Chapter C13
The Estate Tax
Discussion Questions
C13-1 In general, items included in the gross estate are valued at their fair market values (FMVs) on the date of death or alternate valuation date; that is, the amount upon which a willing buyer and a willing seller would agree. Section 2032A allows a departure from the general FMV rule for farm land meeting certain requirements. Such land is valued under a formula approach at less than its FMV. Congress enacted this exception to reduce the probability that the heirs would have to sell the land to pay estate taxes. Students might also mention that Sec. 2033A allows an exclusion of a maximum of $675,500 for decedents dying in 1998 for an interest in a “family owned business.” pp. C13-1, C13-5 through C13-9, and C13-30.
C13-2 For gift tax purposes, properties are valued at their FMVs as of the date of the gift. For estate tax purposes, properties are valued at their FMVs at either the date of death or the alternate valuation date, which is generally six months after date of death. pp. C13-5 through C13-8.
C13-3 For gift tax purposes, a life insurance policy is valued at its interpolated terminal reserve plus the amount of any unexpired premiums. A term insurance policy's interpolated terminal reserve value is zero. For estate tax purposes, a policy is valued at its $150,000 face value. p. C13-5.
C13-4 Shares traded on a stock exchange are valued at the average of their high and low selling prices as of the applicable valuation date. The blockage rule allows a reduction from the average value where the decedent owned a large block of shares that would be difficult to dispose of at one time without using an underwriter and/or accepting a lower price. pp. C13-6 and C13-7.
C13-5 No, the executor may not use the alternate valuation date. It cannot be chosen unless it will result in (1) a lower gross estate amount and (2) a smaller amount of estate tax payable. pp. C13-7 and C13-8.
C13-6 An advantage of electing the alternate valuation date is that the estate tax liability is lower; a disadvantage is that the heirs receive the property at a lower basis. pp. C13-7 and C13-8.
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C13-7 No, the stock is not included in the gross estate because the only properties included in the gross estate under the transfers-within-three-years-of-death rule are those interests that would have been included under Secs. 2036 through 2038 or Sec. 2042 if the decedent had not made the transfer. Stock that has been gifted with no strings attached does not fall under any of these exceptions so it is not included in the gross estate. It will be included in the estate tax base as part of the adjusted taxable gifts if a taxable gift resulted from the transfer. Under the gross-up rule, the gross estate will include the gift tax that is paid or payable on any gift that the decedent makes within three years of death. p. C13-11.
C13-8 The client would prefer that the other person purchase the policy with funds previously accumulated. That way, the client will not potentially be affected by the transfers-within-three-years-of-death rule. pp. C13-10 and C13-11.
C13-9 The "gross-up" rule requires gift taxes imposed on gifts made by the decedent within three years of death to be included in the gross estate. The rule forecloses some of the opportunities that formerly existed for reducing the gross estate and the estate taxes by making "deathbed" gifts. Gift taxes on gifts made more than three years prior to death are excluded from the gross estate. p. C13-11.
C13-10 The gross-up rule can apply where the decedent consented to gift splitting, and paid gift taxes on gifts made by his or her spouse during the three-year period ending with the decedent's date of death. p. C13-11.
C13-11 a. The residence is included in her gross estate, but her estate receives a charitable contribution deduction for the residence's entire value.
b. The 18th century residence is not included in her gross estate because she retained no enjoyment. pp. C13-11 through C13-13.
C13-12 The three retention periods that can cause Sec. 2036 to apply are: (1) the transferor's lifetime, (2) a period that cannot be determined without reference to the transferor's death, and (3) a period that in fact does not end before the transferor's death. p. C13-12.
C13-13 Sections 2035 through 2038 apply only if the decedent made a transfer of a property interest specified in one of those Code sections for less than adequate consideration in money or money's worth. pp. C13-10 through C13-13.
C13-14 If the joint tenants are not spouses, the consideration furnished test of Sec. 2040(a) applies. Under this test, the gross estate includes the fraction of the value of the property that equals the proportion of the consideration that the decedent furnished. If the joint tenants are spouses, under Sec. 2040(b) one-half of the property's value is included in the decedent's estate regardless of how much consideration he or she provided. pp. C13-15 and C13-16.
C13-15 Life insurance is included in the decedent's gross estate under Sec. 2042 if (1) the decedent possessed incidents of ownership in the policy at the time of his/her death or (2) the policy proceeds are payable to the executor or for the benefit of the estate. Even though the insurance may escape being taxed under Sec. 2042, it can be included under Sec. 2035 if it was transferred by gift within three years of death. pp. C13-15 and C13-16.
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C13-16 The entire value of the property, in which the decedent previously gave away a remainder interest but retained a life estate, will be included in the gross estate (Sec. 2036). There will be an inclusion of reversionary interests, provided their value exceeds 5%, if the decedent previously gave away property but kept a reversionary interest therein (Sec. 2037). If, for example, the decedent earlier purchased an asset and had it titled in the joint names of himself and a child, 100% of the property's value will be included in the decedent's gross estate due to the consideration furnished test (Sec. 2040). pp. C13-11 through C13-17.
C13-17 The property is not included in Pam's estate because Pam had only a special power of appointment. p. C13-15.
C13-18 The statement is correct only for pre-October 22, 1942 general powers of appointment. A post-October 21, 1942 general power of appointment is included regardless of whether it is exercised. p. C13-15.
C13-19 The trust assets are fully included in the widow's gross estate if the executor made an election to claim a marital deduction in Carlos's estate for the entire QTIP trust. If the executor made a partial QTIP election, the pro rata portion of the trust for which the election was made is included in the widow's gross estate. Otherwise, the trust assets are not included in her gross estate. p. C13-17.
