significant – for example a litigation claim that has not yet been settled.

5. Mortgages - can be deducted without filing to the extent of the value of the property that is included in the gross estate.The accrued interest is something owed at death – so there is no question that this is a §2053(a) deduction.

6. Subsequent Eventsa. There is a moment that we value all of the property in the decedent’s estate (DOD)

and that same moment is when claims are valued.b. But there is an extent that we will take into account subsequent events that effect the

claims against the estate. i The example of the former spouse who has an right to payments until her death or

remarriage and she dies within the 9 month filing time – should we take her death into account for valuing this obligation?

ii Courts are split on these issues when we know there is an obligation to pay – the only question is the value of the asset

c. Subsequent events should not be taken into account in the valuation of the debt EXCEPT when the validity of the debt is questionable at the date of debt.

d. The courts struggle with these issues – there can be a lot of money involved. Gives an example of a 5th Circuit case – In re Smith(???) It is the value of the claim at death.

L. §2054 Losses1. §2054 is very much like the income tax casualty loss deduction.

a. Prior to filing the estate tax return we might have an event that causes a casualty loss.

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b. We are looking for events of a catastrophic nature. c. This also includes theft. d. We look to the income tax rules to determine what the casualty is. We also look to

the income tax rules to determine what the loss is.e. A taxpayer can only take one of the two provisions – if his estate claimed the 165

deduction on his final income tax form, then he cannot take this deduction.2. FMV before the event – FMV after the event = casualty loss. This is limited to the

FMV before the event.3. Alternative valuation will take into account the reduced value so that you will not be

able to take this deduction if you have chosen the alternative valuation date which was after the catastrophic event.

M. §2055 Charitable Deductions – this is limited to the value of the property transferred to charity, but it is unlimited in the sense that it is not subject to percentage restrictions such as are applicable to the income tax deduction for contributions to charity.1. Qualified Recipients

a. In General i The charitable contribution must get to the charity by way of bequest, legacy,

devise, or transfer by the decedent.ii There will not be a deduction when the decedent’s will fails to identify a

particular qualified recipient. iii Policy

Charitable organizations perform services that are useful to the nation, services that might otherwise have to be paid for out of tax revenues.

Generally take one of two forms: Exemption of the organization from tax A deduction for taxpayer contributions to the organizations

b. §2055(a) Organizations i The US, the several states and their political subdivisions, and the District of

Columbiaii Corporations “organized and operated exclusively for religious, charitable,

scientific, literary, or educational purposes” iii Trusts and certain fraternal organizations – bequests only deductible if they

are to be used solely for charitable and related purposes. iv Veterans’ Organizations incorporated by an act of Congress and their local

chapters and postsc. We see more donors creating their own private foundations that are qualified

charities.i This carries with it some expense – you would want at least 1mil in order for

this to be worth it. ii There is a lot of compliance that is required with these.

If the private foundation is not in compliance there will be a penalty. These are heavily regulated – there is a lot of filing that is required.

iii These can help family members if you name an adult child to run the foundation – they will be entitled to a salary and any necessary travel benefits. Private Foundations have to distribute a certain amount of the assets every year.

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2. Transfers to Charitya. Outright Transfers – decedent leaves cash or other property → reasonably

confident that estate will get the expected deductionb. Indirect Transfers – when the transfer occurs as a result of a will contest, an

assertion of an elective share, or a reformation of a will, in a manner that otherwise qualifies for a charitable deduction and if it is condoned by the local courts. (if it looks like it is simply a collusive effort to qualify property for the deduction it will not be allowed.)

c. Disclaimers – if you have the lifetime interest in a property whose remainder is to go to charity, you can make a qualified disclaimer of the interest and get the charitable deduction.

d. Property Over Which Decedent Had a Power – there is a deduction for property that is brought into the estate by means of 2041 when the power is exercised in favor of a qualified organization.

e. Lifetime Transfers – property that is brought into the trust under 2036 will qualify for the charitable deduction if the property goes to a qualified organization (ex – lifetime transfer of residence to the Red Cross, reserving the right to its use for life, the property is included in the gross estate but 2055 can be used to offset it)

3. The Amount of Deductiona. In General – date of death value of the property is the amount to be deductedb. Expenses of an Estate Affecting the Deduction

i Death Taxes – you have to take out whatever taxes were paid out of these bequests in order to determine the charitable deduction. The deduction has to be the amount that the charity actually received.

ii Administrative Expenses and Claims – amount of deduction is reduced to the extent that any of these payments were made out of the property passing to the charity. Note> Transmission expenses v. Management Expenses – Management Expenses would have to be paid even if the decedent was still alive and thus would not reduce the amount of the deduction.

4. Split Interests: Mixed Private and Charitable Bequestsa. Background

i These allow the decedent to take care of his survivors and take advantage of the charitable deduction

ii The concern had been that there would be manipulation of the investment policy – you want to make sure that everything was properly valued.

b. Present Law – only allowed in circumstances in which the valuation uncertainties arising out of the beneficiaries’ income rights and the trustee’s investment discretion are minimal or nonexistent.

5. Qualified Remainder InterestsNote> In order for a remainder trust to qualify, it must meet all of the requirements of one trust and not mix and match. a. The Charitable Remainder Annuity Trust

i Annuity Trust Requirements – A fixed amount at least annually that cannot be less than 5% nor more

than 50% of the initial FMV of the assets that go into the trust.

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Annuity must be for the life of the annuitant or for a term of years not to exceed 20 years.

The remainder must go in whole or in part to a qualified organization or held in trust for the organization’s use.

The value of the remainder must be at least 10% of the initial FMV of the property placed in the trust.

ii The Amount of the Deduction – the net FMV of the corpus of the trust less the value of the non-charitable interest in the trust.

b. The Charitable Remainder Unitrust i Unitrust Requirements

a fixed % of the annual FMV of the assets in the trust that cannot be less than 5% of the annual FMV of the assets

May have multiple named non-charitable beneficiaries Each non-charitable interest must not extend beyond that beneficiary’s life

or a term of years not to exceed 20 years No other non-charitable interests The remainder must go in whole or in part to a qualified organization or

held in trust for the organization’s use The value of the remainder must be at least 10% of the initial FMV of the

property placed in the trustii The Amount of the Deduction – the net FMV of the corpus of the trust less the

value of the non-charitable interest in the trustc. The Pooled Income Fund – donor contributes money to the fund which is

commingled with money from other donors and the charity invests the money. i Pooled Income Fund Requirements

Annual Fixed Payout - % determined by the charity When the donee dies, the money goes to the charity The value of the remainder interest is what qualifies this fund.

ii The Amount of the Deduction – the value of the entire interest contributed less the value of the income interests

6. Charitable Lead Trusts – the qualified organization gets the first interest with the remainder interest going to a non-charitable partya. There is no imposition of the minimum 5% interestb. Must be either Annuity or Unitrustc. Not limited to 20 yearsd. There is no income tax reduction – because the charitable donee will be exempt

from income tax and the income is for the trust and will not be included in the donor’s income.

e. These can be used to take advantage of certain GST provisions – it will not become applicable until the lead terminates (so you never know – Congress may repeal the GST by the time the annuity interest for charity terminates).

f. These are used mostly by very wealthy individuals – if in life it is probably because they give a lot to charity and are running into percentage limitations and if in death it is probably to take advantage of GST provisions.

g. The lead interest is what qualifies these trusts7. Exceptions to the Split Interest Rules

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a. Remainders in Residencies and Farmsb. An Undivided Portion of the Propertyc. A Qualified Conservation Contribution

i These are most beneficial during life – there is an immediate income tax reduction § 170

ii At death you get a charitable deduction for the value of the easement and you can make an election about how this property will be valued § 2031(c) – this election will reduce the value to be included. This allows you to exclude a portion of the property as well as take the charitable deduction This is kind of like a double benefit.

d. Works of Art and Their Copyrighte. Charitable Gift Annuity

N. § 2056 Marital Deductions1. Introduction

a. The marital deduction is unlimited – it has not always been this way, but it is now. It started when Congress was trying to equalize the community property states and the others.

b. The marital deduction is meant to be a tax deferral tool. So, we want to allow a deduction for items that will be included in the Surviving Spouse’s estate.

c. The marital deduction is generally mandatory – but it is hard to imagine when someone would not want to use this.

2. General Description – Two Basic Featuresa. Deduction allowed for any interest that passes at death or that passed during life

from a decedent spouse to a surviving spouseb. Must be a deductible interest:

i It is included in the decedent’s gross estateii It is not otherwise deductible under some other estate tax deduction provision. iii It is not a terminable interest.

3. Interests Passing to a Surviving Spouse – An interest shall be considered as passing if it goes to the surviving spouse in the following manners: a. By will or inheritance (2055(c)(1&2)) – this includes a deductible interest that

goes to the surviving spouse after a settlement. b. Dower (2055(c)(3) – the statutory share must be claimed by a timely filing under

state law to qualifyc. Transfers (2055(c)(4)) – any transfer during life will be considered as having

passed to the surviving spouse – it does not matter is the SS was the decedent’s spouse at the time of the transfer, but it does matter is SS was spouse at the time of death.

d. Jointly held property (2055(c)(5)) – the deduction will be allowed for the value of the property that would have been included in the decedent’s estate at the time of death – tenancy by the entirety.

e. Property Subject to a Power (2055(c)(6)) – if decedent had a power over an interest and as result of exercising, releasing, or non-exercise of the power, the SS receives the interest. The giving of the power does not in itself constitute an interest in the property passing to the spouse.

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f. Insurance (2055(c)(7)) – insurance proceeds that are paid out to SS at he death of the decedent. The deduction hinges upon whether or not the proceeds were includable in the decedent’s estate.

g. Other “Passing” Problems – support payments will meet the passing requirements if it passes the terminable interest rule.

h. Disclaimers – marital deduction is foreclosed for an interest that the SS disclaims causing it to pass to someone other than SS

4. The Gross Estate Requirement - Can enter the calculation of the marital deduction only to the extent that it is included in determining the value of the gross estate.

5. The Valuation of Interests Passing – must be undertaken with the valuation method and the valuation date adopted for valuing the gross estate. a. Taxes on Surviving Spouse’s Interest – if interests passing to a SS share the

economic burden of any death taxes, state or federal, the value of such interests must be diminished accordingly in computing the marital deduction.

b. Encumbrances on Surviving Spouse’s Interest – 2056(b)(4)(B)i Mortgages –

If decedent is personally liable for a charge against a property, the entire value of the property is included in decedent’s gross estate, but only the value of the decedent’s equity in the property will be includable as a deduction.

This is because it would otherwise cause a double deduction – §2053 operates to reduce the value of the property for indebtedness whether or not the decedent was personally liable.

ii Administrative expenses The marital deduction is reduced if administrative expenses are deducted

under §2053. The marital deduction is also reduced by the amount of administrative

expenses that are deducted under the income tax as a result of a §642(g) election and are paid out of the marital share but are related to non-marital property.

iii Assumption of an obligation – a bequest to a spouse conditioned on the spouse’s assuming an obligation operates to reduce the value of the property passing to the spouse for purposes of the marital deduction.

6. Formula Clausesa. Types of Clauses determining the funding for the Credit Shelter Trust and Marital

Trust:i Fractional Bequest – a specific fraction is given to each trust – ½ and ½. ii Pecuniary Bequest – a specific $ amount is left to one trust with the other to

receive the residuaryiii Formula Fractional Bequest – The fraction is a fixed formula with the

numerator as the amount you want to fund the particular trust and the denominator as the residuary value of the estate.

iv Formula Pecuniary Bequest – The pecuniary bequest is determined by saying that the amount going to the trust is the smallest amount necessary to take full advantage of the unified credit when the formula is for the marital trust or

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maximum amount to take full advantage of the unified credit when the formula is for the credit shelter trust.

b. Special Problem with a Pecuniary Bequest to a Surviving Spouse i A pecuniary marital deduction bequest using date of distribution value shifts

post death appreciation from the surviving spouse to the residuary legatees, who are also called on to absorb post death shrinkage. The estate must recognize the gain for the appreciated value of property. Alternatively, if the estate goes down in value the marital trust portion will

be disproportionately large. ii If the pre-residuary trust is the credit shelter trust using the date of distribution

values – then the credit shelter will get only the 1mil (or stated amount) and then your marital trust will have all of the appreciation. A lot of lawyers use this method because it is easiest.

iii If the pecuniary bequest is satisfied using the estate tax value of the property, then you could fund the martial bequest with the assets that have depreciated in value – this way the credit shelter trust could take advantage of any appreciated assets. Rev. Ruling 64-19 - If you have a Pre-residuary marital bequest that is a

pecuniary formula and the executor is authorized to fund the trust with property at estate tax value, then you have to modify your funding method Minimum worth – you can fund at estate tax value, however you must

also look at the value of the property funding the marital trust at the date of distribution and they have to be at least the same amount as the marital deduction taken on the estate tax return

Aggregate sharing – fairly representative of the aggregate appreciation of the estate.

You have to adopt one of these funding options or you lose the marital deduction – most states have adopted a saving statute so that people will not lose their marital deduction if they do not state how they want it funded in the will.

This is designed to prevent the funding of the pre-residuary pecuniary bequest with all depreciated assets and will still eliminate the recognition of gains and losses.

c. Outdated Formula Clauses 7. Terminable Interest Rule

a. General Rule and Purpose i Non-deductible if:

The interest is terminable; The decedent has also given an interest in the property to another; and On the termination or failure of the spouse’s interest, the other person may

come into possession or enjoyment of the property by way of that person’s interest.

ii Seeks to assure that there is a transmission tax when the property is transferred to others by allowing a marital deduction only where the nature of the interest passing to the spouse is such that, if retained until death, it unquestionably will be taxed in the spouse’s estate.

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b. Identifying Terminable Interests i A legal life estate or life interest is a trust.ii An interest is terminable if it will fail or terminate upon a “lapse of time,” the

occurrence of a contingency, or on the failure of an event or contingency to occur. “widow’s allowance” – must vest at the date of decedent’s death to be

considered non-terminable Survival Clause – renders the interest terminable even if the spouse

survives because the interest is determined based on the failure of an event to occur.

c. Other Elements of the Terminable Interest Rule i No interest in the property has passed gratuitously to anotherii No other person will acquire the property on termination of the surviving

spouse’s interest by reason of any interest that person may have. Must have passed to the other person from the decedent for less than

adequate and full consideration in money or money’s worth. iii The marital deduction is lost only if all three elements of the terminable

interest rule are present. d. The Executor Purchaser Provision – if the decedent directs the executor to

purchase a terminable interest for SS, this is a terminable interest that is non-deductible. However, SS can voluntarily purchase a terminable interest with money left outright to her.

e. The “Tainted” Asset Rule i To the extent a bequest can be satisfied out of assets that would not qualify for

the marital deduction, it is so satisfied – it is enough that the bequest could be satisfied out of the proceeds of such assets in order to run afoul of the rule.

ii This problem can be avoided by stipulating in the will that the SS’s bequest cannot be satisfied with a non-deductible interest or the proceeds therefrom.

8. Terminal Interests that do qualifya. Common Disaster and Related Provisions

The statutory provision is that an interest passing to a SS is not to be considered a terminable interest if it will fail only uponi The SS’s death within 6 months after the decedent’s deathii The SS’s death as a result of common disaster, causing the death of the

decedent as well iii The occurrence of either of such events if, in any event, such failure does not

in fact occur. b. Life Interests with Powers – 2056(b)(5)

i The surviving spouse must be entitled for life to all of the income from the entire interest or a specific portion of the entire interest, or to a specific portion of all income from the entire interest Income is determined using trust accounting The regulations have been modified so that we can use the total return for

the payout to SSii The income payable to the surviving spouse must be payable annually or at

more frequent intervals

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Income must be currently distributable to SS – any mandatory delay in receipt of the income will render the income non-current

iii The surviving spouse must have the power to appoint the entire interest or the specific portion to either surviving spouse or spouse’s estate Where SS has only the power to appoint to her creditor’s this will not

satisfy this requirement If SS can appoint also to another person, the exercise of her power in this

way will result in estate or gift tax and will thus not render the trust invalid.

iv The power in the surviving spouse must be exercisable by the surviving spouse alone and (whether exercisable by will or during life) must be exercisable in all events Any requirement that another person join with SS in exercise of the power

will defeat the exception. To meet the “all events” test the power must arise upon the death of the

decedent and be exercisable, for example, before the estate makes distribution of the property subject to the power; but it is permissible that actual distribution to the appointee be delayed.

v The entire interest or specific portion must not be subject to a power in any other person to appoint any part to any person other than the surviving spouse

c. Insurance with Powers - 2056(b)(6)i The proceeds, or a specific portion of the proceeds, must be held by the

insurer subject to an agreement either to pay the entire proceeds or a specific portion thereof in installments, or to pay the interest thereon; and all or a specific portion of the installments or interest payable during the life of SS must be payable only to SS

ii The installments or interest payable to the surviving spouse must be payable annually, or more frequently, commencing not later than 13 months after the decedent’s death

iii SS must have the power to appoint all or a specific portion of the amounts so held by the insurer to either the spouse or the spouse’s estate

iv The power in SS must be exercisable by the spouse alone and (whether exercisable by a will or during life) must be exercisable in all events

v The amounts or the specific portion of the amounts payable under such contract must not be subject to a power in any other person to appoint any part thereof to any person other than SS

d. Election with Respect to Life Estate for Surviving Spouse – 2056(b)(7)This disposition of the property passes to the SS only a terminable interest that, when coupled with the interests given to others, would not qualify for the marital deduction absent some authority permitting us to pretend that the spouse is the owner of the property for transfer tax purposes. QTIPi The passing requirement – it must be included in the decedent’s gross estate

and pass from the decedent. ii The qualifying income interest requirement

Income Interest

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Must have a right to all income payable annually or more frequently commencing at the decedent’s death

Spendthrift clauses may be allowable An annuity interest is not a qualifying income interest except:

An annuity that is included in decedent’s gross estate under 2039 or is community property included under 2033, and is payable only to SS during her life.

An annuity that is not included under 2039 for decedent’s dying before 1992.

Powers over Property During SS’s lifetime No restriction on SS or anyone else having a power to invade except

that it be only for SS’s benefit Anyone can have a non-general power over the remainder “exercisable

only at or after” SS’s death. We want to make sure that the property will be included in the gross

estate of SS. iii The election

This is operative only if an election is made by the executor on the Estate Tax Return

If you are only electing this for a specific portion of the property – the portion must be expressed as a percentage or fractional share of identifiable property passing from the decedent.

iv Joint and mutual willse. Special Rules for Charitable Remainder Trusts - The terminable interest rule does

not apply to an interest in a CRAT or CRUT that passes or has passed to SS from decedent, if SS is the only non-charitable beneficiary.

f. Interrelationship of the Terminable Interest Exceptions – there may be an overlap between the (b)(5) and (b)(7) trusts making you think that both would work – just remember, you cannot take double deductions.

9. The Non-Citizen Surviving Spouse – must use a QDOT for any deduction to be allowed for a non-citizen spouse.

O. Credits1. §2010 – Unified Estate Tax Credit 2. §2011 – Credit for State Death Tax – this is going away and it was rarely a full credit

anyway unless it was just a pickup tax. This can be included in the credit shelter trust.3. §2012 – credit for gift tax paid on gift tax paid on gifts paid prior to 1977. Gift tax

paid on gifts since 1976 are taken out when calculating the estate tax payable – included in the computation of the estate tax.

4. §2013 – available in estates of persons dying that is included in the estate of someone dying in the past 10 years. Also available if it is included in an estate of someone dying 2 years after D. These will be remainder interests and retained life estates, etc.

5. §2014 – credit for foreign tax6. §2015 – postponement on the payment of estate tax on certain remainder interest.

III.Gift Tax A. §2501: Imposition of a TaxB. §2511: Transfers in General

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1. Direct Gifts – outright gift of property – cash, car, stock, etc.2. Indirect Gifts - Ex – gift to a closely held company. If you have a closely held

company and you contribute property to the corporation, it will be treated as a gift to the extent of the interest in the company of the other shareholders. This will not qualify for the annual exclusion because it is not a present interest – a shareholder cannot get to it right away. Also includes gifts in trust, gifts made through straw persons, discharge of indebtedness, below-market interest rate loans (or the free use of money), gratuitous services, gifts made by incompetents

3. Property Interests Covereda. Remainders

i When the donor gives the remainder interest to a person then the value of the gift is the value of the interest

ii If the person is related then the value of the remainder interest is determined under §2702.

iii Contingencies go only to the value of the remainder – there is still a gift, it will just have a lower value than one that does not have a contingency.

iv You can make a gift of a contingent remainder or contingent reversionary interest that you own. Again – value will be low depending on the likelihood of the contingency.

b. Uncertain Interests – just because it is uncertain does not make it any less a gift – it will just have a lower value.

c. Insurance and Annuities –i A purchase of a policy for the benefit of another, the transfer of an existing

policy to another, or the payment of premiums on an existing policy owned by another, may all constitute gifts if the one making the purchase transfer or payment retains no control over the policy.

ii If he has any indicia of ownership at the time of his death, the proceeds will also be included in his gross estate.

4. When a Transfer is Complete – when the donor has relinquished all dominion and control over the transferred property

5. Revocable Transfers – this is the greatest control a donor can retain over transferred property. You must look to each interest in property to ascertain if the donor has retained any power to revoke – each interest is determined on its own. Once the donor terminates his right to revoke, then the gift is complete.

6. Power to Change Beneficiaries – any power held by the donor over the property, even if it does not include the ability to transfer the property for the benefit of the donor, leaves the gift incomplete. The gift will not be complete until to donor relinquishes this power.

7. Power to Alter Time or Manner – a. If the donor has the power to accumulate income in a trust in which the income

beneficiary and the remainder man are the same person, then the gift is complete when the transfer is made.

b. If the donor has the power to accumulate income in a trust in which A is the income beneficiary and B is the remainder man, the gift of the remainder is complete upon issuance, but because income interest is alterable it is not complete.

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8. Donor’s Power Exercisable Only with Third Personsa. If the one who must consent has no economic interest in the property interest

subject to the power, then it is not a complete gift. b. If the one who must consent has an adverse interest in the exercise of the power,

then it is a complete gift. 9. Powers Held Only by Third Person

a. Generally, as long as the donor has not retained any control over the property, this is a completed gift.

b. If the third party is required to distribute income to the donor as necessary for his support, this is an ascertainable standard and we have a completed gift only to the extent the value o the corpus exceeds the value of the donor’s right to support and maintenance.

c. If the trustee has the power to distribute at his discretion, then as long as the donor has no control, then we have a completed gift. But, if the donor’s creditors have access to the corpus or income of the trust, then it is not a complete gift.

d. If the donor has any control over the distributions what so ever, then it is not a completed gift.

