Slide 14-1
Principles of Taxation: Advanced
Strategies
Chapter 14
 The Transfer Tax System

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-2
Overview of System
Tax imposed on transferor
 Tax is cumulative in nature
 Amount and rate depends on prior
activity
 Integrated gift and estate system integrated
 Rates steeply progressive

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-3
Unified Credit
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Represents a lifetime exemption from transfer
taxes
Credit first used to offset gift taxes. Any
remainder used to offset estate taxes
For year 2001, this results in a exemption
equivalent of $ 675,000
 Exemption equivalent is amount of wealth that
can be transferred free of transfer taxes
McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-4
Gift Tax Formula
Fair market value of gifts during year
Less: Annual exclusion and deductions
Current year taxable gifts
Plus: Prior year taxable gifts
Cumulative taxable gifts
X Transfer tax rates
Tax on cumulative gifts
Less: Tax computed on prior year gifts
Pre-credit gift tax
Less: Unified Credit
Gift tax payable
McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-5
Gifts
Transfers for less than adequate
consideration in money or money’s worth
 No gift until transfer complete

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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-6
Valuation of Gifts

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
Fair market value
 Price that property would change hands with
willing buyer and willing seller
Difficult items to value:
 Land
 Interests in closely held businesses
 Art work
May need appraisal
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-7
Partial Interests
Example: Gift of income interest to
individual 1 for life, remainder to individual
2
 Regulations provide guidance on how to
allocate between the two individuals

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-8
Annual Exclusion
Up to $ 10,000 of gifts to any individual
may be excluded from gift tax
 Married couples may gift split
 Election to treat any gift as made equally
by each spouse
 Only present interests qualify for the
exclusion

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-9
Gift Tax Deductions
Unlimited marital deduction for gifts to
spouse
 Deduction for gifts to charity

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-10
Estate Tax Formula
Fair market value of gross estate
Less: Deductions
Taxable estate
Plus: Post-1976 cumulative taxable gifts
Cumulative taxable transfers
X Transfer tax rates
Pre-credit estate tax
Less: Gift taxes paid or deemed paid
Less: Estate tax credits
Estate tax payable
McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-11
Gross Estate
Items included at fair market value at date
of death
 May elect to value items six months after
date of death if total estate decreases in
value

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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-14
Items Includable in Gross Estate
Property owned by decedent at date of death
 Life insurance owned by decedent
 Portion of jointly owned property
 Transfers with retained life estates
 Certain gifts made within 3 years of death
 Gift tax paid on gifts made within 3 years of
death
 Survivorship annuity benefits

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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-13
Property Owned by Decedent at
Date of Death
Includes all probate property
 Property that passes by will or through
intestacy
 Includes all retirement accounts such as
pensions and individual retirement accounts

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-14
Joint Ownership


Ownership where two or more persons have an
undivided interest in property
Types:
 Joint tenancy- Ownership passes to survivors or
survivors
 Tenancy by the entirety- same as joint tenancy but
between husband and wife
 Tenancy in common- no right of survivorship
 Community Property- property except for gifts and
inheritances acquired during marriage in a
community property state
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide14-15
Joint Ownership

Jointly held property with rights of
survivorship
 General rule: Entire value of property
less contribution of decedent includable
in gross estate
 Exception: If joint owners were
married, 50% of value of property
includable
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-16
Joint Ownership
Tenancy in common – amount includable in
gross estate determined by state law
 Community property – 50% owned and
includable by each spouse

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-17
Estate Tax Deductions
Funeral expenses
 Estate administration costs
 Estate casualty and theft losses
 Certain liabilities
 Gifts or bequests to charity
 Gifts or bequests to spouse

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-18
Estate Tax Credits
State death tax credit
 Subject to a maximum limitation
 Credit for estate tax on prior transfer
 Allowed if property passed through
another estate during past 10 years
 Reduced by 20% for every two year
increment that has passed since property
was previously taxed

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-19
Generation Skipping Transfer
Tax
Tax imposed on transfers that skip a
generation
 Example: gift to grandchild
 Imposed at 55% rate
 Exemptions:
 $ 10,000 annual gift tax exclusion
 $ 1,060,000 exclusion allocated to every
transferor

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-20
State Death Taxes


Imposed by every state
Types:
 Inheritance tax imposed on the privilege of
inheriting assets
 Rate generally based upon relationship between
transferor and transferee
 Estate tax
 Pick up tax
 Tax equal to maximum deduction for state death
taxes on federal return
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-21
Charitable Contributions
Allowed as an income, gift and estate tax
deduction
 Full fair market value generally deductible
for all purposes

McGraw-Hill/Irwin
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Slide 14-22
Tax Basis Issues
Recipient taxable on any income produced
by inherited or gifted property
 Tax basis
 Property acquired from decedent
 Basis equal to fair market value on
date of death or alternative valuation
date

McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 14-23
Tax Basis Issues

Property acquired by gift
 Carryover basis if asset worth more than
donor’s basis
 Split basis if asset depreciated in value
 Carryover basis for gain
 Fair market value for loss
McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc