TEACHER’S MANUAL
to
THE LOGIC OF THE
TRANSFER TAXES
A GUIDE TO THE
FEDERAL TAXATION
OF WEALTH TRANSFERS
Second Edition
■ ■ ■
Laura E. Cunningham
Professor of Law
Benjamin N. Cardozo
School of Law
Noël B. Cunningham
Professor of Law
New York University
School of Law
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Introduction
We hope that you find that our text, The Logic of the Transfer Taxes (2nd Ed.
2021 West), and the Problems & Assignments we have provided, are helpful in teaching
your course in Federal Transfer Taxes. We have successfully used both the text and the
problems in our courses at Cardozo, NYU and Yale. The entire problem set is
appropriate for a three-credit course, a two credit course requires that it be pared down.
We’ve provided the problems both in PDF and Word format, to allow you to edit as you
see fit.
We haven’t created problems for Chapter Ten, largely because we think that
going through the illustrative examples in the book is probably the easiest way to discuss
the material.
This manual provides the answers to all of the questions posed. We’ve provided a
couple of diagrams from slides that we’ve used in the course, we hope that you find those
helpful. Of course, if you have any questions we’d be happy to hear from you.
Enjoy!
Laura & Noël Cunningham
Chapter One
Overview of the Transfer Taxes
Part A. Introduction: Policy Considerations in Taxing Wealth Transfers (1 class)
Our first class is spent principally on policy and historical issues, and the materials
assigned and questions that we pose in the problem provide a basis for that discussion.
Obviously, those can be changed to suit a particular teacher’s approach.
Part B. Interrelationship of the Transfer Taxes (2 classes)
In this problem we attempt to demonstrate the basic operation and interaction of the
gift, estate and GST taxes. This becomes more and more complicated with the
adjustments to the exclusion amount, and we have tried to reduce the complexity by
assuming exclusion amounts unadjusted for inflation. The amount of time a teacher
spends on this material is really a matter of personal preference.
Questions:
In answering the following questions, disregard all inflation adjustments to the basic
exclusion amount under § 2010(c)(3), and assume the following basic exclusion amounts
for the following years:
2011-2017
$5,000,000
2018-2025
$10,000,000
One might begin the discussion with an explanation of the unified credit, and a
calculation of that amount for each of the relevant exclusion amounts ($1,945,800 &
$3,945,800 respectively).
1. Dana made no taxable gifts prior to 2015. Her spouse Harry died in 2007. In 2015, she
made gifts of stock to each of her two children. The stock transferred to each child had a
fair market value of $1,500,000 on the date of the transfer. Dana had paid $500,000 for
the stock. Because Dana utilized her annual exclusions in making holiday gifts to her
children, the amount of her taxable gifts for the year was $3,000,000.
In January 2017, Dana contributed $2,500,000 to a trust established for the benefit of her
two children. Again she utilized her annual exclusions on holiday gifts, so the amount of
her taxable gifts for 2017 was $2,500,000.
Dana died in June 2021, with a taxable estate of $10,500,000. Included in that estate is
$7,000,000 worth of stock, for which Dana had paid $2,000,000.
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a. What is Dana’s gift tax liability for 2015?
There will be no gift tax due. Under § 2502 the total taxable gifts of $3,000,000
results in gift tax due of $1,145,800, which will be offset by the unified credit
under § 2505. After the year the remaining unified credit is $800,000.
This provides an opportunity to discuss the return filing requirements under §
6019.
b. Does the gift in 2015 result in income tax liability for Dana? If one of her
children were to sell the stock shortly after the gift for $1,500,000, what will be
the income tax consequences to the child?
Dana will not be taxed on the unrealized in the stock. The children will each
take a transferred basis of $500,000 in the stock under § 1015(a). If one sold
their stock shortly after the gift for $1,500,00 they would have a gain of
$1,000,000. Since the child would be entitled to tack their mother’s holding
period under § 1223(2), the gain would be LTCG
c. What is Dana’s gift tax liability for 2017?
Now the tax under § 2502 is computed on the sum of current plus prior gifts,
for a total of $5,500,000, resulting in a tentative tax of $2,145,800. This is then
reduced under § 2502(a)(2) by the tax on prior gifts of $1,145,800, reducing the
gift tax to $1,000,000. After reduction by the remaining $800,000 unified credit
there is gift tax due of $200,000.
Students sometime struggle with the “unified” structure of the gift. It can be
useful to review that notion, that no tax is due until gifts exceed the exclusion
amount, and that, as here, when the exclusion is exceeded the tax is 40% of the
excess.
d. What is Dana’s federal estate tax liability?
Because Dana died in 2021, under our assumptionsthe basic exclusion amount
is $10,000,000, and the unified credit is $3,945,800. Computation of her estate
tax is as follows:
§ 2001(b)(1): The sum of her taxable estate and her prior gifts is $16,000,00.
The tentative tax on that amount is $6,345,800. § 2001(b)(2): The gift taxable
payable on prior gifts is $200,000. This brings the estate tax down to
$6, 145,800.
Under § 2010 we reduce the tax by the unified credit of $3,945,000, and the
resulting tax due is $2,200,000.
2
Notice that Dana’s aggregate wealth transfers, both during life and at death,
were $16,000,000. This exceeds her exclusion amount by $6,000,000. Her total
transfer tax liability should therefore be 40% of that excess, or $2,400,000,
which it is, when one combines the gift tax she paid during life and the estate
tax at death.
This is also a good time to discuss the benefits of lifetime giving, including, in
addition to the annual exclusion, removal of property appreciation and gift tax
paid (and appreciation in that amount) from the estate tax base, with a nod to
the gift tax gross up under § 2035(b).
e. Does the bequest of the stock result in income tax liability to Dana or her
estate? If her children subsequently sell all of the stock for $7,000,000, what will
be the income tax consequences to them?
There is no recognition of unrealized gains at death. The children take the
stock with a basis of $7,000,000 under § 1014 and recognize zero gain upon the
subsequent sale.
2. Assume that Dana’s husband Harry died in 2015 rather than 2007, leaving his entire
$1,000,000 estate to charity.
a. Must Harry’s estate file an estate tax return? Should it?
With the advent of portability in 2010, because Harry died after that year, his
unused exclusion amount, which in this case is $5,000,000, will be available to
Dana’s estate under §2010(c)(4). In order for this to be possible the election
must be made on a return filed by Harry’s estate. See Reg § 20-2010-2. This
provides an opportunity to explore the return filing requirements of § 6018, and
to see that even if no return is required under those rules, it will be necessary to
allow for portability.
b. How would your answers to question #1 change if Harry’s estate did file a
return?
In that case, so long as the executor did not opt out of portability (see Reg §
20.2010(a)(2)), Dana’s exclusion amount would be increased by Harry’s to a
total of $15,000,000. , and her unified credit would be $5,945,800 ($345,800 +
40% of $14,000,000). This would offset any gift tax due in 2017. At death her
estate tax of $6, 345,800 would be reduced by that credit to $400,000.
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3. Assume in addition to the above facts that Dana was the income beneficiary of a trust
created by her father in 1990. Under the terms of the trust, on Dana’s death the trust
assets are distributed to Dana’s children in equal shares. Because Dana’s interest
terminated at her death, the assets of the trust (which total $18,000,000 when Dana dies
in 2019) are not included in her taxable estate. Without getting into the details, will the
assets pass to Dana’s children free of any transfer tax?
This is intended as a peek at the GST, and an illustration of how direct skips and
dynasty trusts could avoid tax prior to the GST.
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Chapter Two
Gift Tax Fundamentals
In teaching the transfer taxes, it can be hard to decide where to start. Some teachers
prefer to go straight to the estate tax, and defer the gift tax discussion. Others prefer to
begin with the gift tax. After trying both, we fall into the latter category for a couple of
reasons. First, the gift tax is pretty easy for students to grasp. Second, it raises issues that
will arise in the estate tax setting as well, and we find it helps the discussion of transfers
with retained interests. But reasonable minds can and do differ. What we do here (and in
the book) is discuss the basics, and defer the discussion of some of the intricacies until
Chapter Eight. You may want to cover the two chapters together toward the end of the
course.
Questions:
1. Do any of the following transactions constitute a "transfer of property by gift" as that
phrase is used in § 2501(a)?
(a) Father offers his 35-year old daughter $50,000 if she quits smoking for one
year. She accepts his offer, quits smoking and Father pays her $50,000.
(b) Father pays the following expenses for his 19-year old daughter who is enrolled
in college:
(a) Room and board of $6000
(b) Tuition of $50,000
(c) Spring break trip to Florida $3000
Would your answers be different if daughter was enrolled in graduate school and
was 25?
This raises the question of the extent of a parent’s support obligation. The
difficulty of doing that, and the variance in state laws, could make some of these
transfers taxable gift. Taxpayer tolerance for aggressive enforcement in this area
would be very low, if non-existent. This helps with understanding the role that the
exclusions in §§ 2503(b) and (e) can play.
(c) Mother is a real estate broker. Daughter is selling her house. Mother lists the
property and finds a buyer, and waives the right to collect the $100,000 commission
5
she would otherwise earn from the sale. Has Mother made a gift? What additional
facts might you want to know in answering the question?
Has there been a transfer of property or of services? Transfers of services are not
generally taxable. As in the context of executor commissions, (see book page 29)
the answer may turn on when the waiver takes place.
(d) On January 1 of year 1 Grandmother makes an interest free demand loan to
grandson of $2,000,000. Assume the AFR is 4% compounded annually.
(i) On the date that she makes the loan, has she made a gift?
Clearly no, because of the repayment obligation.
(ii) Are there any other gift tax consequences resulting from the loan?
This is a below market loan under § 7872. Under § 7872(a), the forgone
interest of $80,000 will be taxed annually as a gift by the Grandma, and as
income to Grandma. Because it is the nature of a gift, the grandson will
not have any income (§ 102) and my be entitled to an interest deduction.
In this problem we discuss the reasons for the popularity of below market
loans prior to enactment of § 7872, and how they were blessed in the Dean
(income tax) and Crown (gift tax) case. This leads to a discussion of
Dickman and the statute.
(iii) Five years after making the loan, grandmother forgives the loan. Has
she made a gift?
She has, extinguishment of the obligation results in a transfer of the
principal amount to the borrower. See Reg. § 25.2511-1(a)
(e) In the alternative, assume Grandmother makes a 5 year term loan to her
grandson of $2,000,000 at 0% interest. Assume the AFR is 4% compounded
annually. (Hint: The present value of $2,000,000 payable in 5 years discounted at
4% compounded annually is $1,645,000).
This will result in a gift in the year that the loan is made of $355,000 under §
7872(b). Students struggle with the time value of money concept, but that doesn’t
mean it’s not worthwhile to address it. The same concepts arise later in the
course. The income tax consequences to Grandma are determined under the
demand loan rules of § 7872(a). See § 7872(d)(2).
(f) A and B are competitors in the real estate business and own adjoining tracts of
land. Each tract is worth approximately $1,000,000. A needs $850,000 for
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immediate use in his business. He offers his lot to B for that amount and B accepts.
Might your answer be different if A and B are related?
This raises the ordinary course of business rule in Reg § 25.2512-8. If A and B
are unrelated this sale would presumably fall within that rule. If they are related
more scrutiny would be required, in which case the presence or lack of donative
intent becomes relevant. This is contrary to the notion that donative intent is
unnecessary under Weymyss.
(g) Fred and Ethel execute a pre-nuptial agreement in anticipation of their upcoming
marriage. In the agreement Ethel waives her right to an elective share of Fred’s
estate in the event of his death, and to spousal support in the event of divorce, and in
exchange Fred transfers to her stock worth $2,000,000. Has Fred made a gift?
This would be a gift under Wemyss, due to the lack of consideration in “money or
money’s worth.” See Reg. § 25.2512-8. This may sound familiar to students who
remember the Farid-es-Sultaneh case from income tax, where the court held
differently in the income tax context.
Problems 2 and 3 deal with the question of when is a gift complete. Problem 2
exhaustively runs through the basic principles in the regulations under 25.2511-2.
Problem 3 considers jointly held powers that may render a gift incomplete.
2. Gail Grantor, a fifty year-old individual, creates a trust funded with $10,000,000 in
income-producing securities, and names herself Trustee. The trust instrument provides that
during Gail’s life the Trustee shall divide the trust income between A and B in such shares
and amounts as the Trustee deems appropriate. If either A or B dies during Gail’s lifetime
then the Trustee is to pay the entire income to the survivor, and if the survivor dies during
Gail’s lifetime the income is paid to the survivor’s estate. On Gail’s death, the trust
terminates and goes to C or C's estate. For purposes of this problem 2, assume that A, B
and C are unrelated to Gail.
For purposes of problems (a) – (c), assume that Gail retains the right to revoke the
trust, and at all relevant times is acting as Trustee of the trust.
(a) Does Gail make a completed gift upon the creation of the trust?
Because the trust is revocable there is no completed gift upon creation of the trust.
§ 25.2511-2(c).
(b) Does any gift occur when Gail distributes the first year's income equally
between A and B?
There is a completed gift of the income that is distributed. § 25.2511-2(f)
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(c) What result if, at the end of the second year, Gail relinquishes her power to
revoke the trust but continues to act as Trustee? Has Gail made a gift? If so, how
would you value it?
Gail has made a gift of the remainder, which is complete. Because she retains the
right as Trustee to determine who will receive the income, the income interest is
not complete. §25-2511-2(c)
This requires the students to focus on the separate interests that are created,
something we might illustrate as follows:
Remainder
Income
On Gail’s death, to C or her estate
Income to A or B,
For Gail’s life
Throughout the course we use the arrow for a life or income interest, a
convention that we find useful. Once the students see that there are two separate
interests involved, they can focus on each individually.
For purposes of problems (d) - (h) assume that the trust is irrevocable, and that
during all relevant times Gail acts as Trustee of the trust.
(d) When Gail creates the trust has she made a completed gift?
Again focusing on the separate interests created, the retained power over the
income renders the gift of that interest incomplete; the gift of the remainder,
however, is complete.
(e) Suppose that shortly before the end of the third year, A dies, so that Gail (as
Trustee) no longer has discretion to allocate income; thereafter all the income
effectively becomes payable to B or B's estate. Has a completed gift occurred?
Once A dies Gail loses the power over the income, so gift of income interest is
complete. It doesn’t matter that completion is caused by external event. See §
25.2511-2(f)
(f) Would your answer in (d) be different if the trust instrument directed the Trustee
to distribute $10,000 per year of trust income to A, and the balance of the income to
B?
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In that case Gail as Trustee no longer has control over the amounts of income
going to A and B, the amounts are set by the instrument. Therefore, the gift of
both the income and the remainder are complete.
(g) Would your answer in (d) be different if the trust instrument directed the Trustee
to pay to A as much income as the Trustee deems necessary to maintain A in his
accustomed standard of living, and to pay the balance of the income to B?
This is the first reference that we make to an ascertainable standard, which
appears in the regulations at § 25-2511-2(c). The goal here to establish that an
ascertainable standard is treated by the regulations (and throughout the transfer
taxes) as equivalent to a direction to distribute a fixed amount, as in the prior
problem. Because the standard stated is ascertainable (see § 25.2511-1(g)(2)), the
gift of the income interest is complete.
(h) Would your answer in (d) be different if the trust instrument instead directed the
Trustee to distribute all trust income to A (or his estate) for 10 years, then distribute
the principal to A or A's estate, and in addition the Trustee had the discretion in any
given year to accumulate the income rather than distribute it? What if instead the
trust directs that after 10 years the principal passes to B or B’s estate?
The power to delay enjoyment of the income will not render the gift of the income
incomplete. Under § 25-2511-2(d), reserved powers to change the “time or
manner of enjoyment” are disregarded. It is important to note that this is not
consistent with the treatment of such powers under § 2038.
If B or B’s estate were to receive the principal in 10 years, the gift of the income
interest would be incomplete because Gail retained the ability to accumulate the
income and thereby change the beneficiary.
3. George creates a trust with income to A for A's life, remainder to B or B's estate. To
what extent, if any, has George made a completed gift if:
(a) George retains a power to give income to C, but only with A's approval.
Under § 25-2511-2(e) a donor is treated as the sole holder of a power unless a coholder has a substantial interest adverse to exercise of the power. In this case, A
clearly has an interest adverse to shifting his income to C, so the gift of the income
is complete. The gift of the remainder is complete as well.
(b) George has no power over trust income, but retains a power to substitute C or
his estate as remainder person if he secures A's approval.
A would be indifferent to the identity of the remainder person. So G’s power to
change the remainder person would render the gift of the remainder incomplete.
The gift of the income is complete.
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(c) George retains the power to invade principal for B, but only with A's consent.
The power to distribute principal to B is adverse to A’s income interest, because of
the reduction in trust income that would result. The gift of the income and
remainder are complete.
(d) George retains a power to give income to C, but only with B's approval.
B’s interest as remainder person is not adverse to a change in income
distributions. So the gift of the income is incomplete.
4. Abner owns a piece of land.
This problem introduces students to the various ways that property can be divided,
including temporally. It also addresses the problem of valuation of partial interests in
property. We purposely ignore the subject of discounts at this point.
(a) In the current year, Abner transfers title to the property to himself and his nephew
Bob, as tenants in common. Has Abner made a gift? If so, how would you go
about valuing it for gift tax purposes? Would your answer change if he and Bob
took title as joint tenants with right of survivorship?
In each case, Abner is treated as making a gift of 50% of the property, something
we might call a “vertical” division of the property. Each is receiving an undivided
50% interest is every aspect of the property. See § 25-2511-1(h)(5).
(b) In the alternative, Abner transfers title to the property to Bob, reserving a legal
life estate for himself. Has Abner made a gift? If so, how would you go about
valuing it? Calculate the value of the gift on the assumption that the land has a fair
market value of $3,000,000, that Abner is 65 years old, and the federal mid-term rate
is 5%.
In this case Abner has not divided the property vertically, but over time. Here we
introduce § 7520. The § 7520 rate is 6% (120% of 5%). Under the tables at §
20.2031-7(d) the remainder factor is .40420, leading to valuation of the remainder
of $1,212,600. Abner’s reserved The life estate is not a gift, and it is worth
$1,787,400.
(c) In the alternative, Abner transfers title to the property to a trustee, under a trust
instrument that directs the trustee to pay the income from the property to Abner for
life, remainder to Bob, or his estate. Has Abner made a gift? If so, how would you
go about valuing it?
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While students may remember legal life estates and remainders from their
Property courses, many may not have encountered trusts. The point here is that
trusts also represent a horizontal, or temporal valuation of the property. We use
this to introduce the concept of separating legal from beneficial title, and to make
the point that the Trustee’s legal interest isn’t subject to the gift tax. We then
value the interests as in the prior problem.
(d) What if part (c) provided for income to Abner’s mother Mom for life, remainder
to Abner’s nephew Bob if he survives Mom, and if not then to Abner, or his estate.
In this case we illustrate the three interests created, the income interest to
Mom, the contingent remainder to Bob, and contingent reversion reserved by
Abner. The students should see that the tables used thus far would not be
sufficient in valuing the gifts. This provides an opportunity to discuss Smith v.
Shaughnessy, where the Court rejected the taxpayers argument the because he
reserved a contingent reversion in the property following expiration of the
income interest, the contingent remainder was too difficult to value and tax.
That principle appears in the regs at § 25.2511-1(e).
(e) What difference would it make in part (c) if Bob is Abner’s son?
We now encounter § 2702, which makes much of the foregoing irrelevant in many
cases. If Bob were Abner’s son, then the income interest retained by Abner would
be valued at zero, and the amount of the gift would be the value of the entire
property. We deal with § 2702 in detail in the later Chapter 8. We want students
to be aware of it now, and particularly its relationship to the completed gift rules,
as illustrated in the next problem.
5. Reconsider parts (a) and (d) of Problem 2 on the assumption that A, B and C are Gail’s
descendants.
In part 2(a) Gail’s gift was revocable. § 2702 does not apply where, as here, there is no
completed gift. See § 2702(a)(3)(A)(i). So there would be no change.
In part 2(d) the trust was irrevocable, and Gail reserved the right to divide the income
between A and B. This power rendered the gift of the income incomplete. Under §
25.2702-2(a)(4) the power is treated as an interest retained by Gail, and the income
interest will be valued at zero. As a result, the entire amount of the transfer is taxed as a
gift.
6. Donor Diane, a widow, has three children and five grandchildren. She has previously
made no taxable gifts. In 2020 she transfers $35,000 in cash to each child and grandchild.
(a) What is the amount of her taxable gifts?
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Diane has made 8 gifts of $35,000. Of each gift, $15,000 is excluded under §
2503(b). As a result, her taxable gifts for 2020 are $160,000.
(b) How and when must she report these gifts to the federal government?
Under § 6019 a gift tax return is required if gifts are made that are not excluded
under §§ 2503(b) and (e), or are not deductible as marital or charitable gifts.
Under § 6075 the return is due on April 15 of the year following the gift.
(c) Will she owe any gift tax as a result of these transfers?
Unless she has otherwise used up her exclusion amount (under these fact no),
then no gift tax will be due.
(d) How might your answer change if Diane’s husband was still alive?
§ 2513 allows “gift splitting,” so the spouses can elect to treat each gift as having
been made one-half by each. In that case each will be treated as making gifts of
$17,500, and all but $2500 will be covered by the annual exclusion.
7. Mother dies testate in the current year. Her will leaves $2,000,000 to her son, S, if he
survives her, and if not the gift lapses into the residue. The residue of the estate is left to her
daughter D.
Our intent here is to gently introduce the subject of disclaimers, deferring a more detailed
discussion until Chapter 8. We begin by discussing the local law rules of disclaimers, and
how disclaimed property passes.
(a) S disclaims the $2,000,000 bequest. Has he made a gift?
So long as the disclaimer satisfies the requirement of § 2518 (writing, delivery,
timing, etc.) then the property will pass to the residue of the estate, and to D, and
will not be treated as a gift by S.
(b) S disclaims $1,000,000 of the bequest. Has he made a gift?
§ 2518(c) allows for disclaimers of an undivided interest in property, and under §
25.2518-3(c) disclaimer of a pecuniary amount will come within that rule.
(c) Would your answer in (a) or (b) be different if Mother’s will provided that the
residue of her estate passes into a testamentary trust, providing for income to S for
life, remainder to S’s children?
It would, because of § 2518(b)(4). The disclaimer would qualify only if S was
Mother’s spouse.
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(d) What if, in (a), S's disclaimer occurs one year after Mother's death but is
nevertheless effective under local law?
§ 2518(b)(3) and § 25.2518-2(c)(3) require that the disclaimer must be made
within 9 months after Mother’s death, regardless of local law. This presents a
good example of the purpose of § 2518, to create a uniform rule applicable in all
states.
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Chapter Three
Property Owned at Death: §§ 2033 & 2040
Part A: The Starting Point in Determining the Gross Estate: § 2033
Questions:
1. During the current year, Don dies. His will leaves his entire estate to Ted, as Trustee.
Under the terms of the testamentary trust, Ted is instructed to distribute the income to Abe
for Abe's life. On Abe’s death the remainder is distributed to Bea if she survives Abe, and if
not, then to Charlie or Charlie's estate. In each of the following circumstances, determine if
the designated person holds an “interest” in property which will be included in his or her
estate under § 2033, if:
(a) Ted dies.
Only beneficial interests are included. See § 20.2033-1(a).
(b) Abe dies.
Interests that terminate at death, like Abe’s income interest, are not included
under § 2033.
(c) Bea dies, survived by Abe.
Bea holds a contingent remainder interest. Because she does not survive Abe that
interest terminates with her death, and is not included in her estate under § 2033.
(d) Charlie dies, survived by Abe, but not Bea.
Charlie’s remainder vested when Bea died, and its actuarial value will be included
in his estate.
(e) Charlie dies, survived by both Abe and Bea.
In this case, Charlie’s remainder is contingent upon Bea predeceasing Abe. It will
still be included in his estate, valued actuarially to take into account the
contingency.
2. What if in Question #1 Abe, in addition to holding an income interest in the trust, also
had the right to demand principal distributions during his life, and to designate who should
receive the property on his death, with Bea or Charlie receiving the property only if Abe
failed to so designate. Are Abe’s rights with respect to the property significantly different
from what they would be had D simply left the property to Abe by will? Do they constitute
an “interest” in property for purposes of § 2033?
14
This is an opportunity to discuss the result in the Safe Deposit Trust case, and the narrow
reading the Court gave to § 2033 (in contrast with its expansive reading of § 61 in
Glenshaw Glass). Under the Court’s rule, Abe would not have an interest in property
within the meaning of § 2033. Today, however, it will be an includible power of
appointment under § 2041 (to be discussed later in Chapter Six).
3. Decedent David owned a valuable painting, which was kept in storage during his life.
After his death, David’s son Sam claims that David gave him the painting ten years prior
to his death, although the gift was never documented. The executor of David's estate
applies to the probate court for an order determining ownership of the painting, and the
court issues an order determining that Sam is the owner. Did David have an “interest” in
the painting at his death for purposes of § 2033? In determining your answer, consider
the following: What if Sam was the executor and sole beneficiary of the estate? What if
Sam was not the executor, and shared the estate with five siblings with whom he did not
get along?
The intent here is to discuss Bosch, and the reasons that the federal taxing authorities
should not be bound by a lower state court ruling. See text discussion at page 49.
4. Decedent lent his friend Zoe $10,000 during his lifetime; the loan was evidenced by a
promissory note. If the note remains unpaid at Decedent's death, is it an “interest” in
property for purposes of § 2033? Would it make a difference if Decedent’s will directed
that the loan should be forgiven?
The debt from Zoe is an asset of Decedent’s estate under § 2033. See Reg § 20.2033-1(a),
referring to tangible and intangible property. It will be included even if forgiven by the
will. See § 20.2033-1(b).
5. Decedent owns stock in X Corporation. Two weeks prior to Decedent’s death, the
corporation declares a dividend to the holders of record on that date; Decedent’s share of the
dividend is $100,000. The dividend is not paid until one week after Decedent’s death.
Does Decedent have an “interest” in property for purposes of § 2033? If Decedent is a cash
method taxpayer, what will be the income tax consequences of payment of the dividend to
his estate? Is this double taxation?
The dividend is an asset of D’s estate under § 2033. It is an item of income with respect to
a decedent (IRD) under § 691. It will be included in the estate’s income on receipt, and
the estate will be allowed an income tax deduction for the estate tax attributable to the
item. § 691(c).
6. Hilda and Wally are a married couple and have accumulated assets of $36,000,000
during their marriage. Hilda is the sole earner in the family, Wally is a homemaker. Most
of the assets are held in accounts under Hilda’s name alone.