C. §2702: Valuation for Transfers of Interests in Trust1. The General Rule

a. §2702 merely effects the valuation of remainder interests – this only applies when the trust or remainder interest is to benefit family members and a retained interest in the donor.

b. §2702(a)(2) Valuation of retained interest:i in general, any unqualified interest will be valued at zeroii value of any retained interest will be valued under §7250

2. Exceptions:a. In general

i If such a transfer is an incomplete giftii If such a transfer is a transfer of an interest in trust, all of the property within

the trust is a personal residenceiii To the extent the regulations provide that such a transfer is not inconsistent

with the purpose of this section. b. Qualified Interest

i Consists of a right to receive fixed amounts payable not less frequently than annually → GRAT

ii Consists of a right to receive fixed percentage of the FMV of the property → GRUT

iii Non-contingent remainder if the other interest are either a GRAT or a GRUTThese prevent the portion retained by the grantor being overvalued.

3. The Joint Purchase Rule – 2702(c)(2)a. If two or more persons purchase property such that one person purchases the

income interest and the other purchases the remainder interest, then it will be considered as if the person buying the income interest is buying the entire property and giving the remainder interest to the other with the remainder bing valued at 100% of the property. The amount paid in by the donee will be consideration like a part sale part gift.

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b. The purchase of a remainder interest from a related person will be treated the same way.

c. The remainder interests in these two situations will not be caught by 2036. D. §2512: Valuation of Gifts

1. Timing – the value of the gift is determined at the date of the gift (the date of completion)

2. Premiums and Discounts for Interests in Property a. Premiums for Control Interests – this applies when the donor transfers a

controlling interest, but it does not apply when the donor transfers a minority interest that will give the donee control when it is added to his other shares of the company

b. Discounts for Family Limited Partnerships – When we look at the gift property value, we will not look to the fact that the rest of the interests in the partnership are family.

c. Discounts – we take discounts for minority, marketability, and no control. This can be a huge estate planning tool to get the property out of your estate without using all of your unified credit. The discount will be higher if it is an actual business or real estate.

3. Consideration for a Transfer – the amount by which the value of the property exceeded the value of the consideration a. Must look to see if it was a bona fide business transaction without donative intent. b. The burden is on the transferor to show that there is no donative intent. The

donative intent is presumed under gift tax. 4. Other Receipts for Money’s Worth – the donee pays the gift tax

a. Net Gift – the gift is made on the condition that the donee pay the gift tax. The gift is the value of the property less the gift tax paid.

b. This is a part gift part sale and there will be a gain realized by the donor to the extent that the gift tax exceeds the donor’s basis in the property. He is allowed to look at his entire basis unless it is a gift to a charitable organization, in which case he has to allocate.

E. §2514: Powers of Appointment1. General Power

a. The basic rule is that the general power is one that can be exercised in favor of the possessor of the power, the possessor’s estate, the possessor’s creditors, or creditor’s of the possessor’s estate.

b. Exceptions: i Ascertainable standard – a power that is exercisable in favor of the possessor

as needed for his support, medical expenses, educational expensesii Pre-1942 Powers – if they are exercisable with another personiii Post-1942 Powers – if they are exercisable with another person if that person

is The creator of the power A person with an adverse interest in the power being exercised. A person with an adverse interest in a portion of the property subject to the

power only in respect to that portion of the property 2. Release or Disclaimer

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a. A release of a power is considered as a transfer, but a qualified disclaimer is not. b. A qualified disclaimer must meet the requirements of §2518 must be met.

i Cannot be disclaimed after it has been acceptedii Generally must be within 9 months of creation of the power

3. Lapse of Power – a. in general treated as a releaseb. 5 or 5 Power applies to lapse here as well and if the power meets the 5 or 5 rule

then it will not be considered a release. F. Disclaimers and Transfers Between Former Spouses

1. §2516 Certain Property Settlementsa. If you enter into an agreement and divorce occurs within a 3 year period starting

one year prior to the agreement, the following transfers made pursuant to the agreement will be treated as a for adequate and full consideration:i In settlement of marital or property rightsii To provide reasonable support of issue of the marriage during minority (Child

Support)b. §2043 tells us that the giving up of marital rights is not full and adequate

considerationi Exceptions (the following are for adequate and full consideration):

Giving up of right to support If it is a transfer made pursuant to a decree of the court

ii §2516, on the other hand, allows a giving up of marital rights that is subject to the agreement – so what happens if one of the other parties dies before the transfer has occurred? In order to get the marital deduction it has to fall under one of the following: It was a transfer in discharge of support obligations It was ordered to be transferred by the court It fits under the provision of §2516

2. §2518 Disclaimersa. Purpose – to allow a person to disclaim a gift – no one should have a gift forced

upon them. b. This gives us uniformity for determining disclaimers for estate and gift tax

purposes i Otherwise each state would be different according to their property laws – so

it is possible for you to have effectively disclaimed the gift according to state law, but not for estate or gift tax

ii If you do not disclaim in accordance with 2518 and it passes to the third person, it will be treated as a gift from him to another person. If the disclaimer is effective for state property law, look under the will to see how the property would have passed had the initial beneficiary predeceased the decedent and this is who gets the property – you have given a gift to that person. So, you may have a disclaimer under state law, but not under tax law

c. Elements of an Effective Disclaimer : i irrevocable and unqualified refusal to acceptii in writingiii writing must be received within 9 months of creation

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iv person has not accepted any interest of the property or any of its benefits v passes without any direction on the part of the person making the disclaimer

and passes either to the spouse of the decedent or to someone other than the disclaiming person (it is okay if the spouse is the disclaimer and by reason of the disclaimer some interest in the property would go to the spouse – it will still be effective – no one else can do this, just the spouse)

d. The spouse rule helps us with estate planning :i H and W own the bulk of their property as joint tenants. We planned their

wills with the credit shelter trust and a QTIP, but H dies with 90% of property in joint tenancy. The spouse needs to disclaim an amount necessary to fund the trust – this can be done using a formula.

ii This may also be used to increase the amount of the marital deduction – if you have a joint tenancy with the son, you would have the son disclaim so that the marital trust (QTIP) will be sufficiently funded. Note> child can only disclaim what they are inheriting (so you have to consider the amount that is included in the gross estate of the decedent v. the amount attributable to the son.

G. §2503: Taxable Gifts1. Annual Exclusion - $11,000 per year, per donee

a. Purpose of the Annual Exclusion – so that there would not be a need to keep track of all the small gifts that are made during the year – this amount is large enough so that it should take care of Christmas and wedding and other gifts.

b. Identification of Doneesi Gifts in trust – transfers in trust constitute gifts to the beneficiaries; a single

transfer to a trust may qualify for several annual exclusions limited only by the number of beneficiaries and the future interest rule.

ii Gifts to other entities – gift to corporations is a gift to the shareholders, but it runs afoul with the no future interest rule. Partnerships and LLC’s – indirect gifts to the members.

iii Gift by an entity – deemed to be from each of the shareholders and goes toward their annual exclusion for that person

iv Gifts to charitable organizations – a single gift to the entity v Straw person – if you make a gift to A and a gift to a straw person who then

makes a gift to A – one gift and only 11,000 will be excludedvi Joint donees – generally a gift to two people so you get two annual exclusions.

The problem arises in tenancies by the entirety when the spouses have different life expectancies such that the proportionate value of the property will be different – you have to find the value for each donee and they each only get the 11,000 exclusion.

2. Future Interests Disqualified for Exclusion – remote or contingent future interests in property may be very difficult to value and the ultimate donees may be difficult to identify.

3. Definition of Future Interests – one that is limited to commence in use, possession or enjoyment at some future date or time. Immediate right to use, possession or enjoyment is the test.

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a. Separate Interests Tested – when you have a gift that is made up of several interests, they are each their own gift and you have to separate all of the interests and test each of them on their own to determine if it is a future interest

b. Non-Income-Producing Property – if a gift has no value, then it will have no value for the exclusion – if valuation is prevented, then exclusion is precluded.

c. Powers Affecting Present Interests – if there is a power to invade the present interest for the benefit of someone other than that beneficiary, then there is no annual exclusion because the gift cannot be valued.

d. Brief Postponement of Enjoyment – any postponement of enjoyment defeats the exclusion. If there is a gift of income, the income must be assured and not the mere authority of the trustee to distribute income.

e. Right to Enjoyment Suffices – all we need is the right to the possession or enjoyment, there dos not have to be actual possession or enjoyment – gift of a trust with general provision to accumulate income, but beneficiary has the right to draw down the income or corpus as they wish.

f. Crummey Powers – an interest will have the status of present interest if the donee is also given Crummey Powers. i Powers given to beneficiaries to demand outright ownership of property held

in trust – this is premised on the theory that the present right to possess is equal to possession.

ii Crummey powers say that each beneficiary can withdraw his pro rata share of the gift made to the trust, but we usually do not want them to exercise these powers when they are granted. This presents the problem of lapse – so we restrict the power to 5 or 5 Rule so that there will be no gift tax liability on the part of the beneficiary.

iii Irrevocable Life Insurance Trust (ILIT) In the creation of a life insurance trust, we use withdrawal powers for

distributions so that there is an immediate right – a present interest for the annual exclusion.