C13-20 Estate tax deductions are as follows: marital, charitable contribution, funeral and administration expenses, debts, and casualty and theft losses. Gift tax deductions consist of only the marital deduction and the charitable contribution deduction. pp. C13-18 and C13-19.
C13-21 Administration expenses may be deducted on either the estate tax return or the estate's income tax return or some in each place. They should be deducted on the return where they will produce the greatest tax savings. If the estate tax base exceeds $1,000,000, the tax savings will be larger if the expenses are deducted on the estate tax return because the estate tax rates will be higher than the top income tax bracket for trusts and estates. Debts of the decedent are deductible only on the estate tax return. pp. C13-18 and C13-19.
C13-22 a. There is no marital deduction for the life insurance (even though the spouse is the beneficiary) because the policy is not included in the gross estate. The decedent had no incidents of ownership.
b. The trust is ineligible for the marital deduction because it is a nondeductible terminable interest. The trust does not qualify as a QTIP trust because the spouse will lose the right to the income in the event of remarriage. pp. C13-20 through C13-22.
C13-23 The five credits available for estate tax purposes and illustrations of each are as follows.
· State death tax credit--the estate paid estate or inheritance taxes to the state.
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· Gift tax credit--prior to 1977 the decedent made a gift of a remainder interest in property in which he kept a life estate and paid gift tax. The gifted property is in the donor’s gross estate.
· Previously taxed property credit--the decedent received property that was taxed in the estate of a person who predeceased the decedent by not more than ten years.
· Foreign death tax credit--the decedent owned realty in a foreign country and paid death taxes to that country.
· Unified credit--$192,800 for 1987 - 1997 and $202,050 for 1998.
The only credit available for gift tax purposes is the unified credit. pp. C13-23 through C13-25.
C13-24 The tax policy reason for allowing installment payments of estate taxes attributable to interests in closely held businesses is to reduce the likelihood that some or all of the business would have to be sold to pay the estate taxes. pp. C13-28 and C13-29.
C13-25 The unlimited marital deduction causes the transfer tax results to be neutral. From an income tax perspective, however, a transfer at death is preferable to an inter vivos transfer because a step-up in basis occurs only for transfers at death. pp. C13-32 and C13-33.
C13-26 The advantage of freezing values by removing post-gift appreciation from the transfer tax rolls will be most dramatic if Bala makes a gift of the life insurance policy (provided he survives the transfer by more than three years). The next best items to transfer are the stock in the business with a "bright" future, and the land in a "boom town" because these assets have a good potential for appreciation. The cash is not expected to appreciate. With interest rates rising, the value of the bond can be expected to decline. pp. C13-32 and C13-33.
C13-27 If Bala dies within three years of giving away the insurance policy, the policy will be included in his gross estate. This result is no worse than if he had not made the transfer. The chance for a step-up in basis for the stock and land will be lost if Bala makes gifts of these assets. If Bala incurs a gift tax liability with respect to any transfer and dies within three years of the transfer, his gross estate will be "grossed up" by the gift taxes. p. C13-34.
C13-28 Disposing of an amount equal to the exemption equivalent (applicable exclusion amount) to persons other than one's spouse allows the decedent's estate to make full use of the unified credit and prevents such property from being taxed in the surviving spouse's estate. p. C13-32.
C13-29 The estate tax return is due nine months after the date of death. Generally, the estate tax is due at this time also. An extension of up to one year is available to pay the estate taxes. See Sec. 6161(a)(1). For reasonable cause the Secretary may give an extension of up to 10 years. See Sec. 6161(a)(2). Installment payments may be made automatically if a large enough portion of the estate consists of an interest in a closely held business. See Sec. 6166. pp. C13-35 and C13-36.
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Issue Identification Problems
C13-30 · Does Henry make a gift when he purchases the land?
· What portion of the land will be in Henry's gross estate? (Stated differently, will using this form of ownership reduce his estate taxes?)
· Are there any other estate tax implications?
· What are the generation-skipping transfer tax implications?
At the time of purchase, Henry will make a gift to his grandson of half of the cost of the land.
Because Henry provided all of the consideration, under the consideration-furnished test of Sec. 2040 Henry's gross estate will include 100% of the date of death value of the land. This strategy will not reduce his estate tax liability.
In addition, his estate tax base will include as an adjusted taxable gift the taxable gift made upon the purchase of the land as joint tenancy property. The gift will be so large that gift taxes will be owed; thus, if Henry dies within three years of acquiring the land, there will be gross-up under Sec. 2035 for the gift taxes he paid. Such gift taxes will, fortunately, reduce his estate tax payable regardless of how long he survives.
The grandchild is two generations younger than Henry and is a skip person. Generation-skipping transfer taxes will be owed in addition to the gift and estate taxes. The amount of the transfer exceeds the GSTT exemption amount of $1,000,000.
pp. C13-10, C13-11, C13-14, C13-15, C13-30 and C13-31.
C13-31 · Should Dave consider making a disclaimer? If so, of how much?
Unless Dave makes a disclaimer, Annie's estate will waste its exemption equivalent. Dave should disclaim at least $625,000 to allow Annie's estate to make use of the full unified credit.
Because Dave is in poor health (and likely has a short life expectancy) and any additional inclusion in his estate will be taxed at 55%, he should consider disclaiming some amount in excess of $625,000 in order for some of the property to be taxed in Annie’s estate at rates below the 55% marginal tax rate that will apply to his estate.
pp. C13-33 and C13-34.
C13-32 · In the alternative scenario, the issue is what martial deduction (if any) should be claimed on the trust?
In the alternative scenario, the executor could elect to forego the marital deduction on all or a portion of the QTIP trust. The QTIP trust is a more flexible arrangement because the executor can affect the size of the marital deduction whereas with the outright bequest the amount of the marital deduction will be altered only if Dave is willing to make a disclaimer.