Estate and Gift Taxation
Law T 510
University of Washington School of Law
LLM Program in Taxation
Instructor: Dwight Drake
Winter 2009
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Contact Info – Office Hours
• Email: djdrake@u.washington.edu
• Phones: 206.616.6385, 425.281.1493,
425.222.5988, 360.778.1862
• URL:http://faculty.washington.edu/djdrake/
EstateandGift/index.shtml
• Office Hours: Room 416
- Wednesday 3:30 p.m to 5:00 p.m.
- Whenever else you can catch me!
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Course Objectives
• Substantive knowledge base – Estate, Gift
& Generation-Skipping Taxes
• Enhance tax learning skills
• Strengthen analytical, problem-solving
skills
• Importance of the planning process
• Your individual role – design, not default
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Core Knowledge Prerequisites
• Estate and trust concepts and mechanics –
we will look at 20 types of trusts
• Basics of common business entities:
- C Corporation
- S Corporation
- General Partnership
- Limited Partnership
- Limited Liability Company
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Some Tips…
• First: Beat Up Code. Learn to talk Code
• Then Regs, Commentary and Cases to fill gaps for
you. Learn what works for you.
• Then: Beat up Code again
• Work Study Problems Hard – First solo and slides
• Focus in class
• Think
• Write your personal summary
• Get ahead – Stay ahead!
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Grade Criteria
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24 Hour Final – 100%
Use anything that isn’t living
Not a time for research
Nothing that hasn’t been covered in class
No tricks or gimmicks
Combination short essay and analytical
problems
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Federal Tax Sources
Pers. Income
Corp. Income
Social Insurance
Excise Taxes
Estate & Gift
Misc.
Total Revenue
2001
2002
2003
2004
2005
994.3
151.1
694.0
66.2
28.4
57.2
858.3
148.0
700.8
67.0
26.5
52.5
793.7
131.8
713.0
67.5
22.0
54.4
809.0
189.4
733.4
69.9
24.8
53.9
927.2 1,043.9 1,163.5
278.4
353.9
370.2
794.1
837.8
869.6
73.1
74.0
65.1
24.8
27.9
26.0
56.4
74.0
65.1
1,991.2
1,853.2
1,782.3
2006
2007
1,880.3 2,153.9 2,407.3 2,567.7
All in billions
LLM Corporate Tax
Instructor: Dwight Drake
Estate Tax Agenda
2005
2006
2007
2008
2009
2010
2011
Exem. Eq. UC
$1.5 million
$2.0 million
$2.0 million
$2.0 million
$3.5 million
N/A
$1.0 million
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Max Rate
47%
46%
45%
45%
45%
0%
55%
Wealth Accumulation
Non-Tax Planning Agenda
- Last chance to spend it – Family priorities
- Structural money planning
- Basic Goal: Not outlive the money
Taxable Planning Agenda
- 1/3 of America’s income from capital
- 1% own 56% of financial assets
- 1/3 of America’s elderly have no income
producing assets
- Average 50 yr old has 40k in financial assets
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Arguments For Estate Tax
• Rich people tax – 5% pay 91%
• Death is a great time to strike
• Big bucks down the road:
2002- 2010: $294 billion
2011- 2021: $750 billion
• We’re gonna need – Boomers are coming
• Easy way to redistribute wealth – Person
is dead!
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Arguments Against Estate Tax
• Wrong to cash-in on tragedy – Sick to face
undertaker and taxman on same day
• Peanut tax that does more harm than good
• Costly to administer – valuation games
• Will suck up needed investment capital in
future – big damage to economy
• Will solidify American’s position as worse
savers in the industrial world
• Destroys businesses and jobs
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Dena & Mark
• Both age 61
• 3 kids, 6 grandkids
• Own ABC Inc.
- 350 employees
- Sales: $38 million
- Net After-Tax Profit: $1.1 million
- Owners Salaries: 400K
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
ABC Value
• Adjusted EBITDA Calc:
- Net After-Tax:
$1,100,000.
- Income Taxes:
560,000.
- Interest
800,000.
- Depr/Amort
340,000.
- Owner Add-Back
200,000.
Adjusted EBITDA
$3,000,000.
• EBITDA multiple: 6
• Sales Price: $18 million (1/3 cash; 2/3 stock)
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Projected Estate Tax Hit If Keep
• Assumptions: Other Assets = $2 million
Full unified credits
• Estate Tax:
Last death 2009:
$5,850,000.
Last death 2010
or repeal:
0.
Last Death 2011
or beyond:
$9,380,000.
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Tax Hits If Sell
• Income tax on recognized
sales proceeds:
• Potential future estate and
gift taxes:
Total
Right?
Wrong!
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
$3,400,000.
$7,306,000.
$10,706,000.
Dena & Mark Estate Plan
Remainder
Per. Res.
Trust
Family
L.L.C.
Term Use
Income
Char. Rem.
Trust
Remainder
Invest.
Assets
Home
Stock
Income
Daughter Trust
Son Trust
GC Trust - 1
Dena & Mark
Living Trust
Charitable Deduct
Daughter Trust
LLC
Units
Cash
GC Trust -2
GC Trust - 3
GC Trust - 4
GC Trust - 5
Alma
Maters
Dynasty
Trust
Income, Support
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
GC Trust - 6
Dena & Mark Sell and…
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Have solid income stream rest of lives
Two-third reduction in income tax hit on sale
Estate tax burden near-nada
Big time Heroes at Alma Maters
Huge Dynasty trust forever free of transfer taxes
Business is leaned, stripped
210 employees soon lose job
Local vendors lose big customer
Dena & Mark miss action, age fast, die
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Six Big Tax Tools
• Annual Gift Tax Exclusion – Now 13k
• Unified Credit – Now 3.5 mill
• GST Exemption – Now 3.5 mill
• Marital Deduction – Unlimited
• Charitable Deduction
• Valuation Games
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
The 20 Trust Agenda
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Revocable living trust
Credit shelter trust
QTIP Trust
Clayton Trust
Bypass Trust
QDOT
Irrevocable life insurance trust
2503(c) minors trust
2503(c) gift trust
Dynasty trust
Charitable Annuity Trust
Charitable Unitrust
Charitable lead trust
Personal Residence Trust
Qualified Personal Residence trust
Qualified Subchapter S Trust
Electing Small Business Trust
Descendants’ Trusts
Grantor Retained Annuity Trust (GRAT)
Intentionally Defective Grantor Trust (IDGT)
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Trust Lingo
Players
He Who Sets Up
Revocable or irrevocable
Testamentary or inter vivos
Trustee
Fiduciary
Title Holder
He Who holds legal title
Mandatory
Discretionary
Ascertainable standard
He Who Gets Benefits
Trustor
Settlor
Grantor
Honcho
Beneficiary
Income Beneficiary
Remainder holder
Contingent, non-contingent
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Trust Mechanics
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Legal document
Separate bank account
Transfer documents
Title insurance
Tax ID number
Separate tax return (Form 1041)
Trustee communications
Accounting requirements
Income distributions
Investment management
Fiduciary obligations
Corpus invasion issues
Trustee succession
Creditor protection and spendthrift limitations
Domestic vs. Foreign – Import Law vs. Export Assets
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Trust Taxes
Three Income Tax Scenarios
1. Grantor Trust (671-678) – Income all taxes to Grantor by virtue of control.
2. Simple Trust – Income taxable to beneficiaries; distribution mandatory.
3. Complex trust – Income taxable to trust or Bs. T rate structure 15% to
35%. Max Rate kick in at low income level.
Estate Tax
1. Generally “any interest” per 2033.
2. Inclusion rules of 2035, 2036, 2037, 2038, 2041, 2043, 2044.
Gift Tax
1. All completed gifts
2. Present v. Future Interests
GST Tax
1. Transfers to skip persons
2. Direct skips, Taxable Terminations, Taxable Distributions
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Gift Tax Computation Model
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Value of gifts current year (§§2511-2519)
Annual exclusion (§2503(b))
Marital & charitable deductions (§§2522 & 2523)
Taxable gifts from prior years
Item 1. plus 4. minus 2. minus 3 = “Taxable Gifts”
§2001(c) tax on 5.
