Estate Planning Spring 2010

1) Chapter 1Professional Responsibility and Estate Planning 2) Chapter 2 Basic Transfer Tax Laws and Estate Planning Strategies a) Generation-Skipping Transfer Tax [GSTT] i) 2.24 BACKGROUND ii) 2.25 THE MODERN GSTT (a) The need for a GSTT arises because the estate and gift tax do not reach distribution of property from a trust to a beneficiary (b) 2631- each individual has an exemption which may be allocated by the individual to any transfer of which the individual is the transferor. (i) The amount of the exclusion is the same as the estate tax (2) 2.25.1 Direct Skips and Skip Persons (a) Direct Skip- transfer subject to estate or gift tax and made to a skip person (i) 2613(a) Skip person 1. natural person two or more generations below transferor or 2. trust with all interests held by skip persons or 3. trust with no interest and no distribution to non skip person (ii) 2613(b) Non skip person 1. Any person who is not a skip person (b) Predeceased Parent Exception (i) 2651(e)- when a descendents parent predeceases the transferor the descendent fills the parents place thus removing them from two generations away from transferor (ii) Applicable at time of tax 1. Ex: TGC by will and D, Ts daughter and GC parent, died before T a. GC would not be considered a skip person and thus not a direct skip (3) 2.25.2 Taxable Termination (a) 2612(a) (i) Termination of interest of property in trust unless 1. Immediately afterwards a non skip person has interest in property or 2. At no time thereafter may a distribution be made to a skip person a. Ex: X creates trust with income for life to C. Income to life to GC. Income for life to GGC. i. When C dies it is a taxable termination because it is an interest in trust that terminates upon the death of C following which only skip persons have an interest. (b) 2662(c) Interest (i) Present right to income from corpus

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1. Ex: T to S for life[income from trust] then to children and grandchildren . The death of S is a taxable termination. (4) 2.25.3 Taxable Distribution (a) 2612(b) (i) Property from trust distributed to skip person that is not a taxable termination (ii) Qualified transfers are not GSST Transfers 1. Ex: X creates trust and authorizes distribution to descendents. When the distribution is made to a GC or below there is a taxable distribution. (5) Class Note (a) 2653(a) Taxation of multiple skips (i) Generation skipping transfer of property (ii) Held in trust (iii)Highest interest treated as transferor 1. Ex: P transfers money to trust. Income to C for life. Income to GC for life. Income to GGC for life. a. When C dies there is a taxable termination i. At Cs death GC is treated as the highest interest. C is treated as transferor. ii. When distribution to GC it is not a taxable termination but when GC dies it is a taxable termination iii) 2.26 APPLICATION OF GSTT; INCLUSION RATION; APPLICABLE FRACTION (1) Applicable Rate (a) Max estate tax at time of transfer x inclusion ratio [2641(a)] (2) Inclusion Ratio- amount by which 1 exceeds applicable fraction [2642] (a) Applicable fraction- [amount of exemption allocated to trust/transferred property taxes] (i) Ex: T $500k to trust for GC. T allocated $500k GSTT exemption. AF: [500/500] = 1. IR = 1 exceeds 1 by 0. (45 x 0 = 0) (ii) Ex: T $2.0 million to trust for GC. T allocated $1.5 million to GSTT. AF: [1.5/2.0] = .75. IR: 1-.75 = .25 (45 x .25 = 11.25) (3) E (a) Applicable rate = 45 x [Inclusion ration (Applicable fraction)] iv) 2.27 GSTT EXEMPTION (1) The exemption will be the same as the Estate tax (2) 2631(b)Once made is irrevocable (3) Want to either have an Inclusion Ratio of 0 or 1 in the trusts v) 2.28 REVERSE QTIP ELECTION; DIVISION OF TRUSTS

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(1) Consequences of reverse QTIP is that the decedent who was the creator of QTIP remains the transferor. As a result the decedents GSTT exemption may be allocated to that QTIP and denominator of AF is determined by reference to the value of the trust property in the gross estate of the decedent. (a) 2044 QTIP (i) In a QTIP trust the property is includable in the gross estate of the surviving spouse and the surviving spouse is treated as the transferor for GSTT purposes. (b) 2652(a)(3) (i) Allows the first spouse to die to elect to treat all the property for GSTT purposes as if election to be QTIP had not been made 1. Does not allow partial (ii) The QTIP would still remain in the gross estate of the surviving spouse but for the purpose of identifying the transferor it would be the decedent (2) Severing a Trust (a) 2642(a)(3) (i) Trust severed in qualified severance will be treated as separate trusts 1. 2642(a)(3)(B)- qualified severance requires it be separated on a fractional basis and terms of new trust, in aggregate, provide for same succession of interests of beneficiaries as provided in original trust (b) Want the trusts with the 0 IR to support the future generations and the trust with the 1IR to support the current generations vi) 2.29 ALLOCATION OF EXEMPTION; DEEMED ALLOCATION (1) If timely election not made code determines how exemption will be allocated (a) Allocated to lifetime direct skips to extent necessary to reduce IR to zero (i) If the amount exceeds unused portion all exemption allocated to property transferred (b) If Direct skip made during life but not reported the exclusion will be applied automatically in a manner that gives it a 0 inclusion ratio. (c) Value based on time of gift if filed timely. If not value based at time of allocation (2) 2.29.1 INTER VIVOS TRANSFERS/ ESTATE TAX INCLUSION PERIOD (a) 2642(f) (i) IR for certain inter vivos transfers are not determined at the time of the initial transfer. If property of the gross estate. [ETIP] (3) 2,29.2 CHARITABLE LEAD ANNUITY TRUSTS (4) 2.29.3 DEEMED ALLOCATION OF GSTT EXEMPTION OF CERTAIN LIFETIME TRANSFERS (5) 2.29.4 DEFAULT ALLOCATION OF GSTT AT DEATH (a) 2632(e)
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(i) If not allocated deemed allocated: 1. Property subject to direct skip occurring at death 2. A trust where individual is transferor and when taxable termination or distribution might occur. vii) 2.30 EXCLUSIONS (1) 2611(b) (a) Does not include any transfer which made inter vivos by an individual would not be treated as a taxable gift by reason of section 2503(e) viii) 2.31 VALUATION OF PROPERTY (1) 2624(a) (a) Valued at time of transfer (i) If in gross estate then a special use valuation ix) 2.32 TAXABLE AMOUNT OF GENERATION-SKIPPING TRANSFERS (1) 2.32.1 Direct Skips (a) Tax base exclusive of the GSTT (i) Burden on the donor (b) 2515- taxable gift that is a direct skip shall be increased by the amount of the tax imposed on transferor (2) 2.32.2 Taxable Distribution (a) 2621(a) (i) Tax base is the value of the property received by the transferee less the value of the expense incurred by the transferee with respect to the distribution 1. 2601(a)(1) a. Transferee obligated to pay the GSTT on a taxable distribution (b) Tax Inclusive (3) 2.32.3 Taxable Termination (a) Tax inclusive (i) 2622-taxable amount is the value of property with respect to taxable termination x) 2.33 IDENTIFYING AND CHANGING THE TRANSFEROR (1) 2652(a) (a) Under chapter 11 the decedent is the transferor (b) Under chapter 12 the donor is the transferor (c) 2652(a)(2) (i) Split gift-both treated as transferors for GSTT purposes 1. Autosplit in community property states xi) How to Analyze GSTT Problem (1) Ex: P transfers $10,000,000 to a trust. Income to life to C, GC, GGC, with remainder to GGGC.
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(a) Is the transfer to the trust a direct skip? [2.25.1] (i) Here, C is not a skip person so no GSTT tax on that transfer. [look at time of transfer/funded] (b) When C dies there is a taxable termination. (i) Also, C treated as transferor. [jump up a generation] (c) When distribution to GC it is not a taxable termination (d) When GC dies it is a taxable termination and GC moves up into the position of transferor b) Inheritance Tax on Gifts and Bequests from Expatriates i) 2.43 Overview c) BASIC LIFETIME ESTATE PLANNING TAX STRATEGIES i) 2.44 OVERVIEW ii) 2.45 SHIFT INCOME WITHIN THE FAMILY (1) Ex: Mother with 31% rate and two children with 15% rate. If M was to deflect $10,000 to each child she could save $3,200. [$20,000 x (31-15)] (a) Kiddie Tax- unearned income of children under 19 and full time students under 24 is taxed at max rate of parents. (2) 2.45.1 Methods (3) 2.45.2 Assignment of Income Doctrine (a) Gift of property is enough to shift income but a gift of a mere right to receive income is not effective to shift the income (i) Gratuitous assignment of interest in trust income [life] constituted transfer of an equitable property interest sufficient to shift the income to the assignee (ii) Transfer of one year trust income not sufficient to shift income to assignee 1. Did not part with substantial interest in property a. Assignment for 10 years would transfer the income to the assignee iii) 2.46 Reduce the Size of the Estate: Gifts and Valuation Games (1) 2.46.1 Make Gifts that Qualify for Valuation Discount (a) Undivided interests in real estate and minority interests in business qualify for discounts that make their valuation favorable (i) Marketability Discount 1. Inclusion in estate discounted to how much it would go for on the market as compared to what it is worth at time (2) 2.46.2 Make Gift of Life Insurance (a) Make gift to Life Insurance Trust (i) The trust would apply for the policy 1. Ex: X puts $10k premium in. It doesnt matter who pays the premium (b) Naming someone a beneficiary is not a gift (i) If the beneficiary names someone else a beneficiary then it is a gift
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iv) 2.47 Freezing the Estate v) 2.48 Bypass the Estate of Survivors vi) Defer Payments of Estate and GST Taxes 3) Chapter 3 Concurrent Ownership and Non testamentary Transfers a) INTRODUCTION i) 3.1 Scope b) TENANCY IN COMMON i) 3.2 Substantive Law Summary (1) Each cotenant owns an undivided interest that is freely transferable with no right to survivorship between tenants ii) 3.3 Creation (1) To X and Y as Tenants in Common or simply To A, B, and C (a) Requires express language to create a Tenancy in Common (2) Examples iii) 3.5 Miscellaneous iv) 3.6 Creditors Claims (1) Creditors can reach only the interest of the debtor. If the creditor forecloses it steps into the place of the cotenant debtor. v) 3.7 Gift Tax (1) The contribution toward the purchase determines if there was a gift (a) A gift arises if there is unequal contribution to the purchase of the property. (i) The gift is proportional interest of the other cotenant 1. Ex: X purchases Blackacre for $100,000. Deeds it to X and Y as cotenants. Y would own a 50% share of Blackacre. Thus X would have made a gift to Y for $50,000 (b) The gift can qualify for the annual exclusion (c) Marital Deduction would apply if spouse is a United States Citizen (2) 3.71.1 Termination (a) No gift occurs at termination if both parties receive their share or proceeds proportional to his ownership interest (i) A gift does occur if tenant receives less than his proportional share 1. Ex: X &Y contributed equally to purchase of Blackacre as tenants in common. Sold for $100,000 of which X received $60,000 and Y received $40,000. Unequal distribution resulted in a gift of $10,000 from X to Y. (3) 3.8 Estate Tax (a) 2033 Each individuals interest is included in their estate. [discounted for fractional share] (4) 3.9 Income Tax (5) 3.10 Use in Estate Planning
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c) JOINT TENANCY AND TENANCY BY THE ENTIRETY i) 3.11 INTRODUCTION (1) Joint tenants with right to survivorship passes the ownership interest at death by operation of law (2) 3.11.1 Advantages (a) Free from claims of creditors of either spouse (b) Avoids probate (3) 3.11.2 Disadvantages (a) Inflexible- cannot change without severing joint tenancy. Not severed in will. (b) If owned in joint tenancy then waste unified credit [overfund marital deduction and underfund if joint tenants with heirs] ii) 3.12 Features of Joint Tenancy (1) 3.12.1 MULTIPARTY FINANCIAL ACCOUNTS (2) 3.12.2 Uniform TOD Security Registration Act (3) 3.12.3 Simultaneous Death (a) Survivorship only if one survives the other by 120 hours [or eliminated by instrument] (i) A & B joint tenants die without clear evidence who survived. Right of survivorship is inoperative. Half of interest distributed as if A was surviving tenant and the other half as if B were. (4) 3.12.4 Creditors Rights (a) Can reach undivided share until death (i) At death, action must have been commenced before death. iii) 3.14 Gift Tax (1) Making a gift of JT is a gift of half value of property. (a) There will be a discount if the transfer is made after purchase (i) Gift to wife still qualifies for Marital Deduction (b) Bank account gift is not a gift until the money is withdrawn not at time of deposit (c) Disclaimers (i) Nine months to elect to disclaim 1. If disclaimed, passes by will or intestacy iv) 3.15 Estate Tax (1) 2040 (a) (a) Full value included in estate except to the extent that contributions can be traced to the other joint tenant v) 3.16 Qualified Joint Interests (1) 2040(b) Qualified Joint Interest (a) Husband and wife are only tenants (i) Ex: ???
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vi) 3.17 Estate Tax: Simultaneous Death (1) If not determination who died first, full value included in estate of party who contributed full consideration and half in the other partys estate. [Full value under 2044 and half includable under 2033] vii) 3.18 Terminating Joint Tenancies (1) No additional gift tax consequences at severance as the tax was assessed upon creation. 4) Chapter 4 Wills and Related Documents a) Introduction [Skim] i) 4.1 Overview ii) 4.2 Federal Estate and Gift Taxes in Persepective iii) 4.3 Statutory Wills iv) 4.4 Avoiding Intestacy v) 4.5 vi) 4.6 Income-Splitting Between Estate and Survivors vii) 4.7 Contractual Wills b) Organization and Content of Wills i) 4.8 General (1) Successive articles: (a) Identify testator and family, dispose of testators property, appoint fiduciaries, enumerate powers of fiduciary, provide for execution be testator and witnesses ii) 4.9 Introduction to Will iii) 4.10 Revocation (1) Include in will I revoke all wills and codicils previously made by me. iv) 4.11 Disposition of Remains (1) Funeral Arrangements v) 4.12 Payments of Debts (1) Better left out because it can be superfluous vi) 4.13 Extent of Testators Property (1) Community Property vii) 4.14 Family Status and Definitions (1) Include who decedents wife, children, descendents are. viii) 4.15 Gift of a Specific Item of Personalty (1) Gift or if not in possession/existence at time of death than nothing or sum of money (2) 4.15.1 Ademption (a) gift fails entirely if not in possession of decedent at his death (3) 4.15.2 Alternative Disposition (a) If intended beneficiary is not alive must know where specific gift should go
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(4) 4.15.3 Simultaneous Death (5) 4.15.4 Survivorship for Specified Period ix) 4.16 Cash Gifts (1) Safeguard cash gifts in order to protect the residue of estate. If total value of estate is less than expected include clause that ill reduce the cash gift equivalently (2) 4.16.1 Charitable Deduction for Tax Purposes (3) 4.16.2 Satisfaction (a) Can be paid during life if acknowledged in writing as satisfying bequest. (4) 4.16.2 Distribution in Kind (a) Distribution in kind allows the executor to give property in satisfaction of pecuniary gift. (i) Problems include realization of gain between gift and distribution and basis for the transferee. (5) 4.16.4 Forgiveness of Indebtedness x) 4.17 Tangible Personal Property (1) Include language to make sure that gifts of personal property that are of high value do not pass to minors (a) Include language so the gift is specific as possible (2) 4.17.1 Testamentary Gifts to Custodians for Minors (a) Cannot be multiple beneficiaries of a custodianship xi) 4.18 Disposition of Tangible Property in Accordance with Testators Subsequent Directions (1) 4.18.1 Incorporation by Reference (a) Can incorporate extrinsic writing by reference if writing is in existence at the time the will is executed, adequately described, and is mentioned in the will with the intent to incorporate (2) 4.18.2 Facts or Acts of Independent Significance (a) Ex: gift of all objects listed on fine arts rider to my fire and casualty insurance policy. Changes to this would be recognized as independent acts of significance. (3) 4.18.3 Bequest with Request (a) No legal obligation of person do distribute the gift as the testator intends xii) 4.20 Gift of Residence, Life Insurance, and Employee Benefits (1) 4.20.1 Exoneration (a) Must include if testator wants the encumbrance to be paid and from what source [usually property from the residuary] (2) 4.20.2 Insurance on Realty and Personalty (3) 4.20.3 Insurance on Lives of Others (4) 4.20.4 Testamentary Changes of Beneficiary Designations; Life Insurance

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(a) A will cannot change the life insurance beneficiary. It must be done on the policy. (5) 4.20.5 Revocation by Change of Circumstances (a) Divorce and annulment revoke provisions (6) 4.20.6 Interest in Retirement Plans xiii) 4.21 Residuary Gift (1) Disposes of gifts not mentioned in previous provisions, lapsed gifts and after acquired property. Also prevents property from passing intestate. (2) 4.21.1 Residuary: Powers of Appointment (a) Most states require that the power of appointment be specifically exercised (3) 4.21.2 All to the Surviving Spouse? (4) 4.21.3 Pot trust or a separate trust of each child (5) 4.21.4 Consolidate the Clients Property in One Trust (6) 4.21.5 Discretionary Distributions (7) 4.21.6 Trusts for Minor Descendants (8) 4.21.7 Ultimate Disposition of Residue (a) Wastebasket clause that would distribute if the spouse, descendants, or beneficiaries fail to survive xiv) 4.22 Trust Provisions xv) 4.23 Trust for Minors xvi) 4.24 Provisions Applicable to All Trusts (1) 4.24.1 Successor Trustees (2) 4.24.2 Waive Bond (a) Waives requirement bond paid to trustee [saves costs] (3) 4.24.3 Trustee Powers (a) Incorporate existing state statutory provisions rather than repeating powers (i) Allows attorneys to freeze the applicable powers as of that time (4) 4.24.4 Unified Management of Trust Assets (5) 4.24.5 Investment Criteria (6) 4.24.6 Authority to Terminate Uneconomical Trusts (7) 4.24.7 Merger and Division of Trusts (8) 4.24.8 Spendthrift Clause xvii) 4.25 Guardian of Minor Children xviii) 4.26 Executors (1) Factors: cost (2) 4.26.1 Lawyer-Fiduciary (3) 4.26.2 Corporate Fiduciary (4) 4.26.3 Family Member Fiduciary (5) 4.26.4 Co-Executors (6) 4.26.5 Alternate or Successor Executor
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(7) 4.27.6 Exculpatory Clause xix) 4.27 Debts; Expenses of Administration, and Taxes; Conservations of Easement (1) Will should include provision that identifies the fund from which expenses should be paid. (a) Should give flexibility (2) 4.27.1 Source to pay Estate Tax (a) Usually from the residuary [most statutes follow and overrides equitable apportionment] (b) Equitable Apportionment (i) Unless the will provides to the contrary it will pay proportionately (c) Dont pay out of marital share as it will increase the amount of tax (3) 4.27.2 QTIP and 2207 (a) Deduction for administrative expenses deductible on income or estate tax return (i) $5 million with formula clause with rest to bypass trust. 1. If claimed on estate tax then W gets $1.4 million and trust gets $3.5 2. If claimed on income tax then bypass gets $3.4 and W gets $1.5 xx) 4.28 Wills not Pursuant to Contract (1) Wills do not act as contracts [in case of a reciprocal will] xxi) 4.29 No Contest Clause (1) Would prevent someone from contesting their share. If they do so they will vacate their share xxii) 4.30 Execution (1) Two witnesses. Attestation clause will verify that the witnesses xxiii) 4.31 Self Proving Affidavit (1) Allows witnesses to attest to validity of will by another document other than the will xxiv) 4.32 Execution Ceremony 5) Chapter 5 The Gift and Estate Tax Marital Deductions a) Planning For Use of the Marital Deduction i) 5.5 Approaching the Job (1) 5.5.1 Tax Estimates (2) 5.5.2 Valuation of Property ii) 5.6 General Objectives (1) Utilize exemption and rest to bypass trust (2) Make sure to determine client goals (a) Give them written projection of tax consequences (b) No need for credit if given to charity iii) 5.7 Equalizing the Spouses Estates and Minimizing Overall Taxes
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iv) 5.8 Minimize Taxes- Defer Payments (1) Cannot predict future rates b) Expressing a Marital Deduction Gift-Formula and Nonformula Gifts i) 5.32 Overview (1) Less people are using outright gift because of the lack of control that goes along with it (2) General Power of Appointment [rarely used] (3) QTIP (a) Formula Clause (i) Pecuniary 1. Smallest amount to W to minimize or eliminate estate tax (ii) Fractional Share (4) If combined estate less than $3.5 million then dont use fomula (5) No formula if all to trust that can be QTIP (6) Ex: (a) $6 million Estate with: (i) $10k to spouse (ii) $200k to Child (iii) $50k admin expenses [estate tax deduction] (iv) $50k admin expenses [104] (b) Formula Clause smallest amount to incur no estate tax (i) $6 million 1. -$100k [2056] 2. -$50k [2053] (ii) $5.85 million 1. -$2.35 million [formula] (iii)$3.5 million to trust (7) Fund with true worth means to fund at value of date of distribution (a) Recognize gain [satisfy $10k gift with $10k gift that was worth $7k at time of informing of gift so there is a gain of $3k] (i) Recognize loss as well (b) Easier to manage income tax by making pecuniary gift the smaller gift (8) Date of Death Value funding (a) Gain does not have to gain if goes from $1 to $2 between death and distribution. [donee will get the lower value basis] ii) Rev. Proc. 64-19 (1) Using date of death gives executor too much discretion so if you fund using date of death value the marital deduction will be denied [exec could find assets that were worth value of gift at time of death that have depreciated]

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(a) Can use true worth because it gives spouse exactly what she was entitled under the will (i) Most people use true value (2) Fairly Representative Clause (a) Assets used must be assets that fairly represent the appreciation or depreciation in value (i) Can use FRC for both pecuniary marital or pecuniary bypass 1. Can avoid capital gain when funded (3) Minimum Worth Funding (a) Can use date of death but the FMV at date of distribution must be at least worth the value of the gift in will (b) If expressing bypass gift as pecuniary amount the Min. Worth is not available because the same 64-19 concerns are present (4) Distribution limited to Assets that Qualify for Marital Deduction (a) 2056(b)(2) iii) 5.38 Planning and Drafting a Formula Fractional Share Gift (1) Giving fraction of residue to surviving spouse . [residuary gift] If assets go up in value both receive benefit. [same with depreciation] (a) Limit to only qualifying assets in order to preserve the marital deduction (2) Ex: (a) $5,150,000 gross estate. (i) $100,000 expenses that are deducted on estate tax return. (ii) $50,000 deducted on income tax return. (iii) $100,000 gift to child. (iv) $50,000 pre-residuary gift to surviving spouse. (b) Taxable Estate (i) $5.15 - $100k admin. -$50k pre-residuary gift. 1. $5 million taxable estate a. Need to give spouse $1.5 million to avoid estate tax (ii) Assets [in residuary estate] 1. $4.85 million [$5.15-all above values = $300k] a. Fractional share i. Numerator = value needed to minimize estate tax ii. Denominator = residuary estate iii. $1.5/$4.85 = 31% (c) Potential taxable event because spouse could be giving up X% in one asset for X% in another so might have to recognize capital gain. [would not recognize loss if family members] (i) Usually put in clause that authorizes executor to make disproportionate distribution
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(3) Easy to administer if only a single distribution or every distribution is proportionate to spouse and trust. (4) When satisfy fractional share there would not be gain because there is no specific amount (a) Advantage over pecuniary (i) Both spouse and bypass are treated equally with gain/loss (ii) No income recognized on distribution of appreciated assets (b) Disadvantage (i) More complicated (5) Hubert Regulations (a) Ex: Will (i) Residuary gets income during administration 1. $10 million estate. $5million to child. $5 million to residuary/W estate. If direct executor to pay estate tax from marital share to marital gift will be decreased. a. 2056(b)(4) (b) 2056-4d (i) Management Expenses 1. Fees and interest [pay someone to handle stock portfolio] (ii) Transmission Expenses 1. Not incurred but for decedents death and cost of collecting [executor expenses (most expenses are transmission expenses)] a. if pay fees from marital gift the marital deduction needs to be reduced b. if deduct expenses on estate tax return then deduct from marital deduction c. marital share gets reduced by management expenses attributable to other property but not marital property[unless deducted on estate tax return] i. (iii)Marital Share 1. Includes income produced by property a. Ex: Will $100k to W remainder to Child. Marital share is $100k. If this was reversed and the $100k to Child and remainder to W, the income would be included in the marital share. b. Ex: Blackacre to W. Gifts of specific property included income during administration. [rent would be income] (6) Administration expenses (a) Can be deducted on income or estate tax returns 6) Chapter 6 Life Insurance
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a) Introduction (1) Purchase for security. (a) Accumulation of wealth. (i) Ross IRA does not tax accumulation each year (ii) Insurance also grows tax deferred (b) Withdrawal (i) Roth IRA are not taxable (ii) Traditional IRA are taxable (iii)Insurance Policy taxable if withdraw more than basis but it is not taxable to the beneficiary (2) Need to know basic tax laws and insurance policies available for client (a) Look to third party to give best advice for what client needs [not insurer] (3) Reasons to purchase (a) Pay for living expenses for survivor (i) This does not bring about estate planning issues (b) Pay costs at death which would include estate tax (i) Insurance is easy to get out of estate compared to other assets (c) Provide funds for a buy/sell agreement (i) If X purchases LI on the life of Y, X does not pay income tax on proceeds and when X buys the shares of the company from Y there would be no income tax because Ys estate gets a step up in basis. (4) Most states exempt life insurance from estates creditors ii) 6.3Data Collection (1) Know who owns it (2) Know who the beneficiary iii) 6.5 How Much Insurance (1) The general idea is five to six times ones salary [client has to project what family living expenses should be] iv) 6.8 Types (1) Term-lasts for the year (a) Renewability guaranteed (2) Life-pay for entire life. Buying a form of investment. (3) Universal lifev) Review (1) When to tax [included in estate] (a) Incidents of Ownership or (b) Payable to estate (2) 2042 (a) Exclusive and applies only to life insurance [life insurance defined as risk of premature death involved]
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(3) Questions (a) Is it life insurance? (b) Is it payable to estate? (i) Broad [purchase insurance to pay creditors at death] (c) Possess Incidents of Ownership? (i) If an ILIT and decedent wants to be trustee he would have Incidents of Ownership unless other funds in trust in which case it could be bifurcated and he could be trustee for assets in which case he would not have incidents of ownership (4) If someone other than decedent owns the policy the owner should make themselves the beneficiary or there could be an unintended gift if someone else it the beneficiary (5) If grandchild owns and is beneficiary it is not a direct skip but if someone gives a policy to a grandchild it would be a direct skip and it would be difficult to value. (a) If grandchild buys policy on Xs life and X pays premiums (i) For GST purposes a $13,000 gift to skip person is not direct skip [exclusion still applies] (ii) If paying the premiums which are equivalent to the exclusion then there would be no direct skip (6) If in estate the whole value is included (a) A settlement option would include the entire amount [could get full amount of settlement it is treated as full amount because that is an option] (i) If only option is deferred payment the amount included would be the amount company sets aside to set off amount (7) No reason to give policy to wife because there is no tax benefit. (8) Cashing in policy during life is income tax vi) 6.16 Community Property (1) 6.16.1 Inception of Title Rule (a) Whatever the first source of payment was determines the characteristic of the life insurance. (i) If community property is used to pay subsequent premiums, the premiums will be reimbursed 1. Ex: $100k policy paid originally with separate property. $12k of premiums paid from community property. $88k will be included in estate plus half the premium payment of $6k. (2) 6.16.2 Apportionment Rule (a) The policy is allocated according to the funds used (3) 6.16.3 Risk Payment Doctrine; Term Insurance (a) The last payment made establishes what type of property b) Planning with Life Insurance
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i) 6.17 Introduction (1) Proceeds are generally not taxable income (2) ILIT allows the proceeds to be available to family with little tax consequence (3) Beneficiary Designation (4) Revocation of Beneficiary Designation by Divorce (5) Beneficiary Designation and Slayers Statute ii) 6.18 Combined Marital Estates of Less than One Credit Equivalent iii) 6.19 Combined Marital Estates of Less than Two Credit Equivalents (1) In order to prevent the surviving spouse from including the entire proceeds in her/his gross estate they would need to set up either a settlement option or establish a bypass trust. (a) When option selected by insured then not included in beneficiarys estate but when selected by beneficiary it will be included (2) 6.19.1 Protect Minor Children (a) If minor child becomes beneficiary after being contingent beneficiary the proceeds should go to the trustee of a contingent testamentary trust for the minor child or to a custodian. (3) 6.19.2 Use Revocable Trusts (4) 6.19.3 Plan Based Upon a Revocable Trust (5) 6.19.4 Plan Based on a Testamentary Trust iv) 6.20 Choosing Between a Revocable Trust and a Testamentary Trust v) 6.21 Combined Marital Estates of More Than Two Credit Equivalents: Eliminating the Insurance From the Estate of the Insured vi) 6.22 Ownership by an Individual Other than the Insured (1) 6.22.1 Cross Owned Insurance (2) 6.22.2 Applications and Assignments (3) 6.22.3 Community Property (4) 6.22.4 Premium Payments (5) 6..22.5 Beneficiary Designation (6) 6.22.6 Successive Ownership vii) 6.23 Marital Deduction Planning (1) 6.23.1 Beneficiary Designation (2) 6.23.2 Premium Payments (3) 6.23.3 Successive Ownership viii) 6.25 Other Types of Life Insurance Trusts (1) 6.25.1 Community Property Widows Election Life Insurance Trust (2) 6.25.2 Business Uses (3) 6.25.3 Charitable Uses c) Estate Taxation and Life Insurance i) 6.26 History
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Estate Planning Spring 2010

ii) 6.27 Life Insurance Revocable by or for the Benefit of the Estate 2042 iii) 6.28 Incidents of Ownership (1) Policy facts and intent facts (2) Incidents of ownership (3) Power to change beneficiaries by Divorce, Birth, or Adoption (4) Power to terminate membership in Group Plans (5) Convert Group to Ordinary (6) Right to Prevent Cancellation by Purchasing Employer Owned Life Insurance (7) Power to Remove/Replace Trustee (8) Negative or Veto Power (9) Incidents of Ownership Under Extraneous Contract (10) Held in Fiduciary Capacity iv) 6.29 Attribution of Incidents of Ownership (1) Stock Held as Community Property (2) Insurance Owned by a Partnership v) 6.30 Reciprocal Trust Doctrine and Life Insurance vi) 6.31Transfer of Interests in Insurance within Three Years of Death 2035 vii) 6.32 2035 Pre 1982 viii) 6.33 2035 Post 1981 Law (1) Insured Transfers Owned Insurance ix) 6.34 Insurance Acquired with Joint or Community Property Funds x) 6.35 Sale of Life Insurance by Insured within Three Years of Death 2035 xi) 6.36 Exclusion of Proportion of Proceeds to the Extent Premiums Paid by Others [Silverman Rule] xii) 6.37 Insurance on the life of a Person other than the Decedent 2035 xiii) 6.38 Premiums Paid within Three Years of Death xiv) 6.39 Transfer of Incidents of Ownership within Three Years or Death xv) 6.40 Retained Life Insurance xvi) 6.41 State Death Taxes xvii) 6.42 Generation Skipping Transfer Tax [GSST] (1) GSST Inapplicable to some Nontaxable Gifts (2) GSST Exemption d) Gift Taxation of Life Insurance i) 6.43 General ii) 6.44 Valuation of Policies iii) 6.45 Annual Exclusions iv) 6.46 Transfer of a Policy v) 6.47 Payment of Premiums 7) Chapter 7 Planning Lifetime Noncharitable Gifts
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Estate Planning Spring 2010