A life insurance trust will not have anything to distribute for a while, but if the beneficiaries have the power to invade then it is okay – thus we give them Crummey Powers.

We do not want the beneficiaries to exercise their power so we add the 5 or 5 restriction, but there is a further problem here when the policy premiums are being paid – the donor will not get to take full advantage of the annual exclusion to the extent it is more than the 5 or 5 restriction of their power. So we create Hanging Powers.

Hanging Powers - only allows the power to lapse for the 5 or 5 and the other accumulates.

The more power holders you have, the better – because it reduces the pro rata share. These powers go only to the people who are beneficiaries of the trust. We do not want to give this power to persons who have no other interest in the trust – the courts have not ruled on this, but the service has said that these powers will be presumed to be illusory.

iv The service has tried (unsuccessfully) to limit these powers:

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Cannot be illusory because of lack of knowledge or unreasonable time within to exercise the right,

Holder of the power must have a substantial economic interest in the property – courts have not let this fly

Should not be recognized where it is shown that there has been a prearranged understanding that the right to withdrawal will not be recognized

g. Qualified Tuition Programs and Education Savings Accounts i Qualified Tuition Programs – you can get up to 5 times your annual exclusion

per beneficiary and then you spread it out over the next 5 years. It is treated as a present interest and there is no taxable gift when it is distributed to the beneficiary

ii Education Savings Accounts – you are only allowed to contribute 2,000 per year per beneficiary, so you do not have problems with the annual exclusion. It is treated as a present interest and there is no taxable gift when it is distributed to the beneficiary.

iii Note> Any transfer of beneficiaries that is not a family member or is in a generation below the old beneficiary, it will be a taxable transfer.

4. Gifts to Minors – if it is a direct gift it will qualify for the exclusion, if it is an indirect gift look to 2503(c)

5. Special Statutory Rule for Minor Doneesa. First Requirement – the property and the income therefrom may be expended by

or for the donee before the donee reaches 21i the transfer terms are such that the property and its income

are properly expendable for the minor doneeb. Second Requirement – the property and income not so expended will pass to the

donee when the donee reaches age 21, or to the donee’s estate or pursuant to the donee’s exercise of a general power of appointment if the donee dies before reaching that age.

6. Medical Expenses and Tuition – unlimited amounts of tuition and medical expenses for any number of donees is allowed – but it does have to be paid directly to the institution.

7. Waiver of Survivorship Benefits – not treated as a gift when waived before the participant’s death.

8. Loans of Qualified Artwork – not treated as a transfer if loaned to a qualifying organization.

9. Gift Tax Returns – generally must be filed in the year the gift was made. IV. Generation Skipping Tax

A. §2611. Generation Skipping Transfer Defined1. Three Types of Generation Skipping Events: Taxable Termination, Taxable

Distribution, Direct Skip2. Certain Transfers Excluded:

a. Medical and Tuition Expenses that are not treated as a taxable gift under §2503(e)b. Transfers that have already been taxed

B. §2612. Taxable Termination, Taxable Distribution, Direct Skip

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1. Taxable Termination – the termination of an interest in property held in trust such that the property goes to a skip person.

2. Taxable Distribution – any distribution from a trust to a skip person3. Direct Skip – a transfer of an interest in property to a skip person

C. §2613 Skip Person and Non-Skip Person Defined1. A natural person who is assigned a generation which is two or more below the

generation assignment of the transferor2. A trust, if all of the interests in the trust are held by skip-persons and there are no non

skip-persons who hold an interest (interest being a present interest) in the trust or who will have a distribution from the trust.

D. §2651 Generation Assignment1. Transferor – you, spouse, brothers, sisters, for non-family:12 ½ older and 12 ½

younger2. 1st Generation – children, nieces and nephews + spouses, for non-family: more than

12 ½ to 37 ½ younger3. 2nd Generation – grandchild, great nieces and nephews + spouses, for non-family:

more than 37 ½ to 62 ½ younger (25 year increments)4. 3rd Generation – great-grandchild, etc.

E. When you have a Generation Skipping transfer, you will be taxed on that transfer in addition to your gift tax for the transfer. You are taxed on the property interest that you transfer to that person.

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