§2001 (c) tax on 4.
Item 6 less 7 = “Gift Tax Pre-Credits”
Maximum gift tax unified credit (§2505)
Unified credit used in prior periods (§2505(a)(2)
Item 9 less 10 = “Available Unified Credit”
Credit for foreign gift taxes
Item 8 minus 11 and 12 = “Gift Tax Due”
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Estate Tax Computation Model
1.
2.
3.
4.
5.
6.
7.
8.
9.
Gross Estate - (§§2031-2046)
Gift taxes on gifts within 3 yrs – (§2035(b))
Estate deductions – (§§2051-2058)
Sum of 1 & 2, less 3 = “Taxable Estate”
Taxable gifts post 12/31/76 not included in estate
Tax on sum of 4 & 5 = “Tentative Tax” (§2001(b)(1))
Gift tax payable on post 12/31/76 gifts (§2001(b)(2))
Subtract 7 from 6 = “Gross Estate Tax”
Compute and sum:
- Unified credit (§2010)
- Credit for pre-’77 gift taxes (§2012)
- Credit for taxes on prior transfers (§2013)
- Credit for foreign death taxes (§2014)
10. Subtract 9 from 8 = “Net Estate Tax”
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Mildred’s 2001 Gift
Current year gift:
$2,400,000.
Annual exclusion:
0.
Deductions:
0.
Prior years taxable gifts
0.
§2001(c) Tax
976,800.
Less: Unified credit
220,550.
Gift Tax
$ 756,250.
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Fact Changes
• Scenario 1: Mildred makes 2001 gift, dies in 2009
with taxable estate of $4.5 million
• Scenario 2: Mildred makes no 2001 gift, dies in
2009 with taxable estate of $7,656,250.
(Sum of $4.5 million and 2001 gift amount and gift
tax)
2009 Estate Tax Hit Under Each?
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Mildred 2009 Estate Tax Hit
2001 Gift
No Gift
Taxable Estate
4,500,000.
7,656,250.
Post-76 Gifts
2,400,000.
0.
Tentative Tax
2,985,000.
3,325,312.
Post-76 Tax
(960,000 – 220,550)
739,500.
0.
Gross Estate Tax
2,245,500.
3,325,312.
Unified Credit
1,455,800
1,455,800.
Net Estate Tax
789,700.
1,869,512.
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Recap Mildred Scenarios
Gift Tax Paid
Estate Tax Paid
Total taxes paid
Difference:
Gift
No Gift
756,250.
789,700.
0
1,869,512.
1,545,950.
1,869,512.
$323,562.
WHY?
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Jim’s 2004 Gift Taxes
Gifts value
Annual exclusions
Deductions
Prior year taxable gifts
Taxable gifts
Tax under §2001(c)
Less: Unified Credit
Gift Tax
$3,000,000.
33,000.
0.
0.
2,967,000.
1,244,960.
345,800.
899,160.
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
Jim Dies 2009 - Estate Tax
Taxable Estate:
Gift taxes within 3 yrs.
Post 76 Taxable gifts
Total
Tentative Tax
Tax on Gifts
(1,215,950 – 345,800)
Gross Estate tax
Unified credit
Estate Tax
9,000,000.
0.
2,967,000.
11,967,000.
5,265,950.
870,150.
4,395,800.
1,455,800.
2,940,000.
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake
The GST Nightmare
Grandparent gives 200k ball to grandchild
- All unified credits and GST exemption gone
- Max 2001(c) rate of 45% (2009 rate)
Gift tax on transfer
$ 90,000
GST tax on direct skip
$ 90,000
The 2515 Whammy – Gift
Tax on GST Tax (45% of 90k)
Total Transfer Taxes
$
40,500
$ 220,500
Net Impact: Taxes equal to 110% of gift value
Law T 510 - Estate & Gift Tax Instructor: Dwight Drake