a) Tax Objectives of Gifts i) 7.7 General ii) 7.8 Eliminate Further Appreciation in Value From the Donors Estate (1) 7.8.1 Annual Exclusion Gifts and Unified Credit (a) Per donee rather than per donor limit (b) Limit of $1 million (c) Gets value, income, and appreciation out of estate. [annual exclusion gifts] (i) Must make sure it does not come back into estate [sufficient powers] 1. Ex: trust with income to self remainder to Max with Crummey Power to Max a. If Max does not exercise it would be a gift of $8,000. i. Any income and appreciation would be included in estate as would principle under 2036 (d) Look at tax consequences at time of gift compared to leaving it at death [tax exclusive compared to tax inclusive] (i) Ex: $10 million dollar gift if donor use exemption would cost him $15 million. $10 million at death on a $20 million dollar estate would cost more. (2) 7.8.2 Carryover of Donors Basis (a) Donors basis in the gift carries over to the donee under 1015. (i) Basis stepped up when donor dies if property is included in the donors estate under 1014. 1. Ex: Donor used up $1 million lifetime gift exemption. This year gave relative cash gift equal to annual exclusion. Later in the year D gave B 100 shares of stock. Stock had adjusted basis of $10/share and current value of $100/share. a. D pays $4,100 in gift tax. It was a $10,000 gift to B, 90% of which was attributable to excess in value above Ds basis. [Ds basis was $1000] i. B has basis equal to Ds plus gift tax paid by D with respect to the $9,000 unrealized appreciation. [$3690] Thus, basis for B is $4690. ii. The cash and the stock excluded will be excluded from estate. If D survives gift by three years the gift tax will also be excluded from estate. b. Annual exclusion must be applied chronologically [here it was cash first then stock] iii) 7.9 Shift Income from Donor to Donee (1) Kiddie Tax

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Estate Planning Spring 2010

(a) Net unearned income of child under 19 [or 24 if student] is computed at marginal rate for childs parent. [child can earn $1,900 of unearned income before parent must pay tax] (i) Earned income to the child does not require the parent to pay kiddie tax (b) Amount saved is not as great as it used to be. (c) Also, keep track of alternative minimum tax (2) Shifting Capital Gains iv) 7.10 Reduce Nonbusiness Holdings of Donor in Order to Qualify for Benefits (1) 2032(a) value farm land based on qualified use (a) Real estate must comprise 25% of adjusted gross estate and equipment must comprise 50% of estate (i) Give away other investments in order to satisfy threshold requirments (2) 6166- 35% threshold, allows the person to pay tax over15 years (3) Both are limited by 2035 v) 7.11 Minimize State Transfer Tax Costs (1) Avoid state estate tax (a) Limited by 2035 [state equivalent] b) Tax Factors Involved in Selecting Property to Give i) 7.12 Give Appreciated Property (1) Ex: O gives D 1000 shares of stock with basis of $10 and current value of $200. Gift uses up $187,000 of lifetime exclusion. D takes a basis of $10. O dies that year. (a) If no change in value, O will have annual GT exclusion removed from estate plus any income generated by stock. However D will not get step up in basis on stock because its not included in estate. (i) Taxable gift included in the tax base. 1. Absence of increase in basis means D will have to pay capital gain if D sells it. A sale at $200 per share will give her a gain of $190,000. At 15% the tax would be $28,500. (2) Ex: Unified credit used up. Gift of $13,000 cash and 100 shares of stock with basis of $10 and current value of $100. Exclusion applied to cash so tax on stock is $4,100. (a) [(9000/10000) x 4100 ] / 100 = $36.90 (b) Adjustment to basis = [(net appreciation in value of gift/fmv) x gift tax paid] (3) Class notes (a) Should avoid giving away low basis gifts before death [step up in basis is an important consideration] (i) Deeding land that was contracted to sell to son right before sale could be looked at as an assignment of income [not allowed] ii) 7.13 Do Not Give Property Subject to Encumbrances in Excess of its Basis
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Estate Planning Spring 2010

(1) Transfer of encumbered property will probably be treated as an exchange to the extent of the indebtedness which will require the donor to realize gain if the indebtedness exceeds the donors basis (a) Give away asset subject to liability in excess of basis requires donor to report gain on transaction (b) Assuming responsibility of encumbrance the value of the gift would be the net value [avoids gain] iii) 7.14 Do not give property with a basis that exceeds its current FMV (1) For determining a loss the basis cannot exceed the fair market value on the date of the gift. [ex: gift of asset that has an adjusted basis of $10,000 and a fair market value of $5,000 would leave the donee with a basis of $5,000] (2) Ex: Stock worth $10k with a basis of $15k iv) 7.15 Do not give property with positive tax characteristics v) 7.16 Valuation Discounts, Give Property that Diminishes Value (1) Ex: own 51% in corp. right before death gives son 2%. Corporation worth $1,000,000. Would get lack of marketability and minority discount which would give a value discount. Now own 49% of corporation. In this example, the value discount would bring the gift to around $12,000 which would qualify for annual exclusion. vi) 7.17 Do not give gifts that have adverse income tax consequences for the donor (1) Most gifts will not require the donor to recognize any gain. c) Specialized Gift Techniques i) 7.18 Introduction ii) 7.19 Nonqualified Stock Options iii) 7.20 Small Below-Market Loans (1) Gift loan is a below market loan where the foregoing interest is in the nature of a gift. (a) No gift or income consequences for loans that do not exceed $10,000 unless borrower uses proceeds to purchase or carry income producing assets. (i) Ex: M made interest free loan to D for $100,000 who used it to purchase residence. No payments. No income tax consequences. For gift tax purposes, assuming federal short term rate is 6%, M would have been treated as having made a gift of $6,000. (2) Transfer of cash to child in exchange for noninterest demand notes were gifts and not bona fide loans because no creditor-debtor relationship created. iv) 7.21 Payment by One Spouse of Entire Income or Gift Tax Liability (1) Payment of income and gift tax liability by a spouse under a joint income tax return does not constitute a gift. v) 7.22 Grantor Pays Tax on Income of Grantor Trust