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(a) The couple lives in a common law state. Hilda dies, and leaves her entire estate
to her children from a prior marriage. Under the elective share statute of their state,
Wally is entitled to elect against Hilda’s will and receive one third of Hilda’s probate
estate. What is included in Hilda’s gross estate under § 2033?
The estate will not be reduced by the amount of the elective share. § 2034. This is
largely academic, because amount going to the spouse will qualify for the marital
deduction.
(b) Hilda and Wally jointly hold title to their home, which they purchased for
$1,000,000. At the time of Hilda’s death, the property’s value is $15,000,000. In
each of the following situations, describe what portion of the property would be
included in Hilda’s estate under § 2033.
(i) The couple lives in New York and hold title to the property as tenants in
common, and Hilda leaves her interest in the property to Wally by will.
Further question: What is Wally’s basis in the property for income tax
purposes?
Hilda’s one-half interest in the property will be included in her estate
under § 2033. Wally’s basis in that half of the property will be $7,500,000,
which will be added to his original basis in his half of the property, for a
total basis of $8,000,000.
(ii) The couple lives in California and hold title to the property as community
property, and Hilda leaves her interest in the property to Wally by will.
Further Question: What is Wally’s basis in the property for income tax
purposes?
The estate tax result is the same; one half of the property will be included
in Hilda’s estate under § 2033. But the income tax answer is different.
Under § 1014(b)(6) both halves of the property will receive a step up in
basis, so that Wally’s basis in the home will be $15,000,000.
(iii) The couple lives in New York and holds title as joint tenants with right
of survivorship.
Because Hilda’s interest in the property is extinguished by her death, it will
not be reached by § 2033. It will, however, be included under § 2040,
which is discussed in Part B.
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Part B. Joint Interests in Property -- § 2040
Questions:
We first deduce the rules of § 2040 from the statute and the regulations. They can be
summarized creating two regimes:
In the case of spousal joint tenancies, always include half. Because of the
marital deduction, inclusion of these does not have a meaningful estate tax
effect.
In the case of non-spousal joint tenancies, the statute provides:
➢ General rule: include full value except part that was originally owned by other
person (and wasn’t received from decedent) (provided rule: only pull out
portion attributable to consideration furnished by other owner)
➢ Provided further rule: if acquired by gift, devise or inheritance, include
proportionate part
➢
Once those rules are on the table the problem goes quickly
1. Abby and her two daughters, Beatrice and Carol hold title to a parcel of real estate as
joint tenants with right of survivorship. If Abby predeceases Beatrice and Carol, what
portion of the property will be included in her estate (and under what authority) if title to
the property was acquired in the following alternative manners:
(a) The three jointly purchased the property, each making an equal contribution to
the purchase price from their earnings.
Include 1/3 in Abby’s estate
(b) The three jointly purchased the property. Abby used funds from her earnings,
and Beatrice and Carol used funds that they had received five years earlier from
their mother by gift.
Include 100% in Abby’s estate
(c) The three inherited the property from Abby’s husband Harold.
Include 1/3 in Abby’s estate
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(d) Beatrice purchased the property, and transferred title into joint names with
Abby and Carol.
Include zero in Abby’s estate. § 20.2040-1(c)(3)
(e) Abby inherited the property from Harold, and transferred title into joint names
with Beatrice and Carol.
Include 100% in Abby’s estate
2. Darlene is a wealthy widow. She owns a home on the Gulf Coast of Florida, the
property was left to her in her deceased husband’s will. Several years after her first
husband’s death she marries Gary, her tennis instructor. Shortly after marriage, Darlene
transfers title to the Gulf Coast home into Darlene and Gary’s names as joint tenants,
with right of survivorship. Darlene dies several years later. Assume the property had a
fair market value of $10,000,000 when Darlene’s first husband died, and a value of
$15,000,000 when Darlene dies.
(a) What are the gift tax consequences when Darlene creates the joint tenancy?
Darlene has made a gift on ½ of the property. It qualifies for the marital
deduction under § 2523
(b) What portion of the property will be included in Darlene’s estate?
50% of the property will be included in her estate. § 2040(b)
(c) What is Gary’s basis in the property following Darlene’s death?
As to the portion included in Darlene’s estate, Gary’s basis will be $7,500,000,
its date of death value (§ 1014). Gary will have a basis of $5,000,000 in the
other half, for a total basis of $12,500,000. Note that if Darlene had not made
the gift and left the property to Gary by will his basis would be $15,000,000.
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Chapter Four
Property Transferred During Life: §§ 2035-2038
We begin this chapter by discussing the shared history of the transfer sections, their
common goal of reaching “testamentary substitutes,” and the fact that they differ in
the relevant “string” held by the decedent and the amount that will be included.
Part A. Retained Rights and Powers over Income and Principal
Problems:
1. Consider the following trusts. In each case, identify whether all or any portion of the
trust will be included in the Grantor’s (or other designated decedent’s) estate under §
2033, 2036, or 2038.
(a) Bob creates a trust with income to his sister Sally for life, remainder among
Sally’s children in such shares as Sally designates by will. Absent designation,
the property passes to Sally’s children, or their estates, in equal shares.
(i) Will any portion of the trust be included in Sally’s estate at her death?
No, her interest ends with her death, and there is nothing to include in
her estate.
(ii) If Bob predeceases Sally will any portion of the trust be included in his
estate?
No, creation of the trust was a gift, but because Bob did not retain any
interest in the trust it will not be included in his estate.
(iii) How would your answer to part (ii) change if Bob reserved the right
to revoke the trust?
This would be a classic illustration of § 2038, which would include the
entire trust in his estate.
The purpose of this problem is to drive home the point that property can
be gifted during life, outright or in trust, and it will not be included in
the donor’s estate. It is only when one of the proscribed “strings” is
held at death that it will be brought back into the estate.
(b) Bob creates a trust with income to Bob for life, remainder to Bob’s children,
or their estates, in equal shares. Sally is the Trustee.
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This is classic § 2036(a)(1) inclusion.
(i) Would it make a difference if under the trust Bob was not entitled to
the income for the month preceding his death?
No, he retained the right for a period not ascertainable without
reference to his death.
(ii) What if the trust called for income to Bob for 15 years, instead of for
life, and Bob dies after 10 years?
No, he retained the right for a period that did in fact end with his death.
(c) Bob creates a trust with income to Bob’s children for Bob’s life, remainder to
Bob’s children, or their estates, in equal shares.
This would not be included under § 2036 unless the income can be used
to defray Bob’s legal obligation to support a child. The trust instrument
should expressly prohibit that. § 20.2036-1(b)(2)
(d) Bob transfers $2,000,000 into a trust, providing for income to Sally for life,
remainder to Sally’s children, or their estates. Six months later Sally transfers
$1,000,000 in trust with income to Bob for life, remainder to Bob’s children, or
their estates.
This provides an opportunity to discuss Estate of Grace, which would
likely hold here that Bob’s estate would include the smaller trust, or
$1,000,000.
(e) Bob creates a trust with income to Sally’s children for Sally’s life in such
shares as the Trustee shall determine, remainder to Sally’s children, or their
estates, in equal shares. Bob predeceases Sally.
Assume, in the alternative:
(i) Bob was acting as Trustee at the time of his death.
The power to determine income shares will result in inclusion under §
2036(a)(2).
(ii) Sally was acting as Trustee of the trust at Bob’s death, and Bob had the
power to remove the Trustee and appoint a successor, including Bob.
The powers of the Trustee will be attributable to Bob, and inclusion will
result. § 20.2036-1(b)(3) (last sentence).
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(iii) Sally was acting as Trustee of the trust at Bob’s death, and Bob had
the power to remove the Trustee, and appoint a successor other than Bob.
The Service argued for inclusion under these facts under a theory of
“trustee shopping”. That argument was rejected in Wall. See the
discussion of Rev Rul 95-58 on page 70 of the text.
(f) Bob creates a trust with income to Sally for Bob’s life as needed for her
health, remainder to Sally’s children, or their estates, in equal shares. Bob
predeceases Sally, and was acting as Trustee at the time of his death.
The ascertainable standards renders § 2036 inapplicable. See Jennings.
(g) Bob creates a trust with income to Sally for Bob’s life, remainder to Bob’s
children in such shares as Bob shall designate by will, absent designation then to
his children, or their estates, in equal shares.
Bob’s retained power over the remainder will trigger § 2038. The value
over the remainder, which in this case is the full value of the trust, will
be included in Bob’s estate.
(i) What if 2 years prior to his death, Bob irrevocably released his power
to designate the remainder?
Inclusion under § 2035, which is covered in more detail in Part C
(h) Bob creates a trust with income to Bob’s mother Marie for life, then income to
Bob for life, remainder to Sally, or her estate. Bob predeceases Marie.
The value of the trust, reduced by Marie’s income interest, will be
included in Bob’s estate. § 20.3036-1(b)(1)(ii).
(i) Bob creates a trust with income to Marie for ten years, remainder to Marie, or
her estate. Bob predeceases Marie, and was acting as Trustee at the time of his
death.
(i) The Trustee has the power to invade principal for Marie.
As far as § 2036 is concerned, Marie’s interest in the income will not be
reduced if she receives a principal distribution, she will continue to
receive income as fee owner. So no inclusion under § 2036. With
respect to the remainder, however, Bob has the power to accelerate
principal distributions, which affects the “time and manner” of
enjoyment of the principal, resulting in inclusion of the remainder only
under § 20.2038-1(a)(3). This rule has its source in Lober.
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(ii) Alternatively, the Trustee has the power to accumulate income and add
it to principal
The regulation cited above would include the value of the income
interest only in Bob’s estate. There is some support for the argument
th
that § 2036 should apply, See Alexander (TC 1983, aff’d 4 Cir. 1985)
th
Struthers v. Kelm (8 Cir 1955). SM&L disagree, as do we, because the
statute expressly refers to the identity of the beneficiary.
(j) Bob creates a trust with income to Bob’s mother Marie for life, remainder to
Sally, or her estate. The Trustee has the discretion to distribute principal to Marie
as he deems appropriate. Bob predeceased Marie, and was acting as Trustee at
the time of his death.
A principal distribution would not reduce the income going to Marie. So
no inclusion under § 2036(a)(2). It would, however, reduce the
remainder, so inclusion of the remainder occurs under § 2038.
(i) Would it make a difference if the Trustee’s power to distribute
principal to Marie was limited to amounts needed for her health?
It would, see Jennings.
2. Diane transfers to her son, Sam, her personal residence for no consideration. Will all
or any portion of the residence be included in Diane’s estate under the following
alternatives?
(a) Diane continues to live alone in the house until her death.
Potential inclusion under § 2036(a)(1) if Service can establish there was an
express or implied agreement that she would continue to occupy the house.
Cases are more likely to find an implied agreement if the transferor retains
exclusive possession.
(b) Diane and Sam live in the house together until Diane’s death.
This creates a harder case for the government, if Sam is occupying the house as
well.
(c) Diane leases the house from Sam for its fair rental value, and continues to live
in it alone until her death.
So long as the lease is at a market rent, there should be no inclusion. See
Barlow, cited in Maxwell
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(d) Diane sells the house to Sam for cash equal to its fair market value, and
continues to live in it alone until her death.
If the property is truly transferred for adequate and full consideration there will
be no inclusion. The raises a discussion of the Maxwell case.
Part B. Retained Reversionary Interests
§ 2037 can be tricky, we think it is useful to begin with a discussion of its goal (as
announced in its title), to include “transfers taking effect at death,” i.e. ones where the
beneficiary must survive the decedent to enjoy the property. We then list the four
requirements described on page 76 of the text.
1. Gene creates a trust with income to Harriet (Gene’s sister) for Harriet’s life, remainder
to Carrie (Gene’s niece), if she survives Harriet and if not, then to Gene or his estate. If
Gene predeceases Harriet and Carrie, is all or any portion of the trust includible in his
estate?
Here Gene has retained a contingent reversion. But the other interest granted,
to Harriet and to Carrie, can be enjoyed during Gene’s life, so § 2037 will not
apply.
2. Gene creates a trust with income to Harriet or her estate for Gene’s life, remainder to
Carrie if she survives Gene, and if not then to her estate. If Gene predeceases Harriet and
Carrie, is any portion of the trust includible in her estate?
It is not included, Gene has not retained a reversion.
a. Would your answer be different if the words “and if not then to her estate” were
removed?
Now Gene has retained a reversion by operation of law. Because Gene’s is the
measuring life for Harriet’s income interest, Carrie’s enjoyment of the property
is postponed until his death. At this point it’s a question of the value of the
reversion, if it exceeds 5% of the value of the property, then inclusion of the
remainder will result under § 2037. In this case, because Gene’s is the
measuring life, the entire trust would be included. This is an opportunity to
discuss the reason for the 5% rule, as discussed on page 78 of the text.
3. Gene creates a trust with income to Harriet for Harriet’s life, reversion to Gene if he
survives Harriet and if not then remainder to Carrie or her estate. If Gene predeceases
Harriet and Carrie, is any portion of the trust includible in his estate?
This is a classic example of § 2037. Because Carrie cannot enjoy the property if
Gene survives Harriet, then the value of the remainder will be included in
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Gene’s estate IF the value of Gene’s reversion exceeds 5% of the value. The
value of the income interest would not be included.
Part C: Retention of Voting Rights in a Controlled Corporation
X Corporation has one class of stock outstanding, voting common stock. Andy owns
10% of the stock, and his wife Wendy owns an additional 10%. Andy transfers one-half
of his stock, worth $3,000,000, (representing a 5% interest overall) to a trust for the
benefit of son Sam. Andy is the initial Trustee of the trust. The trust provides for
payment of the net income to Sam for Andy’s life, remainder to the Sam, or his estate.
When Andy dies, the stock owned by the trust is worth $5,000,000. At the time of his
death, Andy still owned his remaining 5% of the X Corp. stock outright, and Wendy still
owns her 10% interest.
(a) What amount, if any, is included in Andy’s gross estate under IRC §
2036(a)(1)?
Andy’s right to vote the transferred stock is retained under § 2036(b) because
he is Trustee. The stock will therefore be included in his estate if X Corp is a
“controlled corporation” within the meaning of the statute. Andy owns 5%,
and under § 318 the shares owned by Wendy (10%) are attributed to him. In
addition, the trust shares (5%) attributed to Sam, and are also therefore
attributed to Andy. Therefore, Andy is deemed to own 20%, X Corp is a
controlled corporation, and § 2036(a)(1) will include the stock owned by the
trust in Andy’s estate.
As we shall see in (b) & (c), § 2036(b) is very simple to avoid and is really just a
trap for the unwary.
(b) Would your answer change if Andy had instead named an independent
commercial trust company as trustee?
In this case X Corp would still be a controlled corporation, but because Andy
did not retain the right to vote the transferred shares § 2036(b) will not apply.
(c) Same as (1) except X Corp. had two classes of common stock outstanding
(one voting and one nonvoting), and the 5% interest transferred to the trust
consisted of nonvoting shares?
This would not cause an issue under § 2036(b) because the shares are nonvoting.
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Part D. “Adequate and Full Consideration” Transfers within Three Years of Death
1. Grantor, age 55, transfers $1,000,000 to a trust that provides for income to the
Grantor for life, remainder to Grantor’s nephew, or his estate. Ten years later,
when the Grantor is 65 years old and the value of the trust principal is $3,000,000,
Grantor makes the following alternative transfers. Assume that at the time of the
transfer the actuarial value of the Grantor’s income interest is $700,000, and the
value of the nephew’s remainder is $2,300,000.
a. He makes a gift of the income interest to his niece and dies (i) two years after
the transfer, or (ii) 4 years after the transfer.
Grantor makes a gift of $700,00. If he dies two years later, the entire value
of the trust at that time, $4,000,000, will be included in his estate, plus any
gift tax paid on the gift. § 2035(a) & (b). If he dies 4 years later, there will
be no inclusion.
b. He sells the income interest to his niece for $700,000.
The issue raised here is whether the Grantor received adequate and full
consideration for the income interest. Under Allen, discussed in the text at
pp. , the Grantor would not have been considered to have received full and
adequate consideration and her estate would have to include $3,300,000
($4,000,000 less the consideration received, $700,000) if she dies two years
after sale. § 2035(a). Once again, if she dies 4 years later, there would be no
inclusion.
2. Grantor creates a $1,000,000 trust, with income payable to Grantor’s niece for
life, reversion to Grantor or her estate. When the Grantor is 80 years old and his
niece is 50 years old Grantor makes one of the following alternative transfers:
a. He makes a gift of the reversionary interest to his nephew, and he dies 2 years
after the transfer, or (ii) 4 years after the transfer.
If the Grantor dies 2 years after the gift, the full value of the remainder
would be included in her estate. § 2035(a). If she dies 4 years later, no
inclusion.
b. He sells the reversionary interest to his nephew for its actuarial value.
The issue here is whether the Grantor received adequate and full
consideration for her remainder interest. Under D’Ambrosio, the
consideration would be considered adequate, and there would be no
inclusion whether the Grantor died 2 or 4 years later. It might be
interesting to have the students square Allen & D’Ambrosio.
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3. Grantor, having made no prior gifts, transfers stock worth $6,000,000 to her
daughter, and pays gift tax on the transfer of $350,000. Grantor dies two years
later, when the stock is worth $8,000,000. What, if anything, will be included in
her estate?
Although the stock will not be included, Grantor would have to include the
$350,000 gift tax paid on the gift under §2035(b). This is another opportunity
to discuss the difference in the tax bases of the gift tax (tax exclusive) and the
estate tax (tax inclusive).
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Chapter Five
Annuities & Life Insurance: §§ 2039 & 2042.
Part A. Annuities receivable by the Decedent
Problems:
1. X Corporation maintains a qualified retirement plan for its employees. Under the plan,
both the employer and the employee make contributions to the plan on a pre-tax basis,
i.e., amounts contributed to the plan are not included in the employee’s taxable income.
Instead, the benefits will be included in the employee’s taxable income when paid to the
employee. When each employee retires, he or she has the option to receive the amount in
his or her account in one lump sum, or to have the amount paid out as an annuity, i.e., the
employee receives regular payments over a period of time. If the employee dies prior to
receiving the entire amount in his or her account, then the balance is payable to the
employee’s surviving spouse, if any, and if none then to other beneficiaries designated by
the employee.
(a) Dave is an X Corp employee, who retires at age 65. He elects to receive a
lump sum payout of the $600,000 in his retirement account. He pays income tax
on the amount, and invests it in the stock market. He dies two years later. What
portion, if any, of his retirement benefits will be included in his estate? Under
what authority?
The investments will be included in his estate under § 2033.
(b) Debby is also an X Corp employee, a widow, who retires at age 65. She elects
to receive her retirement benefits as an annuity. She receives $100,000 per year
for three years, and then she dies. At that point her undistributed account balance
is $800,000, and under the terms of the plan the company pays that amount out to
her adult children. What portion, if any, of her retirement benefits will be
included in her estate? Under what authority?
Here there is nothing that can be reached by § 2033, and this is where § 2039
steps in. We discuss the four requirements for § 2039 on page 85 of the text,
and see that under these facts the $800,000 is included in Debby’s estate.
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(i) In order to answer this question, do you need to know what portion of
the account was contributed by Debby, and what portion came from her
employer?
No, under § 2039 contributions by the employer are attributed to the
employee.
(ii) What income tax consequences will result when the account proceeds
are paid to Debby’s children?
The proceeds are an item of IRD, taxable to the children on receipt.
Part B. Life Insurance
Problems:
1. Darlene owns a $5,000,000 annual renewable term insurance policy on the life of her
husband Hubert. The policy premiums are $50,000 per year. Under the terms of the
policy, the owner of the policy has the sole right to name (and change) the beneficiary of
the death benefit, and to cancel the policy.
(a) Darlene names her son Sam beneficiary of the policy. Has she made a taxable
gift?
She has not, unless the designation is irrevocable.
(b) Darlene predeceases Hubert. Is the policy included in her gross estate? If so,
what amount would be included?
It is an asset of her estate, and would be included under § 2033. The value of
the policy would be determined under § 25.2512-6.
(c) Under the terms of Darlene’s will, ownership of the policy passes to Hubert.
Hubert continues to pay the premiums and dies several years after Darlene. The
$5,000,000 death benefit is paid to Sam. Is anything includible in Hubert’s
estate?
The proceeds would be included in Hubert’s estate under § 2042
because he is the owner.
(i) Would your answer be different if Darlene’s will left the policy to Sam
instead of Hubert?
Then the proceeds would not be taxed. Many will forms specifically
dispose of property on a spouse’s life to the children.
28
(d) Alternatively, assume Darlene’s will leaves the policy to Hubert, who shortly
thereafter transfers ownership of the policy to Sam. Hubert dies one year later.
(i) Has Hubert made a gift? Of what amount?
He has made a gift of the policy. The rules for valuing policies are at §
25.2512-6.
(ii) Is anything includible in Hubert’s gross estate? Under what authority?
The policy proceeds are included under § 2035.
2. Fred and Wilma are a married couple in their 40’s, who have two school age children.
Fred is the principal wage earner, and although Fred’s interest in his computer company
has substantial value, they don’t have much cash. Fred’s will leaves his estate to Wilma
if she survives him, and if not the estate is held in trust until the children reach age 25.
Wilma’s will mirrors Fred’s.
The couple’s financial advisor has suggested that they purchase a substantial
insurance policy on Fred’s life in order to provide the family with liquid assets in the
event of Fred’s death. The advisor has offered the following suggestions for structuring
the purchase of the policy. Evaluate the benefits and risks of each of them:
(a) Fred will purchase the policy as owner, naming Wilma as beneficiary, and the
children as contingent beneficiaries.
Bad idea, if Fred dies first the proceeds will be includible in Fred’s estate under
§ 2042, although will qualify for the marital deduction. But the proceeds will
increase Wilma’s estate, to the extent not consumed by her. If Wilma
predeceases the proceeds will be taxed in his estate before getting to the
children.
(b) Wilma will purchase the policy as owner, naming Fred’s estate as beneficiary.
The proceeds can then be used to pay the expenses of Fred’s estate, including
estate taxes, if needed, and any remaining cash can pass under Fred’s will.
Also a bad idea, if Fred dies first the proceeds will be included in his estate, and
qualified for the marital deduction, but will increase Wilma’s estate, as above.
If Wilma predeceases the proceeds will be taxed in Fred’s estate on his later
death.
(c) Wilma will purchase the policy as owner, and will be named beneficiary, with
the children as contingent beneficiaries.
The problem with this approach is that if Fred predeceases Wilma, the proceeds
won’t be included in his estate, but will add to Wilma’s estate (to the extent not
consumed) at her later death. There is also the risk, unless her will specifically
29
provides otherwise, that the policy could pass to Fred under her will if Wilma
predeceases him.
(d) Fred will create a trust, funded with sufficient assets to pay at least pay the
first year’s premium on the policy. The trust will purchase the policy as owner,
and will be the named beneficiary. Under the terms of the trust, after Fred’s death
the proceeds are held in trust, with income to Wilma for life, and then for the
benefit of the children until they reach age 25.
This illustrates why insurance trusts are so popular. If planned correctly, the
proceeds of the policy can avoid taxation in the estate of either spouse. This is
why we sometimes describe the taxation of life insurance as essentially voluntary,
if one successfully avoids § 2042 and designates a trust as beneficiary, they are
not subject to tax.
(i) Should Fred be trustee?
He should not. § 20.2042-1(c)(4)
(ii) Should Wilma be trustee?
Wilma can be trustee so long as the beneficial interests given to her fall
short of a general power of appointment.
(iii) Assume the premiums on the policy are $20,000 per year, and that
Fred will contribute to the trust the funds necessary to pay the premiums
each year. Will that constitute a gift? If so, will it qualify for the annual
exclusion?
It will constitute a gift but will not qualify for the annual exclusion
because there are no present interests in the trust. Defer discussion of
Crummey until Chapter Eight. Payment of the proceeds is not treated as
a transfer of the policy. See note 11 on page 89 of the text.
3. Grantor has heard about the benefits of irrevocable life insurance trusts. He creates
such a trust, naming a bank as Trustee, and providing that after receipt of the proceeds on
his death the trust will pay income to his wife for life, remainder to their children (or
estates). He then purchases a $5,000,000 policy on his life, and transfers the policy to the
trust.
a. What are the estate tax consequences to the Grantor if he dies within three years
of the transfer?
The proceeds will be included under § 2035.
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b. Can the Grantor avoid these consequences by selling the policy to the trust for
its fair market value? Are there any income tax issues raised by the sale?
Maybe, but it’s risky. The Service took the position in TAM 8806004 that the
principles of Allen should apply here. This could also be a transfer for
consideration under § 101(a)(2) that would result in taxability of the proceeds.
c. What does this tell you about how the purchase of life insurance should be
structured?
The donor should never own the policy.
4. D owns 60% of X Corp. Several years ago, X Corp. took out a $5 million life
insurance policy on D’s life. This year D dies. Is all or a portion of the life insurance
proceeds includible in D’s estate? Do you need to know additional facts? See § 20.20421(c)(6).
The issue raised here is whether the incidents of ownership on a life insurance
policy on the decedent’s life will be attributed to the decedent if the decedent is
the controlling shareholder. Under the cited regulation, if the proceeds are
payable to the corporation or for its benefit, the incidents of ownership will not
be attributed to the decedent. Note that the proceeds of the policy will increase
the value of the corporation and the value of the decedent’s stock. On the
otherhand, if the proceeds are payable to a third party and do not increase the
value of the corporation, they will be and the proceeds will be includible in the
decedent’s estate.
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Chapter Six
Powers of Appointment
Problems:
Many students have never heard the term “power of appointment” before, so we always
begin with a definitional review, both for local law and federal law. We teach the
federal law as creating a bright line rule.
Note: in answering the following problems disregard any potential application of the
tax on generation-skipping transfers.
1. Gilda’s will creates a trust for the benefit of her son Sammy. The trust provides that
Sammy is entitled to all of the income from the trust for life. Alternative principal
distribution provisions are listed below. In each of the following alternatives, determine
if Sammy holds a general power of appointment over the trust. In each case, consider if
your answer depends on whether Sammy is Trustee at the time of his death.
(a) Remainder to Sammy’s issue, by representation.
Sammy holds no power, either individually or as Trustee.
(b) On Sammy’s death the trustee shall distribute the principal to such one or
more of Sammy’s issue as he shall appoint by will. In default of appointment the
principal will pass to Sammy’s issue, by representation.
Sammy holds a power, but it is a non-general power.
(c) On Sammy’s death the trustee shall distribute the principal to such one or
more persons or entities as Sammy shall appoint by will. In default of
appointment the principal will pass to Sammy’s issue, by representation.
There are no restrictions on to whom Sammy can appoint the property.
Therefore, Sammy holds a general power.
(d) During Sammy’s life the trustee may distribute principal to Sammy’s sister
Betty, in the Trustee’s discretion. On Sammy’s death the remainder passes to
Sammy’s issue, by representation.
Here the power is held by the Trustee, so there is only an issue if Sammy is
acting as Trustee. Even if he is acting as Trustee, this would be a non-general
power.
(e) During Sammy’s life the trustee may distribute principal to Sammy, in such
amounts as the trustee deems appropriate solely in the trustee’s discretion. On
Sammy’s death the remainder passes to Sammy’s issue, by representation.
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Again, the power here is held by the Trustee. If Sammy is Trustee, he would
hold a general power over the trust.
(f) During Sammy’s life the trustee shall distribute principal to such persons and
in such amounts as Sammy shall request from time to time. On Sammy’s death
the remainder passes to Sammy’s issue, by representation.
Here the power is held by Sammy, whether acting as Trustee or not. It is an
inter vivos general power.
(i) During a particular year Sammy directs the Trustee to distribute
$50,000 to Betty. Has Sammy made a gift?
He has, under § 2514
(g) During Sammy’s life the trustee may distribute principal to Sammy in
amounts needed for his health, education, maintenance and support in his
accustomed standard of living. On Sammy’s death the remainder passes to
Sammy’ issue, by representation.
The power is held by the Trustee. If Sammy is Trustee he would hold a nongeneral power. § 2041(b)(1)(A)
(h) During Sammy’s life the trustee may distribute principal to Sammy in
amounts needed for his happiness and comfort. On Sammy’s death the remainder
passes to Sammy’s issue, by representation.
This power, which is not subject to an ascertainable standard, is held by the
Trustee. If Sammy is Trustee he would hold a general power.
2. Under the terms of a $1,000,000 trust created by his mother’s will, Dave was entitled
to the entire net income, and as much of the principal as he requests from time to time,
remainder to Dave’s niece Ann, or her estate. Assume, in the alternative:
a. Dave never exercised the power and died holding it.
Inclusion of the trust under § 2041(a)(2). As you can see in (a)(1), for pre-1942
powers exercise was required.
b. Dave exercised the power two years prior to his death, and withdrew $200,000
of the principal of the trust, which he invested.
The assets remaining in the trust will be included in his estate by § 2041, and
the investment assets will be included under § 2033.
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c. Dave exercised the power two years prior to his death by directing the Trustee
to distribute $200,000 to his child.
Dave has made a gift under § 2514. Any gift tax paid on the transfer would be
included under § 2035(b).
d. Dave exercised the power five years prior to his death by directing the Trustee
to distribute $200,000 of the trust principal to a new trust, of which Dave is
Trustee, which provided for income to his children for Dave’s life, in such shares
as the Trustee determines, remainder to Dave’s children or their estates.
Dave has exercised the power “by a disposition which is of such nature that if it
were a transfer of property owned by the decedent” in would be includible
under § 2036. § 2041(a)(2). This essentially treats exercise or release of a
power as a “transfer of property” for purposes of §§ 2036-2038.
3. Several years ago, George created an intervivos trust for the benefit of his daughter
Debbie and her family. The trust instrument directs the Trustee that during Debbie’s life
it is to distribute the net income and/or principal of the trust to Debbie and her three
children in such proportions and amounts that the Trustee deems appropriate. On the
death of Debbie, the Trustee is to distribute the principal to Debbie’s children, or their
estates, in equal shares. Debbie is named Trustee. On Debbie’s death, will any portion
of the trust be included in her estate under § 2041?
Under these initial facts, Debbie has a general power of appointment, and the
trust would be included in her estate.
a. Would your answer change if George was co-Trustee of the trust, and was
acting in that capacity when Debbie died?
It would. Under § 2041(b)(1)(C)(i) this is not a general power.
b. What if George predeceased Debbie, and Debbie was sole Trustee at the time
of her death?
Now the power is general, and would be included in Debbie’s estate
c. What if Debbie’s brother Bobby was appointed co-Trustee?
The Co-Trustee must either be the creator of the power or someone with a
substantial interest adverse to its exercise. Here Bobby has no such interest. It
is a general power.
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d. What if Debbie’s eldest child Sarah was Co-Trustee?
Sarah’s interest in the remainder is a substantial adverse interest, so the power
is non-general.
e. What if Sarah was Co-Trustee, but the trust instead provided that the remainder
passes to Bobby or his estate at Debbie’s death.
Sarah’s only interest in the trust now is as a permissible appointee under the
power. That in itself is not a substantial adverse interest. The regulations treat
the co-holders of the power as co-owners of the property, so that here ½ of the
trust would be included in Debbie’s estate. Reg § 21.2041-3(c)(3)
4. Horace’s will created a trust, with a bank as Trustee, for the benefit of his son Sean.
The trust provides for income to Sean for life, remainder to Sean’s children, or their
estates. In addition, Sean is entitled to withdraw $20,000 of the principal of the trust each
year, by submitting a written request to the Trustee. This right is non-cumulative, so that
if in any year Sean does not request a principal distribution his right to that year’s
distribution terminates. Sean died five years after creation of the trust, and never made a
request for a principal distribution. For purposes of this problem, assume that the
principal of the trust during all relevant times is $400,000.
a. What portion of the trust, if any, will be included in Sean’s estate?
At the time of his death Sean held a general power over the $20,000 that he had
the right to withdraw at that time. The harder question is the effect, if any, of
the lapse power in each of the four prior years. This raises the lapse problem
discussed in the text.. Because the power here is exactly 5% of the trust, its
lapse is not a release.
b. Would your answer to part (a) be different if the right to withdraw could only
be exercised during the month of December, and Sean died in November?
In that case he would not hold a power over the $20,000 on the date of his death
and nothing would be included in his estate.
c. Would your answer to part (a) be different if the withdrawal right was $50,000
per year?
It would. Now the lapsed power exceeds 5%, and it will be treated as a release
to the extent of the excess, or $30,000 per year. Each year that it lapses, Sean is
treated as making a transfer to the trust of $30,000, which would be a gift
(taxable at the full amount under § 2702). That release represented 7.5% of the
trust value each year, so that after four years Sean is treated as settlor of 30%,of
the trust. For this reason, Sean would have to include the $50,000 general
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power he held on the date of his death, plus 30% of the balance of the trust
($400,000 - $50,000) or $355,000. See the discussion in the text at pp 127.
5. A partner in your law firm asks you to draft a trust for the benefit of a wealthy client.
The client wants to make a substantial gift to his paramour, but because the paramour is
quite wealthy in her own right the client wants to protect the assets from estate tax on her
death. The partner asks you to draft a trust that provides the paramour with as close to
complete ownership of the trust assets as is consistent with non-includibility in her estate.
What type of distribution provisions would you include?
This provides an opportunity to describe how powers are used in estate
planning. The beneficiary can have the right to income from the trusts, and
rights to principal as long as the fall short of a general power. If she is not
Trustee, the Trustee can have a discretionary power to distribute principal. If
she is to be Trustee, then that power should be limited by an ascertainable
standard. She can also have a 5 and 5 power, entitling her to principal each
year, without regard to need. She can have a testamentary special power, as
broad or narrow as the client deems appropriate, so long as the permissible
appointees exclude the beneficiary, her estate, her creditors, or the creditors of
her estate.
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Chapter Seven
Deductions
A. § 2053: Expenses, Indebtedness & Taxes
Problem:
Decedent died in 2017 with the following assets and liabilities:
1. The only asset of his probate estate was his margin investment account
holding $8,000,000 in marketable securities. D owed the brokerage firm the
sum of $400,000 on the account.
2. D was the grantor and lifetime beneficiary of a revocable living trust that
contained most of his other assets, with a total value of $5,000,000.
3. Several years prior to his death D transferred his home into joint tenancy with
his daughter, subject to a $500,000 recourse mortgage. At the date of death,
the property was worth $1,500,000, and the mortgage still had a principal
balance of $500,000.
4. D maintained a charge account with Tiffany’s. On the date of his death he
owed Tiffany’s $50,000.
5. Shortly before he died D delivered a promissory note to his housekeeper for
$50,000.
Consider the effect of the following transactions in determining the amount of D’s
taxable estate:
a. The brokerage firm filed a claim against D’s probate estate for payment of the
$200,000 on the margin account. The executor paid the claim.
The investment account would be included in D’s estate under § 2033, and
there would be an offsetting deduction for the loan under § 2053(a)(4)
b. Tiffany’s filed a claim against D’s probate estate for payment of the $50,000
due on the charge account. The executor paid the claim.
Deductible as a claim under § 2053(a)(3).
c. The housekeeper filed a claim against D’s probate estate for payment of the
$50,000 promissory note. The executor paid the claim.
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The claim may be deductible under § 2053(a)(3), although § 20.2053-1(b)(2)
provides that only bona fide claims are deductible, not those that are “a
mere cloak for a gift or bequest.” More facts would be needed.
d. The probate court administering D’s estate approved an executor’s
commission for D’s executor of $30,000. The executor paid the amount.
Deductible under § 2053(a)(2).
e. The Trustee of the revocable living trust paid himself $100,000 as a fee for
managing and distributing the assets of the trust after D’s death.
This too would be deductible under § 2063(a)(2). See §§ 20.2053-1(a)(2) &
20.2053-8.
f. Because of D’s death the joint tenancy property vested in his daughter’s name.
The bank holding the mortgage agreed to allow the daughter to become the
obligor on the mortgage, and she took over the payments. Would the result be
different if the mortgage was nonrecourse?
If the mortgage is recourse, it is deductible. If it is nonrecourse only the net
equity in the property is returned. See § 20.2053-7.
B. Transfers to Charity § 2055
Questions:
D died with a gross estate of $15,000,000. Would any of the following alternative will
provisions result in a deduction for his estate?
a. $5,000,000 to the Metropolitan Museum of Art, residue of his estate to his
mother.
The estate would be entitled to a deduction of $5,000,000. § 2055(a). Outright
bequests to charity raise few issues.
b. The entire estate in trust with the following terms:
i. income to his mother for life
ii. principal to his mother as needed for her health.
iii. remainder to the Metropolitan Museum.
This raises the problems involved in charitable remainder and lead trusts.
Here, if one wanted to allow a deduction for the remainder it would be
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impossible to value, because of the principal distribution possibility. So ask the
students if a deduction should be allowed if you eliminate that power to
distribute. You can illustrate the problems in relying on valuation tables, when
the trustee has the ability, to some extent, to manipulate the return. No
deduction is allowed. § 2055(e)(2).
c. The entire estate in trust with the following terms:
i. income to Metropolitan Museum for 10 years
ii. remainder to D’s children, or their estates.
Again by choosing low yield investments, the Trustee could enlarge the value of
the remainder, and no deduction will be allowed.
d. The entire estate in trust with the following terms:
i. $700,000 per year is paid to his mother for life.
ii. Remainder to the Metropolitan Museum.
Here the remainder would qualify for the deduction because the trust is a
charitable remainder annuity trust. § 664(d)(1). The amount of the deduction
would be determined under § 7520.
e. The entire estate in trust with the following terms:
i. $100,000 per year is paid to his mother for life.
ii. Remainder to the Metropolitan Museum.
This highlights the requirement in § 664(d)(1) that the sum certain must be
between 5 and 50% of the initial fair market value of the trust. Here the
annuity is only 1.4% of the trust’s initial value, so the remainder is not
deductible.
f. The entire estate in trust with the following terms
i. Each year for her life, D’s mother receives an amount equal to 6% of the
value of the trust on the last day of the calendar year.
ii. Remainder to the Metropolitan Museum.
This is an example of a charitable remainder unitrust, and the
remainder will qualify for the deduction. § 664(d)(2). The fixed
percentage must be more than 5% and less than 50%.
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g. The entire estate in trust with the following terms
i. Each year for 10 years the Trustee pays $700,000 to the Metropolitan
Museum.
ii. Remainder to D’s children, or their estates.
This is a charitable lead trust, and the lead interest will qualify for the
deduction. § 2055(e)(2)(B). Note that charitable lead trusts are not
subject to the percentage limitations imposed on charitable remainder
trusts.
C. The Marital Deduction: § 2056
We begin by discussing the history of the marital deduction, and its current role, which
is to postpone taxation of spousal property until the survivor’s death.
1. D died in 2019, and as a result of his death the following occurred. In each case, what
is the amount of the marital deduction available to D’s estate:
a. D died owning stocks and bonds valued at $1,000,000. His will left those
assets to his wife.
$1,000,000 marital deduction. This problem explores the “passing”
requirement. § 2056(c)(1).
b. D died owning stocks and bonds valued at $1,000,000. His will left those
assets to his same sex husband.
Same as (a), post-Windsor.
c. D died without a will and under the intestacy law of his state the stocks and
bonds were distributed to his wife as heir.
Same, § 2056(c)(2).
d. D and his wife owned their residence (valued at $2,000,000) as joint tenants
with right of survivorship. At D’s death title to the property vested in his wife.
One-half the value of the residence is included in D’s estate, $1,000,000, and
the estate is entitled to a deduction in that amount for D’s ½ interest that vests
in his wife at his death. § 2056(c)(5).
e. Under a trust created by his father’s will, D held a testamentary general power
of appointment over $2,000,000. In his will D appointed those assets to his wife.
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§2,000,000 deduction. § 2056(c)(6).
f. Under a trust created by his mother’s will, D held a non-general (special)
testamentary power of appointment. In his will D appointed those assets to his
wife.
This will not qualify for the deduction. Because D’s power is non-general, it
will not be included in his estate. Only assets or powers included in the estate
are eligible for the deduction. § 2056(a), last sentence.
g. D owned a $1,000,000 life insurance policy on his own life. At his death the
company paid the death benefit to his wife, who was the designated beneficiary.
$1,000,000 deduction. § 2056(c)(7).
h. D had a $2,000,000 retirement plan, which paid the death benefit in that
amount to his wife, the designated beneficiary.
$2,000,000 deduction. § 20.2056(c)-1(a)(6).
2. Decedent’s will made the following dispositions. Which will qualify for the marital
deduction?
a. My residence to my spouse, outright and free of trust.
Qualifies. Outright bequests always qualify.
b. My residence to my spouse for life, remainder to my children (i.e., a legal life
estate).
Here we encounter the terminable interest rule. This example illustrates the
need for the rule. Because the spouse’s interest terminates with his death, there
will be nothing to tax in his estate. The marital deduction is not intended to
eliminate tax entirely, but to postpone taxation until the survivor’s death.
c. $1,000,000 to my trustee, to pay income to my spouse for life, remainder to my
spouse’s estate.
This is a so-called “estate trust,” and it will qualify for the deduction. The
terminal interest rule is not trigerred because the entire property passes to the
surviving spouse (and his estate). § 20.2056(c)-2(b)(1)(i), (2)(ii)
d. $1,000,000 to my trustee, to pay income to my spouse for life, remainder as my
spouse appoints by will, in default of appointment to my children, or their estates.
Qualifies. § 2056(b)(5).
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e. $1,000,000 to my trustee, to pay income to my spouse for life, remainder to my
children, or their estates.
Won’t qualify under (b)(5) because the power isn’t general. Since 1981 it will
qualify as a Qtip trust under § 2056(b)(7) if the proper election is made.
f. $1,000,000 to my spouse, outright and free of trust, if she survives me by 90
days.
This is a terminable interest, because the spouse’s right will terminate if he fails
to survive the 90 days. The statute, however, provides an exception for survival
requirements of up to 6 months. § 2056(b)(3)
g. $1,000,000 to my spouse, outright and free of trust, if she survives until
distribution of my estate.
This will not qualify, even if distribution occurs within 6 months. § 20.2056(b)3(d) Ex. 4.
h. D leaves her spouse a patent with 12 years remaining in its useful life.
Qualifies. This is not a terminal interest. Although the spouse’s interest will
terminate at the end of the patent’s life, no one else will be able to possess or
enjoy the property after the termination. § 2056(b)(1)(B). Indeed, this is really
an outright gift of the entire patent!
3. D’s will created a trust that provided for income to his spouse for life (payable at least
annually), and the remainder to his children, or their estates. D's executor made a QTIP
election under § 2057(b)(7). When her life estate was worth $10 Million and the
remainder was worth $15 Million, D’s spouse transferred by gift 1/2 of her income
interest. What are the transfer tax consequences, if any, of that transfer?
Under § 2519, the spouse is treated as making a gift not only of the ½ income
interest, but of 100% of the remainder.
4. H & W, both age 60, have 4 children and jointly hold $50 million in assets. By will,
H leaves his estate to his spouse if she survives him, and if not then to his children or
their estates in equal shares. Any assets disclaimed by his spouse will be placed in Trust
with the following terms: Income to W for life, Remainder to his children or their estates
in equal shares. H dies with a gross estate of $25 million. Should W consider
disclaiming all or a portion of her bequest?
W should seriously consider disclaiming $10,000,000. As we shall see in
Chapter Eight, the disclaimer should be valid. If she does disclaim, H’s estate
will still not owe any estate tax because of his basic exclusion. Although the
basic exclusion is portable, it can never exceed the current exclusion. Under
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current law, the basic exclusion is to be reduced in January, 2026 to $5,000,000
(adjusted for inflation).
5. W is married to H, they have no children. W wants to provide for H for his life, and
wants the ASPCA to receive her estate after H’s death. What will be the amount of W’s
taxable estate if she leaves her $15 million in assets in trust as follows:
a. $1,500,000 per year to H for life, remainder to ASPCA.
This is a charitable remainder annuity trust, and will qualify for the marital
deduction under § 2056(b)(8). The trust cannot allow for distributions of
income or principal in excess of the designated annual payment. It does ensure
that the property goes to the ASPCA on H’s death.
b. Income to H for life, remainder to ASPCA.
This would qualify for the marital deduction as a QTIP trust, provided the
necessary election is made. This trust can provide for discretionary principal
distributions, as well as a five and five power. It too ensures that the property
ends up with the ASPCA. The property will be included in H’s estate, but there
will be an offsetting charitable deduction.
c. Income to H for life, remainder as H appoints by will.
This will qualify for the marital under § 2056(b)(5). It will not ensure that the
property ends up with the ASPCA.
The point of this question is that, with the enactment of § 2056(b)(7), there seem to be
few reasons to rely on (b)(8), because of the increased flexibility allowed by the former.
6. W, age 45, creates an inter vivos trust by transferring $10 Million to a Bank as
Trustee. The terms of the trust give the Trustee discretion to distribute to the spouse so
much of the income as the Trustee determines appropriate. Any income not distributed is
accumulated and added to principal. On the death of the spouse the principal is
distributed to W’s children, or their estates.
This type of trust is known as a SLAT (Spousal Limited Access Trust). What might be
one of the advantages of such a trust? See § 20.2010-1(c).
This type of trust is quite popular these days. One of the advantages of this
trust is that it locks in the current basic exclusion amount, which many people
believe will be reduced in the next several years. As we will see in Chapter
Nine, this type of trust can be used to reduce the amount that is subject to the
GST.
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Chapter Eight
Advanced Gift Tax Issues
Part A: Annual Exclusion Gifts in Trust
Note: In answering the following questions disregard the potential impact of the
GST.
1. In 2019, Donor Don, a widower, transfers $15,000 into a trust with Bank as Trustee
that provides for income to Don’s daughter Ann for life, remainder to Ann’s son Bob, or
his estate. If Ann is age 45, and the § 7520 rate is 3%, what is the amount of Don’s
taxable gifts?
This introduces the present interest rule, which would limit the annual
exclusion is this case to the value of the income interest, here $9,177 (applying
the remainder factor of .38817). The rule can be rationalized as consistent with
a per donee rule. In the case of a future interest we can’t know the ultimate
recipient.
a. Would your answer change if the trust allowed the Trustee the discretion to
accumulate income?
This would mean no part of the transfer will qualify for the annual exclusion. §
25.2503-3(c)(Ex 1)
b. Would your answer change if the Trustee was directed to divide the income
during Ann’s life between Ann and Bob in such proportions as the Trustee
deemed appropriate?
It would not qualify. § 25.2503-3(c)(Ex 3)
c. Would your answer change if the Trustee was directed to distribute the
principal of the trust to Ann at her request?
This gives Ann a general power of appointment over the entire trust, and the
entire transfer would qualify for the annual exclusion. § 25.2503-3(b). This
prepares students for the discussion of Crummey powers, below.
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d. Would your answer change if Ann had a testamentary general power of
appointment over the trust?
Now her right is not unrestricted, so only the income interest would qualify for
the annual exclusion.
2. Granny would like to make gifts to her grandchild George that will qualify for the
annual exclusion. George is currently in grade school. Consider the consequences if
Granny adopts the following alternative gift giving plans:
a. She transfers $15,000 each year to George’s parent as custodian under the
Uniform Transfers to Minors Act.
Such gifts do qualify for the annual exclusion. Rev. Rul. 59-357 & Rev. Rul. 73287.
b. She transfers $15,000 each year to George’s parent as Trustee of a trust that
provides for accumulation of the income until George reaches age 21. When
George reaches age 21 the trust terminates and all of the principal and
accumulated income is distributed to George. If George dies prior to attaining age
21 the property passes to his estate.
This is similar to a custodianship but will not qualify for the annual exclusion
because it prohibits use of the income &/or principal for George’s benefit.
c. She transfers $15,000 each year to George’s parent as Trustee of a trust that
provides for distribution of income and principal to George as the Trustee deems
appropriate until George reaches age 21. Any undistributed income is
accumulated and added to principal. When George reaches age 21 the trust
terminates and all of the principal and accumulated income pass to George. If
George dies prior to attaining age 21 the property passes to his estate.
This is a qualified minor’s trust under § 2503(c), and it will qualify for the
annual exclusion.
(i) Would your answer be different if the trust continued until George
reaches age 30 unless, within one month following his 21st birthday, he
elects to terminate the trust?
No, see See Rev Rul 74-43.
d. She transfers $15,000 each year to George’s parent as Trustee of a trust that
provides for distribution of income and principal to George as the Trustee deems
necessary for George’s education until he reaches age 21. Any undistributed
income is accumulated and added to principal. When George reaches age 21 the
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trust terminates and all of the principal and accumulated income is distributed to
George. If George dies prior to attaining age 21 the property passes to his estate.
This will not qualify under § 2503(c). There cannot be restrictions on the
Trustee’s ability to use the property for the beneficiary’s benefit. See Reg. §
25.2503-4(b)(1)
e. She transfers $15,000 each year to George’s parent as Trustee of a trust that
provides for distribution of income and principal in such amounts as the Trustee
deems necessary for George’s health and education. When George reaches age
35 the trust terminates and all of the principal and accumulated income is
distributed to George. If George dies prior to attaining age 35 the principal passes
to Granny’s issue, by representation. The trust contains a provision that directs
the Trustee to send written notice to George within 10 days following a
contribution to the Trust by Granny. For 30 days thereafter George has the right
to demand distribution of that contribution, up to the lesser of the amount
contributed or the then applicable annual exclusion under § 2503(b).
This trust contains a “Crummey power,” and the annual contributions will
qualify for the annual exlusion. The beneficiary essentially has a general
power over each year’s contribution. Here we discuss Crummey, Kohlsaat, etc.
f. George attends private school, at an annual cost of $45,000. Granny pays the
tuition. What is the amount of her taxable gifts if she (i) pays the tuition directly
to the school, or (ii) reimburses George’s parents for the cost.
Exclusion under § 2503(e), but only if made directly to the school.
3. Donor Diane creates a trust that provides for income to her 3 children for their lives,
and on the death of the last child the trust is divided among Diane’s issue, by
representation. Assume also the trust contains a “Crummey” provision, granting a
withdrawal power to each of her three children and five grandchildren. In 2018, what is
the maximum amount of wealth she can transfer to the trust without making a taxable gift
if (i) she is unmarried, and (ii) she is married.
Under Kohlsaat, she would be entitled to 8 annual exclusions, if she is married
that amount doubles.
This is an opportunity to compare the current use of the annual exclusion with
it’s original purpose of exempting holiday and weddings gifts.
4. Irene owns a $3,000,000 whole-life life insurance policy on her own life, which has
been in effect for a number of years. Its current value (determined under Reg. § 25.25126) is $500,000. The annual premium on the policy is $30,000. On December 1, 2019, she
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assigned all right, title and interest in the policy to a trust with her brother as Trustee
which provides as follows:
a. During Irene’s life the Trustee will pay annual premiums on the policy. In the
event the Trust lacks sufficient cash to pay the premium the Trustee is authorized to
borrow against the policy as necessary.
b. Following Irene’s death the Trustee will collect the insurance proceeds, and
will pay to Irene’s daughter Abby, for her lifetime, the entire net income, together with so
much of the principal as the Trustee deems appropriate for Abby’s support. On Abby’s
death the trust passes to Abby’s daughter Betty, or her estate.
c. If the Trustee receives a cash contribution to the trust from Irene, he is directed
to notify Abby and Betty that they have the right to withdraw their pro-rata share of the
contribution. For 30 days thereafter the beneficiary may exercise their right of
withdrawal.
In 2020 Irene contributed $30,000 to the trust. The Trustee sent the requisite notice to
Abby and Betty, and they did not exercise their withdrawal right. The Trustee then used
the funds to pay the policy premium.
a. What are Irene’s total taxable gifts in 2019?
Because no one holds a present interest in the trust, the transfer will not qualify
for the annual exclusion.
b. What are Irene’s total taxable gifts in 2020?
Contributions of the premium payments will qualify for the annual exclusion
under Crummey.
c. Will the assets of the trust be included in Irene’s estate if she dies in (i) 2021,
or (ii) 2023?
If she dies with three years of making the transfer of the policy it will be
included in her estate under § 2035. Payment of premiums is not a transfer of
the policy.
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B. Gift tax valuation: split gifts
1. Grantor Gayle transfers $1,000,000 into trust for the benefit of her niece Ann. The
trust provides for income to Gayle for 15 years, remainder to Ann. Applying a discount
rate of 10% the present value of Ann’s remainder interest is approximately $240,000.
a. What are the gift tax consequences of the transfer?
Gayle has made a gift of the remainder valued at $240,000.
b. If Gayle dies 10 years after creating the trust, what will be the estate tax
consequences?
The date of death fair market value of the trust will be included in her estate
under § 2036(a)(1).
c. If Gayle dies 18 years after creating the trust, what will be the estate tax
consequences?
No part of the trust will be included in her estate. She has successfully removed
$1,000,000 in assets (or more, if they have appreciated) from her estate at a
transfer tax cost of $240,000.
d. Suppose Gayle also retains a reversionary interest in the trust, so that if she
dies within the 15 year period the trust will revert to her estate. If the actuarial
value of that reversionary interest is $140,000, how would that change your
answers in (a) – (c)?
Now the amount of Gayle’s gift in (a) would be reduced to $100,000. The estate
tax results would not change. In part (c) she would have removed the trust
assets at a transfer tax cost of $100,000.
e. How would your answers in questions (a) and (d) change if the remainder
beneficiary was Gayle’s son Sam?
§ 2702 would apply, and value the retained income and reversion at zero, and
the amount of the gift would be $1,000,000. The estate tax results don’t
change. It’s important to get across the point that § 2702 is a valuation rule
that applies only to the gift tax. Here we explore the statute in detail, including
the list of who is a family member for this purpose.
2. Grantor Greg transfers $1,000,000 in trust for the benefit of his two children. The trust
provides for income to Greg for 10 years, remainder to his children in such shares as
Greg shall direct in writing.
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a. What are the gift tax consequences of the transfer?
Greg’s retained power to allocate the remainder renders the gift incomplete,
b. What consequences if five years later Greg irrevocably directs that the
remainder should be divided equally between the children, or their estates?
A completed gift of the remainder occurs. Greg’s retained income interest is
valued at zero, and the full fair market value at that time is taxed as a gift.
c. Would it make a difference if at the point he makes the designation the
children pay him the actuarial value of the remainder at that time?
It would not. § 2702 applies to value a gift, and to determine if a gift has
been made. If we value the income interest at zero, he has not received full
and adequate consideration, and the value of the trust, less the
consideration received, would be taxed as a gift.
d. What if instead the trust provided for income to Greg’s children for 15 years,
in such shares as the Grantor shall determine, remainder to the children, or
their estates.
The power over the income renders the gift of the income interest
incomplete. That power is treated as a retained interest under § 25.27022(a)(4), and is valued at zero, so the full $1,000,000 would be taxed as a gift.
e. What if instead the trust provided for income to Greg’s brother for 10 years,
remainder to Greg’s children in equal shares, or their estates.
There is no interest retained by Greg, so § 2702 won’t apply. But we don’t
need it here, because he has made a gift of both the income and the
remainder interests.
f. What if instead the trust provided for $100,000 per year to Greg for ten years,
remainder to Greg’s children in equal shares, or their estates.
This is a qualified interest, and its value can be subtracted in determining
the value of the gift of the remainder. § 2702(b)(1).
g. What if instead the trust provided for annual payments equal to 8% of the
value of the trust, determined annually, for 10 years, remainder to Greg’s
children in equal shares, or their estates.
This too is a qualified interest. § 2702(b)(2).
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3. In 2016, Mom transfers property worth $1 Million into a trust that provides as follows:
Income to Mom for life, remainder to Daughter, or her estate. At the time of the gift,
the actuarial value of the remainder was $300K. Four years later, when the trust principal
is worth $2 Million and the actuarial value of Mom’s income interest is worth $500K,
one of the following alternative events occurs:
(i) Mom makes a gift of her income interest to Daughter, or
(ii) Mom dies
For each alternative, what are the transfer tax consequences to Mom or her estate in
2020? See Reg. § 25.2702-6(a) & (b).
This problem illustrates how the regulations deal with the fact that we have
overstated the value of what Mom has actually transferred if she subsequently
transfers the interested retained. In (i) where Mom transfers the gifts the
retained interest to her Daughter, the regs reduce her taxable gifts for 2020 to
zero. § 25.2702-6(b). If Mom dies in 2020, the entire value of the property
would be included in her estate (§ 2036(a)(1)). But she be given credit for all
“gift tax payable” on the 2016 transfer.
4. Recall Grantor Gayle from Problem 1. Assume that the property she places in trust is
her vacation home, worth $1,000,000. She retains the right to occupy the property for 15
years, and if she dies within that 15 year period the property will revert to her estate.
After fifteen years the property passes to her son Sam.
a. What are the gift tax consequences upon creation of the trust?
This is intended to raise the exception for transfers of personal residences in
§ 2702(a)(3)(ii). We purposely don’t go into the detailed requirements for
personal residence trusts in the regulations.
b. What are the estate tax consequences if Gayle dies after 20 years, when the
house is worth $5,000,000?
No part of it will be included in her estate. This assumes she moved out of
the house after the 15 year term ended.
5. On September 1, 2017 Gaylord transfers $10,000,000 in assets to an irrevocable
intervivos trust. Under the terms of the trust, the trustee is directed to pay to Gaylord the
sum of $5,090,000 on September 1, 2018, and on September 1, 2019, at which point the
trust will terminate and any remaining assets will pass to Gaylord’s children, or their
estates. If Gaylord dies during the trust term the annuity will be paid to his estate. On
September 1, 2017 the § 7520 rate is 1.2%. Applying that rate, the value of the children’s
remainder interest is zero.
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What are the estate and gift tax consequences of the trust? In answering, consider what
difference it would make if the assets (i) appreciated at the § 7520 rate, or (ii) appreciated
at the rate of 5% compounded annually.
This is an example of a short-term zeroed out GRAT. If the investment in fact
yield only the § 7520 rate, then all of the principal will return to Gaylord. If,
however, it appreciated at 5%, then the value of the remainder was actually
$590,000, and that amount will pass to the children free of transfer tax. This is
a good chance to discuss the Walton case, and the opportunities for dramatic
tax reduction.
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Part C. Disclaimers
1. On January 1, 2010, George creates an irrevocable inter vivos trust that provides for
income payable quarterly to his niece Nell for life, remainder as Nell appoints by will. In
default of appointment the remainder passes to Nell’s children who survive her, in equal
shares. In each of the following variations assume all the requirements of § 2518(b) are
met except those described.
a. The Trustee makes the first two quarterly income payments to Nell. On
August 1, 2010 she delivers to the Trustee a written disclaimer of both the
income interest and the power of appointment.
The disclaimer of the income interest is invalid, because she has accepted
the benefits. The disclaimer of the power of appointment is valid. § 25.25182(d)(1)
b. On August 1, 2010, Nell delivers to the Trustee a written disclaimer of the
power of appointment as to one-half of the property.
Disclaimer of an undivided portion is allowed. § 2518(c)(1) & §25.25183(b).
c. On August 1, 2010, Nell delivers to the Trustee a written disclaimer of her
right to appoint the property to herself or her estate, thereby converting the
power to a special power.
This is not an undivided portion and won’t qualify. § 25.2518-3(b)
d. On January 1, 2015, Nell dies, survived by three children. Her will
exercises the power of appointment in favor of her 35 year old son Sam.
On March 1, 2014 Sam:
i. Disclaims the property entirely, or
The disclaimer is valid. § 25.2518 -2(c)(3): recipient of exercise of
general power has 9 months after exercise to disclaim.
ii. Disclaims the remainder interest in the property, but retains the
income interest.
The disclaimer is invalid, because he has not disclaimed an
undivided portion.
iii. How would your answer in part (i) differ if the permissible
appointees of the power were limited to Nell’s issue?
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In the case of a non-general power, the disclaimer by a permissible
appointee must be made within 9 months after the creation of the
power, which would be when George created the trust in 2009. §
25.2518 -2(c)(3).
iv. Assume that Sam was 18 when Nell died. The assets of the estate
were distributed to him, and he used some of the funds to pay for
his college education. Sam turned 21 on March 15, 2018, and he
executed a written disclaimer of his interest in the property on that
date.
The clock is essentially tolled until he reaches age 21, and actions
taken with respect to the property are not treated as acceptance of
the interest. § 25.2818-2(d)(3). The disclaimer is valid.
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Chapter Nine
The Tax on Generation-Skipping Transfers
A. Introduction to Terminology: Who is a “Skip Person”?
After introducing the GST we go through the definition of a skip person, with
reference to the table of consanguinity in the text. After that it is possible to move
through the problem quickly.
1. In each of the following situations, determine if the designated person is a skip person
with respect to T. Unless otherwise specifically noted, assume the parent of every
designated person is alive.
a. T’s child.
No, there are two generations between T and his grandparent, and three
between his child and his grandparent.
b. T’s nephew.
Same, there are two three generations between the nephew and T’s
grandparent.
c. T’s first cousin.
T and his cousin are in the same generation, so not a skip person.
d. T’s grandchild.
Yes, the grandchild is a skip person. There is a difference of two generations.
e. T’s grandchild, whose mother, T’s child, is deceased.
Under § 2651(e) (the “orphan’s rule”) the grandchild is moved up one
generation, so is not a skip person.
f. T’s grandchild, whose father, T’s son-in-law, is deceased. The mother of the
grandchild is alive.
Deceased parent must be a lineal descendant of a parent of T, so if the
grandchild’s mother is still alive the orphan’s rule doesn’t apply.
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g. T’s great-grandchild, whose parent, T’s grandchild, is deceased.
The answer depends on whether T’s child, the grandparent of the greatgrandchild, is alive. The great-grandchild will move to either the
grandchildren’s’ generation (if T’s child alive) or to T’s child’s generation (if
T’s child is not alive). In the first case he would be a skip person, in the second
he would not.
h. T’s grand-niece, whose parent, T’s nephew, is deceased. What additional
information do you need to know in order to answer?
If T has lineal descendants, then the orphan’s rule won’t apply to collaterals. If
he does not, then the grand-niece would be moved up to the nephew’s
generation, and would not be a skip person. § 2651(e)(2).
i. T’s first cousin, twice removed, whose parent, T’s first cousin once removed, is
dead.
The orphan’s rule doesn’t apply unless the person is a descendant of T’s
parent. Skip person.
j. T’s spouse.
Never. § 2651(c)
k. T’s step-child, i.e., the child of T’s spouse
§ 2651(b)(2): treat lineal descendants of grandparents of spouse the same. The
step child is one generation below T
l. T’s step-grandchild, i.e., the grandchild of T’s spouse.
The grandchild would be a skip person.
m. The spouse of T’s grandchild.
§ 2651(c)(2): same generation as grandchild, so also a skip person.
n. T’s long time companion. T is 70, her companion is 55.
The following diagram helps in teaching the rules for non-lineal descendants of
grandparents
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The companion is one generations below T, and is not a skip person..
o. T’s long time companion. T is 70, the companion is 30.
The companion is two generations below T, and is a skip person.
p. The child of T’s companion. T is 70, the companion is 45, and the child is 15.
Would it make a difference if T adopted the child?
The child is a skip person. If T adopts her, then she is not. § 26.2651-2(b).
2. T’s will leaves his entire estate in trust. T has one child, C, C has one child, GC. T
also has a spouse, S. Unless specifically stated otherwise, assume that T is survived by
C, S and GC. Will the trust be a skip person if it provides:
It is important to first establish what is a “interest” in the trust for this purpose.
Under § 2652(c) only a PRESENT right to receive income or corpus, or
permissible CURRENT recipient of income is an interest in the trust.
a. Income to Spouse for life, remainder to C, if living, and if not then to GC, or
his estate.
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Only S has an interest in the trust and she is not a skip person. Therefore the
trust is not a skip person.
b. Income to Child for life, remainder to GC, or his estate.
Only C has an interest in the trust, so it is not a skip person.
c. Income to GC for life, remainder to his estate. The Trustee has the authority to
invade principal for the benefit of C.
GC and C both have interests in the trust, so the trust is not a skip person.
d. Income to GC for life, remainder to GC’s estate. C predeceased T.
GC is not a skip person because of the orphan’s rule, and he holds the only
interest in the trust, so the trust is not a skip person. § 2651(e).
e. Income to S for life, remainder to C, if living, and if not then to GC or his
estate. C survives T, but predeceases S. Assume, in the alternative, (i) T’s estate
makes no Qtip election with respect to the trust, or (ii) T’s estate does make a
Qtip election with respect to the trust.
This raises the question of who is the “transferor” under § 2652(a).
First, whether or not a Qtip election is made, at D’s death D is the transferor,
and the trust isn’t a skip person. If no Qtip election made, then S’s death will be
a taxable termination, and distributions to GC will be taxable, because C was
alive at D’s death.
But if Qtip is election made, then S will become the transferor when the assets
are included in her estate under 2044. At that point we determine if the trust is
a skip person, and the ophan’s rule will apply, because C was dead then.
Reverse Qtip election is available, that permits D’s estate to treat the property as
not in S’s estate for Chapter 13 purposes. § 2652(a)(3)
f. Income to be accumulated until GC reaches age 35, at which the income is
payable to GC and C in amounts determined in the Trustee’s discretion. When
GC reaches age 50 the trust is distributed to him, or his estate.
Here no one has an interest in the trust, and because distributions could be
made in the future to C, and non-skip person, the trust is not a skip person.
g. Income to be accumulated until GC reaches age 35, at which point the trust
terminates and is distributed to GC, or his estate.
Now because no one has an interest in the trust, and no distribution can be
made to a non-skip person, the trust is not a skip person. § 2613(a)(2)
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B. Taxable Events: What is a “GST”?
In each of the following situations identify if a generation-skipping transfer (GST) has
occurred, and, if so which type of GST it is. Unless otherwise specifically noted, assume
the parent of any beneficiary is alive at the time of the transfer, and ignore the effect, if
any of the annual exclusion.
We begin by reviewing the three types of GSTs under § 2611(a).
1. T dies and her will leaves $100,000 to her daughter, D.
D is not a skip person, so no GST.
2. T’ dies and her will leaves $100,000 to her grandson GC.
This is a direct skip.
3. T dies and her will leaves $100,000 to her grandson GC, whose mother, D (C’s child),
predeceased T.
§ 2651(e) applies and GC is not a skip person.
4. T makes an inter vivos gift of $100,000 to her great-grandson GGC.
This is a direct skip. Note it has jumped two generations but is taxed only once.
§ 26.2612-1(a).
5. T leaves his estate in trust with income to Daughter D for life, then to grandson GC for
life, remainder to great-grandson GGC, or his estate.
a. Is there a GST when T dies?
No, the trust is not a skip person because of D’s interest, so there can be no
direct skip at that time.
b. Is there a GST when D dies?
Yes, this is a taxable termination. There has been a termination of an interest
in trust, and after no non-skip person has an interest in the trust. Distributions
can be made to a skip person. See § 2612(a)
c. Is there a GST when the Trustee distributes income to GC following D’s death?
Once the GST applies to the trust at D’s death, under § 2653(a) the trust is
treated as though the transferor is assigned one generation above GC, or D’s
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generation, so that subsequent distributions to GC are not distributions to a skip
person.
d. Is there a GST when GC dies?
There is a taxable termination when GC dies. GGC is a skip person. See Reg §
26.2612-1(f)(ex 4)
6. T transfers $10,000,000 into a trust with the following alternative dispositive
provisions. In each case, what are the GST consequences?
a. Income to GC for 10 years, remainder to GC, or his estate. .
Creation of the trust is a direct skip. Therefore, T is assigned to one generation
higher than GC, e.g., C’s generation. § 2653(a). Therefore, subsequent
distributions of income and principal are not made to a skip person, and not
taxable as GST’s.
b. Income to GC for 10 years, remainder to GGC or his estate.
Now the expiration of the term would be a taxable termination because GGC is
a skip person.
c. Income to GC until age 21, as needed for his support and maintenance,
remainder to GC, or his estate.
The issue here is whether use of the income can defray C’s legal obligation to
support GC, and, if so, does this mean that C has an “interest” in the trust. If C
does, then the trust is not a skip person and creation of the trust would not be a
direct skip, termination of the trust at GC’s majority would be a taxable
termination.
Under § 2652(c)(3): so long as the use of the trust for such purposes is
discretionary, the support obligation is disregarded, and C doesn’t have an
interest in the trust See also example in Reg § 26.2612-1(f)ex 13.
d. $1,000 of income per year to C for life, balance of the income to GC for life,
remainder to GC’s estate.
The issue here is whether C has an “interest” in the trust, which would delay
imposition of the GST until C’s death, which would be a taxable termination.
Under § 2652(c)(2) certain interests are disregarded if it is used primarily to
postpone or avoid the GST. See also § 26.2612-1(e). It would seem likely this
interest would fall into that category.
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7. T pays a $30,000 hospital bill incurred by her grandchild.
Not a GST. See § 2641(c)(1) & (3), which essentially exclude nontaxable gifts
from the GST by applying a zero inclusion ratio to the transfer.
8. T creates a trust with income payable to her two grandchildren for T’s life in such
shares as the Trustee deems appropriate. On T’s death the trust is distributed to the
grandchildren in such shares as T directs by will, and absent direction the property is
divided equally between the grandchildren, or their estates. T is trustee of the trust and
continues in that capacity until her death.
a. Is there a GST on creation of the trust?
There is not. In order to have a direct skip, the transfer must be subject to the
gift or estate tax. There is no completed gift here, and therefore no direct skip.
b. Assume that the Trustee distributes the first year’s income equally between the
two grandchildren. Has a GST occurred?
Both a completed gift and a direct skip have occurred.
c. When T dies, does a GST occur?
The trust will be included in T’s estate under § 2036 and 2038, so a direct skip
occurs when it goes to the grandchildren.
d. How would your answers change if T was not Trustee of the trust?
In that case there would be completed gift of the income interest at that time,
and under § 2702 that gift would be of the entire value of the trust because of
the retained power over the remainder would be valued at zero. From a GST
standpoint, the trust is apparently a skip person and the transfer is apparently a
direct skip. If we taxed the transfer, it is not entirely clear how much would be
subject to the GST. Under § 2642(f), however, we are told not to tax the
transaction until the end of the Estate Tax Inclusion Period and that no portion
of T’s exemption can be allocated to the trust until that time.
9. T’s will creates a trust that provides for income to T’s daughter D for life, then to D’s
living children in equal shares until D’s youngest child reaches age 40, at which point
the trust terminates and is divided among D’s then living children. D dies when her
youngest child is age 35.
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Creation of the trust is not a direct skip because the trust is not a skip person.
D’s death is a taxable termination.
a. Suppose the trust also provided that the Trustee could invade principal for the
benefit of D’s children during D’s life, and the trustee makes a principal
distribution to one of the children.
That would be a taxable distribution. It is not subject to the estate or gift tax, so
it can’t be a direct skip. No interest has terminated, so it can’t be a taxable
termination. It is a distribution to a skip person.
b. What if the distribution in (a) was made by the Trustee to the child’s college in
satisfaction of his tuition bill?
No GST: § 2611(b)
c. What difference would it make if the trust also gave D a testamentary general
power of appointment over the assets in the trust?
Now at termination of D’s interest the property is included in her estate, and
she becomes the transferor of the trust. §2652(a). So distribution to D’s
children is not a GST, because they are not skip persons.
10. T’s will leaves his estate in trust for the benefit of his spouse for life, remainder to his
issue, by representation. T’s spouse dies 20 years later, and the trust is distributed equally
between T’s son S, and T’s grandchild GC, who is the child of T’s daughter D, who
survived T but predeceased S.
a. Assume first that the executor of T’s estate did NOT make an election under §
2056(b)(7) with respect to the trust.
There would be no GST at T’s death because the trust is not a skip person. The
property would not be taxed in the spouse’s estate as her later death, and her
death would trigger a taxable termination with respect to the half going to GC.
Because D survived T, GC remains a skip person.
B. Assume instead that the executor of T’s estate DID made an election under §
2056(b)(7) with respect to the trust, and made no other elections.
There would still be no GST at T’s death, but now the property will be taxed at
the spouse’s death under § 2044. D survived T but did not survive the spouse.
The issue here is whether GC is a skip person: what is the relevant date for
determining if the orphan’s rule applies.
The key is the definition of transferor. Because the property was subject to the
estate tax on the spouse’s death, she becomes the transferor. § 2652(a)(1). And
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because D did not survive her, GC is not a skip person with respect to her
because of the orphan’s rule.
b. Assume the executor of T’s estate made an election under § 2056(b)(7) and
2652(a)(3) with respect to the trust.
§ 2652(a)(3) allows T’s executor to make a “reverse Qtip election” with respect
to the trust, which means that T will continue to be the transferor in spite of the
Qtip election. Under these facts, that would mean the GC would be skip person,
and the spouse’s death would be a taxable termination with respect to the half
going to GC.
Sections C and D cover the computation of the GST tax. Here is a chart that we find
helpful in beginning the discussion:
C. The Taxable Amount
What is the amount of the transfer tax due in the following transactions, assuming a flat
estate tax rate of 40% and an inclusion ratio of 1. Assume also that T has previously
exhausted his unified credit, and any available annual exclusions:
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1 T makes an intervivos transfer of $2,000,000 to his grandchild, and pays the
resulting gift and GST tax.
This is a direct skip, and liability for the tax falls on the transferor.
Using the chart on page 162 of the text, we see that the taxable amount
is the amount received by the skip person, under § 2623. The amount of
the tax paid is not included in the GST, but it is added to the amount of
the gift. § 2515
There will be GST tax of $800,000, and the amount of the taxable gift
will be $2,800,000, resulting in gift tax of $1.120,000. Total transfer tax
liability will be $1,920,000 on the $2,000,000 gift.
2. T transfers $2,000,000 in trust for the benefit of Child for life, remainder to
Grandchild. Child dies when the assets of the trust are still valued at
$2,000,000. The trustee pays the GST tax out of trust funds.
This is a taxable termination, and liability for the tax falls on the trustee.
The amount subject to the tax will be the amount of trust principal
(including the funds used to pay the tax, which makes it tax inclusive).
There will be gift tax of $800,000 on creation of the trust. The taxable
termination will result in GST tax of $ 800,000, and the amount going to
Grandchild will be $1,200,000. So total transfer taxes of $1,600,000.
3. T transfers $5,000,000 in trust for the benefit of Child for life, remainder to
GC, and the trustee is authorized to make distributions of principal to
Grandchild in the trustee’s discretion. The trustee distributes $2,000,000 to
Grandchild. In addition, the trustee pays the GST tax due by reason of the
distribution.
This is a taxable distribution, and liability for the tax falls on the
distributee. If the trustee pays the tax, that is an additional taxable
distribution. § 2621(b). On the $2,000,000 distribution there will be
$800,000 in GST tax. That is an additional distribution, which will
result in addition tax of $320,000 (which at this point we hope the
distributee pays!) Total GST tax of $1,120,000.
If the Trustee ends up paying all the GST tax that will eventually be due
we have an Old Colony Problem. The solution can be expressed
algebraically: Assume X is the amount of the taxable distribution and
$2,000,000 is the amount the Grandchild will have after the GST is paid.
Therefore,
X = $2,000,000 + .4X
X = 3,333,333.
or .6X = $2,000,000
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Therefore, the Trustee must pay $1,333,333 in GST taxes.
D. The Applicable Rate
To help our students understand how the applicable rate is determined and the
purpose of the “inclusion ratio,” we begin with a slide containing the following:
Maximum federal estate tax rate (40%) times “inclusion ratio”
If inclusion ratio is zero, how much tax will be due?
What can cause the inclusion ratio to be zero?
Inclusion ratio: One minus “applicable fraction”
So if applicable fraction is one, inclusion ratio is zero, and no tax!
Applicable fraction: Allocated GST exemption/value transferred
So how much can be transferred tax free?
10,000,000/10,000,000 == 1
In each of the problems below, assume an inclusion ratio of one, unless otherwise
specifically stated. Also assume that the parent of any beneficiary is alive at all relevant
times.
1. In 2018 T transfers $15,000 per year to each of her fifteen grandchildren. What is her
total gift and GST tax liability?
Zero. § 2503(b) excludes the amounts from gift tax, and § 2642(c)(1) & (3)
assign an inclusion ratio of zero to such nontaxable gifts, resulting in a zero
rate.
2. In 2018 T transfers $225,000 into trust for the benefit of her fifteen grandchildren. The
trust calls for accumulation of income until the youngest grandchild attains age 21, at
which time the trust is to terminate and is equally divided among the grandchildren who
are then living. In addition, the trust contains a “Crummey” power giving each
grandchild a 30 day right to withdraw their ratable share of any contribution to the trust.
While the annual exclusion will be available for gift tax purposes under
Crummey, annual exclusion gifts in trust must comply with § 2642(c)(2), which
essentially would require a separate trust for each grandchild, drafted in such a
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way that the trust would be included in the grandchild’s estate (i.e., either
payable to her estate or by giving her a gpa). This trust would not comply.
3. D dies in 2019, and leaves her entire estate to her grandchild GC. D has made no
previous taxable transfers. What is the amount of her federal transfer tax liability?
D’s estate would owe no estate tax or GST tax. The estate is less than the basic
exclusion amount. The applicable fraction for GST purposes would be one
(10,000,000/10,000,000), giving an inclusion ratio of zero. The applicable rate
would then been 0%, and no GST tax would be due.
a. How would your answer change if D’s estate was $20,000,000, and D’s
husband died in 2018, leaving his entire estate to charity. His executor
filed a timely estate tax return.
Because of portability, D’s estate would still owe no estate tax. The
unused exclusion amount of her husband, combined with her own,
would result in no tax due. BUT, unlike the unified credit exclusion
amount, the GST exemption is not portable. So under these facts the
applicable fraction would be ½ (10,000,000/20,000,000), meaning that
the inclusion ratio would be 50%. The applicable rate would be 20%,
and the estate would owe GST on the $20,000,000 transfer of
$4,000,000. (Note this is 40% of the excess over the exemption).
4. Decedent dies in 2019, having made no previous taxable transfers. Her husband died
in 2001. D had two children, Abby and Ben, both of whom are very wealthy. Abby has
two children and several grandchildren, Ben has one child Charlie, who is 45, has never
been married, and does not expect to have children. D leaves her $35,000,000 estate as
follows:
(i) $10,000,000 in trust for the benefit of Abby’s children for life, then for the
benefit of Abby’s grandchildren for life, remainder to Abby’s greatgrandchildren, or their estates.
(ii)$10,000,000 outright to her grandson Charlie.
(iii). All the rest, residue and remainder, after payment of all federal transfer
taxes, to the ASPCA.
How would you recommend that D’s executor allocate her GST exemption?
One obvious possibility would be to divide the exemption equally, allocating
$5,000,000 to the trust and to Charlie. If that were done, then the applicable
fraction for each would be ½ (5/10), the inclusion ratio would be 50%, and the
applicable rate would be 20%. Thus, on each of the two direct skips, there
would be GST tax of $2,000,000, for a total of $4,400,000 in GST tax.
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In that case, the taxation of Charlie’s share would be done, but the GST would
continue to apply to the trust for Abby’s children. The grandchildren would be
moved up one generation, but on distribution to the great-grandchildren and
the great-great grandchildren, there would be a 20% tax.
A better alternative would be to allocate the exemption entirely to the trust,
which would give it an inclusion ratio of 1, and an applicable rate of 0%. The
trust would have that inclusion ratio indefinitely, so distributions to future
generations would incur to GST tax.
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