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(1) G transferred income producing property to a trust of which Gs children are income beneficiaries. G retained power that causes him to be treated as an owner. G pays income tax on income of trust even though income distributed to children. By paying tax G in effect makes a tax free gift to the beneficiaries (a) Class notes (i) Ex: family trust sprinkle income to kids. Trust is tax paying entity. Reports all income and distribution to kids. Gets distribution deduction. 1. Intentionally Defective Grantor Trust [example 7-7] a. Trust with income to kids and remainder to grandkids reserving right to swap property of equal value. The power to swap property will not cause trust to be included in estate vi) 7.23 Free Service and Free Use of Property (1) IRS has not sought to apply gift tax to the free performance by one person of services for another. (a) Use of services and property are tax free vii) 7.24 Gift of Residence with Continued Use by Donor- Outright gifts and QPRTs (1) If grantor transfers but continues to occupy, it is includable in gross estate unless pays FMV rent. (a) Treat like landlord tenant situation. (2) Drawbacks (a) Made gift (b) Lose step up in basis [exemption for personal residence up to $250,000] (c) Creditors could go after it. (3) QPRT (a) Reserves a term of years [cannot be reserved for life] Must live term. The QPRT issues come up when the term ends. Make sure through rent or something that you still own can occupy the house. (b) Made gift in year but the value is very low viii) 7.25 Installment Gifts: Periodic Forgiveness of Transferees Notes (1) If at time of loan there is an intent to forgive or not collect it will be treated as a gift to the full extent of the loan. (a) If no intent to forgive/not collect at time of loan then it will not be considered a gift ix) 7.26 Net Gifts (1) 7.26.1 Income Tax (2) 7.26.2 Gift Tax (3) 7.26.3 Estate Tax x) 7.27 Gifts of Encumbered Property xi) 7.28 Part Gift and Part-Sale
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Estate Planning Spring 2010

d) Gifts to Minors i) 7.29 Importance of Gifts to Minors (1) Always ill-advised (a) If setup trust for child. $10k income. Distribution to child to support. Trust must report income but when it makes distribution the distribution is carried with it. (i) To extent income of trust used to support minor it is taxed to parents under grantor-trust rules. (b) Non support distributions would still be subject to kiddie tax (2) No income tax savings when child is minor ii) 7.30 Outright Gifts (1) 7.30.1 Gift Tax (a) UGMA-Uniform Gift to Minors Account [good for small amounts] (i) Appoint custodian and money goes to custodian not child. [looks like trust but isnt one] 1. If child dies before 18 then goes to estate. (b) Completed gift. (c) Qualifies for annual exclusion because treated as given directly to child (d) Income taxed to parent [at parents rate] (e) Drawbacks of custodianship (i) If donor appoints self custodian, it is still a completed gift, it is not a GPA, but under 2038 donor has retained sufficient powers to bring into gross estate. 1. If someone else puts money in then custodian isnt required to include in estate (ii) Custodian holds only until 18. Rules are governed by statute rather than trust language. 1. Should use transfer to trust with Crummey Power [allows more flexibility with regard to support distributions to avoid taxing the parent] (2) 7.30.2 Estate Tax (3) 7.30.3 Income Tax iii) 7.35 Gifts to Minors Under Uniform Acts (1) 7.35.1 Gift Tax (2) 7.35.2 Estate Tax (3) 7.35.3 Income Tax (4) 7.35.4 GSTT iv) 7.38 Discretionary Trust with Power of Withdrawal (a) Income to M until 35. Remainder to M or Ms estate.

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Estate Planning Spring 2010

(i) When he lets $13,000 power lapse it is not a gift because it goes back to him. 1. If there are contingent gift then letting it lapse it would be $8,000 gift [5/5 power] (ii) Gift splitting does not occur until return filed. As a result a $26,000 contribution that is intended to be split is not a present interest. (b) 5 in 5 power (i) Setting up multiple trusts to get around 5 in 5 rule does not work. Three separate contributions to one trust does not work. Separate donors making contribution does work. (2) Gift Tax (3) Limit the Amount Subject to Withdrawal (4) Allow Each Donor to Restrict the Amount That is Subject to Withdrawal (5) Hanging Power (a) Contribute in year $13k and only lapse portion that can be lapsed tax free. Lapse $5k in first year and $8k power to withdraw. $13 more in second year. $5k lapse so $16k hanging. (i) As hanging power grows the incentive to withdraw increases (6) How many beneficiaries May Hold a Power of Withdrawal? (7) Notice to Beneficiary (a) In order to qualify for annual exclusion the beneficiary must have a reasonable opportunity to exercise before lapse. [Trustee should inform/give notice] (i) Right to withdraw has to exist at time of contribution to create present interest 1. Need not be written but suggested (b) If child, notify the parent. (c) Provide for in trust document (8) Must the Trust Have Liquid Assets to Satisfy Withdrawal? (a) No, as long as assets in trust it is acceptable (9) How Long Should Power be Exercisable? (a) 30 day period is used by practitioners (i) December 31 is when the contribution lapses. 1. Make contributions early enough to power lapses before the end of the year (10) Beneficiary Interest in Trust (a) If no economic interest in trust then not going to respect power to withdraw because no expectation of withdrawal. (11) Separate Trusts or One Trust for Multiple Donees (12) Income Tax (13) Estate Tax
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(14) Model Power of Withdrawal (15) Class Notes (a) With no estate tax, no reason to make annual exclusion gifts other than for income tax savings. 8) Chapter 9 Limiting Estate Size Through Intrafamily Transactions a) Introduction i) 9.1 Overview ii) 9.2 Professional Responsibility b) The Installment Sale i) 9.3 General (1) Ex: (a) $100,000 basis in farm with FMV of $1,000,000. (i) Selling on installment basis. $50k at time of closing. $50k for each of the remaining 19 years. 1. If sold outright there would be $900,000. a. Tax burden spread out over 20 year period. i. 10% of each payment is return on basis and 90% is capital gain. 2. If FMV increases the parent does not pay transfer tax on increase [value of farm frozen at $1million] (ii) Can take security interest in farm. [such as security interest in farm] (b) If gift the basis would be $100k but since purchased the basis is $1 million (2) Disadvantages (a) Any future appreciation is treated as capital gain to child. (b) Donor has to pay tax [capital gain which is at 15%] or alternative minimum tax (c) After the term of the installment the seller loses retirement income [if that was purposes] ii) 9.4 Gift Tax Consequences (1) If meet minimum safe harbor rate (a) Gave $1 million and received $50k down and a 95% secured loan. FMV installment note bearing minimum safe harbor could be less than $1 million so the excess would be a gift. (i) Would qualify for annual exclusion (2) If H and W own, gave forgive $26,000 of each years payment [annual exclusion] (a) Does not matter if you forgive interest or principal (i) Still must report interest and capital gain (3) If in future years reduce interest rate from 4% to 2% then could be considered a gift (a) Business exception that protects non familial transactions
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iii) 9.5 Estate Tax Consequences (1) Sell on installment and die before period ends but 2036 does not apply. iv) 9.6 Income Tax Consequences (a) Interest would be imputed. Every payment would be re characterized as part interest part payment. Interest is regular income. (2) 9.6.1 Payments Received (a) Gain = payment received x [gross profit/contract price] (i) Note from buyer not a payment. Security for note is not payment. 1. Demand note not treated as installment so all is treated as income in year one 2. If secures with something readily marketable then it is payment received 3. If half paid up front and the rest is kept in escrow there must be bona fide reason for purchaser to put restrictions on seller than for the seller to be able to spread out gain over two yers. (b) Ex: FMV of $100k. Basis of $50k. Mortgage of $20k. Assume mortgage. Payments of $20k/3 years (i) As long as mortgage does not exceed the basis then the assumption of mortgage does not constitute payment received (ii) Gain = 20,000 [50,000/(100,000 -20,000[mortgage assumed])] =12,500 1. If mortgage $60,000 then it is a payment received. Contract price increased by amount mortgage exceeds basis] a. Gain = 30,000 x [50,000/90,000] 2. Ex: $100,000 sale with $50,000 basis. $60,000 mortgage. $20,000 paid the next two years. a. Gain = [amount in excess of payment] x [gross profit/ contract price- amount of mortgage in excess of basis] i. Year one = 10,000 x[50,000/50,000] ii. Year two =30,000 x [50,000/50,000] (3) 9.6.2 Inter Vivos Disposition of Obligation (a) Transfers to spouses are excepted from rule that gain/loss recognized when seller sells, exchanges, or otherwise disposes of the installment obligation (b) Transfer of obligation to trust is not a disposition of income of trust is taxable to transferor under grantor trust rules (c) When obligation is cancelled it is treated as a taxable disposition (i) If obligor is a related person they are treated as having received the full face value of the transaction 1. Ex: T sold Blackacre, basis of $10k to X for $100k represented by interest bearing note which no principal payments were due until 5 years following sale.
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a. T gave note to X before principal due. i. If X is related then T recognizes $90k in year note becomes unenforceable. ii. If X not related then T recognize gain in amount equal to excess of the FMV of the note over his basis. (4) 9.6.3 Disposition at Death (5) 9.6.4 Imputed Interest or Original Issue Discount (6) Class Notes (a) Intentionally Defective Grantor Trust (i) If sell property to IDGT on installment basis then grantor does not have to recognize gain on that sale 1. If intend to annually forgive payment to trust it is debatable whether it is a present interest v) 9.7 Resale by Related Person 453(e) (1) 9.7.1 Related Person (2) 9.7.2 What Disposition Constitute Resales? (3) 9.7.3 Involuntary Transfers (4) 9.7.4 Marketable Securities vi) 9.8 Self-Cancelling Installment Notes [SCINs] (a) Sell asset to child over 20 years but contract states that if not paid off in full then debt is cancelled. (i) If died with payments left when seller died then note would be in estate under 2033 [if no self cancelling provision] 1. Its possible nothing will be in gross estate in this situation if done correctly a. Could argue, based on term, that it was a gift because note not worth value of asset if term is unreasonable [50 year note sold at age 60] 2. If negotiated and consideration paid for self cancelling provision then more likely to keep out of estate [consideration might be a note worth more than asset] (b) Ex 9-8 (c) Income tax consequences (i) Reporting gain on installment basis (ii) If die, still have to report gain 1. Include on either individuals tax return or the estates return. a. If on individual tax return then income tax owed is a debt deductable on the 706 b. If income tax obligation of estate then not deductable on 706 and must pay entire amount
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(iii)E-bonds that have increased in value that has not yet been reported 1. Can accelerate to decedents final return and pay it immediately a. If paid then can be deducted on estate tax return 2. Can have estate do it 3. Can give to beneficiary and report it as cash (2) 9.8.1 Estate Tax (3) 9.8.2 Gift Tax c) Dividing Interests: Sales of Remainders, Joint Purchases, Grits, Grats, Gruts, and QPRTS i) 9.40 Introduction (1) GRIT (a) Grantor puts in $100k of stock. Reserve income for 20 years. Remainder to child. (i) Before 2702 gift would be value of stock less value of retained interest. Not present interest in property. If person dies within 20 years the value of stock at time of death is in estate. (b) 2702 (i) Can no longer do GRIT unless is a QPRT ii) 9.41 Sale of Remainder Interest (a) Blackacre worth $1,000,000 and remainder interest sold for $50,000 (i) 2702(c) (2) 9.41.1 Gift Tax Consequences (3) 9.41.2 Estate Tax Consequences (4) 9.41.3 Income Tax Consequences iii) 9.42 Joint Purchases (1) 9.41.1 Gift Tax Consequences (2) 9.42.2 Estate Tax Consequences (3) 9.42.3 Income Tax Consequences iv) 9.43 Grantor Retained Interest Trusts [GRITS, GRATS, and GRUTS] (1) 9.43.1 Gift Tax Consequences (2) 9.43.2 Qualified Interests [Grats and Gruts] (a) GRAT (i) $100,000. $5,000/year for 20 years. Remainder to Max. 1. Gift would be actuarial value of $5,000 a year for 20 years (3) 9.43.3 The Zeroed Out GRAT (4) 9.43.4 Successive Term Interests (5) 9.43.5 Grantors Death During Term (6) 9.43.6 Contingent Annuity or Unitrust Interests v) 9.44 Personal Residence Trusts; Qualified Personal Residence Trusts (1) Class Notes
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(a) Retain use of residence for less than time expected to live because if person dies within period of QPRT then is included in estate at current value. (i) Transfer residence to QPRT with a retention of residence for 20 years (2) 9.44.1 Two Person Residential Limit (3) 944.2 QPRTs (4) 9.44.3 Estate Tax Consequences (5) 9.44.4 Income Tax Consequences (a) Making gift of remainder interest. Value what retained using tables. File gift tax return showing remainder interest. Does not qualify for annual exclusion. (i) If person lives term and trust terminates the beneficiary becomes the owner. (ii) Could continue trust. 1. Cannot require trustee to sell back and have it be considered a QPRT. Transfer current value into trust and get residence in return. Not a gift. No gain. 2. If grantor trust and leasing from trust after term it could be argued that rent made it a 2036. a. If not grantor trust the trust would recognize the income. Could depreciate it. vi) 9.45 Conclusion vii) Class Notes (1) Corporate Freeze (a) Ex: Own 100% of Gillett Inc. worth $1 million. Do a tax free reorganization. Receive 100 shares of common and 100,000 shares of new preferred stock. (i) Preferred stock worth $990,000 and common worth $10,000. Give common stock to son. Gift of $10,000 to son. 1. Preferred stock remains the same regardless of increase in corporation. a. Transferred growth to son. He would get all the increase and there would have been no tax consequences. (b) 2701 essentially changes the corporate freeze and reverses the above result. (i) If transfer of growth interest to family member and frozen interest is held by donor immediately after transfer there are special valuation rules: frozen interest reduced and growth interest is increased. 1. 2701 only applies if two different kinds of equity interests (2) Harrison Case (a) Partnership (i) General and Limited Partnership 1. Parents transferred millions to partnership. Parents took back almost all limited partnership and some of general partnership. Most of value of millions transferred are attributable to limited partnership.
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a. Kids transferred in small amount and got general partnership. 2. No gift at time created because parents got value and kids contributed value. 3. During life all general partners should terminate/liquidate (b) 2704 (i) Creates a transfer 9) Chapter 11 Closely-Held Business Interests a) Introduction i) Overview ii) Growth of S corporation, FLPs and LLCs (1) File informational income tax returns but do not pay income tax as an entity. Income, credits, and deductions flow through their owners. iii) Valuation Discounts (1) Noncontrolling interests in entities that are not publically traded are valued at discount for lack of marketability and lack of control [minority interest] iv) Income Tax Considerations (1) Check the box regulations allowed entity to be treated as a corporation or as a partnership v) Management and Control vi) Buy Sell Agreements vii) Gifts and Other Transfer Strategies viii) Sections 303 and 6166 ix) Recapitalization x) Sale of ESOP, 1042 xi) Ethics-Conflicts of Interest b) Family Limited Partnerships and LLCs i) Overview ii) Failed IRS Attacks (1) Gift on Formation (2) Economic Substance Doctrine (3) 2703 (4) 2704 iii) Successful IRS Attacks (1) 2036(a) (2) Failure to Respect Business Form (3) Deathbed Formations and Transfers (4) No Annual Exclusions (5) Arguments to Limit Discounts 10) Chapter 12 Post-Mortem Planning a) Introduction
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i) Scope ii) Initial Steps (1) Letter or Memo for Personal Representative; Locating and Protecting Decedents Property (2) Cash needs (3) Federal Tax Notices (a) Allows the fiduciary to communicate directly with IRS (4) Extensions of Time, Reg 301.9100 (a) No extension for filing estate tax return b) Income Tax i) The Decedents Final Income Tax Return: General (a) Must file final income return based on the time the decedent lived. Filed on normal date as if he had lived the entire year. (2) Disadvantages of filing Joint return (a) Filing a joint return allows the liability for taxes, interest, and penalties to attach to surviving spouse. (3) Deduction of Medical Expenses (a) Deduction if expenses exceed 7.5 percent of taxpayers adjusted gross income. (4) Passive Activity Losses (5) Miscellaneous Itemized Deductions (a) Allowed if exceed 2 percent of AGI. (i) 67(b) lists items that are nonmiscellaneous (6) Election to Report Accrued Interest as Income 454 (7) Election to treat Qualified Revocable trust as part of Decedents Estate for Income Tax Purposes (8) Income from Assets that were Formerly Community Property ii) S Corporation Election 1362 (1) Certain Domestic Small Businesses are permitted to elect that their income be taxed directly to their shareholders rather than the corporation. (a) Requires one class of shares, or more than 100 shareholders, all of whom must be individuals, estates, or trusts. iii) Partnership Elections (1) Ex 12-4
11) Chapter 12 Post Mortem Tax a) Medical Expenses i) Can be deducted on estate tax return or on decedents final income tax return [lose 7.5% on income tax] (1) 2053 debt on estate tax (a) If taken on income tax return would reduce income tax thus reducing deduction would otherwise receive on estate tax

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Estate Planning Spring 2010 (b) If paying estate tax take it on estate tax return [greater percent taxed on estate tax return] (i) If not paying estate tax then must take on income tax return (c) If surviving spouse (i) $5 million estate. $1.5 to spouse. Balance to bypass trust. 1. If dont save much on income tax, taking on 706 would force less property to be passed to spouse. Passive Activity Losses i) 469 (1) Only take passive activity loss to extent of passive activity gains (a) [capital loss carryovers disappear on decedents death] (2) Allowed whatever PAL might be carried forward are generally allowable on decedents final return (3) Can be offset by any gain ii) Limitation (1) Deduction on final return limited to amount total loss is in excess of the basis of the property in the hands of the transferee [stepped up] over the adjusted basis of property in hands of decedent immediately before death (a) $2000 PAL. $1000 FMV on DOD. $200 decedents basis. [$800] (i) Able to deduct $1,200 EE Bonds i) Do not have to report interest as it accrues. (1) Bond $100 cashed fifteen years later its $200. Increase in value a result of accruing interest. $100 basis and $100 interest income. ii) Can report interest in final income tax return (1) if estate paying tax, paying it on final return allows them to deduct income tax attributable to it on estate tax return iii) Can report on estates income tax return iv) Could distribute to beneficiaries (1) Can continue to hold/delay reporting of income (2) Can cash (3) If estate tax return or beneficiary report then would receive deduction for estate tax attributable [$45 on a $100 gain] b/c IRD v) Could give to charity (1) If give bonds to OU then they do not have to report income S corporation i) No tax at corporate level [taxed similar to partnership] (1) Shareholders report their share of the corporate earning ii) Must be individual shareholders (1) Estate is permitted shareholder as long as being administered Partnership Elections 754, 732(d)(4) i) Ex: (1) Partnership with three partners [A B C] (a) $1,000,000 farm which all contributed equally [farm is possessed by partnership] [32]

b)

c)

d)

e)

Estate Planning Spring 2010 (2) A owns portion of farm. (3) A dies. (a) At his death partnership worth $2 million (i) Partnership included in As estate. $667,000 in estate. 1. Can file election for partnership in increase basis a. A would get more depreciation each year f) Declaration and Payment of Estimated Tax i) On decedents final return wont be penalized if estimated tax not made ii) Trusts (1) Required to pay estimated taxes from the date of creation iii) Estate (1) Taxed same as trust-to extent it does not make distributions it must pay (a) Does not have to pay estimated taxes for first two years g) Taxable Year for an Estate or Trust i) Ex: $100,000 (1) Income to max (a) Must report income in year win which trust tax year ends (i) If Jan-Dec 1. Max treated as if he received in 12/31 it would be reported on 2010 return (ii) If fiscal year and ends 1/31/2011 1. Would report on 2011 return which is due April 2012 (2) Remainder to GC ii) Trusts now required to be on annual year return iii) Estates can still elect a fiscal year (1) Ex: date of death Jan 15 2009 (a) Estates first year begins January 16. (i) Can elect how long the first year will run 1. First period must end on last day of month and cannot be longer than 12 months (b) Considerations (i) Get as many tax years as possible [spread out income[ 1. Estate gets exemption [first $600 exempt] 2. Estate has lower tax bracket for first $4,000 (ii) If too much income then distribute before date (iii) Earlier in the year the greater opportunity for deferral (c) March 31,2009 elected as first year (i) Beneficiary must report in 2009 return which would be April 2010 h) Waiver of fees i) Fees deductible on either estate or income tax return (1) If pay expenses that exceed income they generate no tax value whatsoever in the first year (2) If you pay in final year, excess expenses can be distributed to beneficiaries and they can take on their individual income tax returns ii) Executor does not have to take fees. [33]

Estate Planning Spring 2010 (1) If does elect to take, then deductible on either income or estate tax return i) Estate Tax and Income Tax Deductions i) 642(g) (1) If deduction under 2053 or 2054 then no income tax deduction. If taken as income tax deduction file statement saying not taking as estate tax (a) If sale related to administrative expenses can either take commission and deduct under 2053 or offset amount received on farm [step up in basis on farm so may not have gain at all] ii) 642(h) (1) Unused loss carryover iii) 691(b) (1) Deductions with Respect to Decedent allowed to be deducted on both iv) Only Estate Tax (1) Funeral expenses (2) Gift taxes (3) Other debts/claims not allowable for income tax (4) Under 2053 (a) Has to be paid (b) Reasonable (c) Otherwise allowable under local law v) Only Income Tax (1) State income taxes on income earned after death vi) Estate tax (1) Some interest is deductible [borrow money to pay administrative expense so interest deductible] (a) Do not deduct until paid (b) File amended return to get credit vii) 67 Two percent floor on miscellaneous deductions (1) Only claim to extent they exceed adjusted gross income (2) 67(e) not subject to 2% floor (a) Ex: pay executor fees. (i) Most administrative expenses are allowable in full and not miscellaneous deduction j) Elections Affecting Estate and GST Taxes i) Alternative Valuation Method 2032 (1) Election to value at six months after date of death (2) Valuation must decrease estate and tax owing (3) Purpose is to protect them if assets go down in value during administration [make election if this happens] (a) Brings with it a lower basis in asset (4) 2032(d) (a) Election made on return (b) (2) can make election on late return as long as within 1 year (of extended due date) (c) Once made it is irrevocable unless change mind within due date [34]

Estate Planning Spring 2010 (5) Special rules 2032(b) ii) Special Use Valuation 2032A (1) (b) qualified real property (a) Passes to qualified heir [members of family] (b) On date of death was being used for qualified use [used as farm which allows crop share but no cash rent] by decedent or family member. Must have a material participation [earned income]. (i) Requires that 50% or more of adjusted estate made up items related to farming [real or personal] [qualified is broad but defined as to qualified heir and qualified use-farming purpose] (ii) (b)(1)(B)- 25% qualified real property, 5 of 8 years, material participation (iii) 25% of property must be elected (2) Pre death (a) Qualified use (i) (b)(1)(C) 1. Owned by decedent or family (b) Material participation 1. 5 of 8 year period by decedent or member of family a. If cash rent to son then qualified use and material participation satisfied b. If crop share with neighbor the qualified use is maintained and material participation can be maintained 2. Material participation can be inferred if person on social security/retired [qualified use cannot be inferred on this retirement provision] 3. If husband has been farming and dies. Gives to spouse. She then crop shares. Active management satisfies material participation. [lower standard] (3) Post death (a) Qualified Use [use as farm] (i) Can sell it to sell to qualified heir (ii) If disposes to anyone other than qualified heir [within 10-12 years] then there is additional tax (iii) Must be maintained by heir 1. [if not then years later will have to recapture the tax and there can be partial recapture if for example 40 of the 100 acres were cash rented] 2. If decendent of decedent can net cash rent to member of family of such spouse [Max can cash rent to grandchild who must still material participate] (b) Material Participation (i) Must be maintained by qualified heir or member of heirs family (c) 10 years (d) Estate has two years to re-up the qualified use. If they use this 2 year period then it can be up to 12 years iii) 2057(b)(7) Marital Deduction QTIP Election (1) Made on return or on a late return [on first return filed] (a) Once made it is irrevocable [can change if timely filed including extensions] (i) Include language that it is a formula clause and the amount may change [35]

Estate Planning Spring 2010 (2) Partial election (a) $7 million estate. (i) Trust. Income to wife with remainder to kids. 1. Would elect $3.5 million a. Partial election done on percentage basis not dollar amount i. Formula QTIP election [pg 12-60] (3) Protective election (a) Legitimate issue of fact or law

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