GIFT AND ESTATE TAX
OUTLINE
Note: Tax rates/exclusion amounts change from year to year. These numbers may be/will become
outdated, however the methodology should remain relatively consistent. (Note many of the problems are
done under exclusion amounts that may no longer apply).
THE GIFT AND ESTATE TAX
DiRusso: “There are a lot of misconceptions about studying gift and estate tax, I’d like to clear
those up really quick.”
Misconception #1: “Tax is harsh, scary, and exceedingly difficult.”
NO. Tax isn’t harsh, scary, or exceedingly difficult. Lots of other people have learned it, you can
to.
Misconception #2: “Tax is boring.”
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NO. Tax is not boring. In fact, tax can be quite interesting. Helping clients save lots of money is
pretty interesting.
Misconception #3: “To do well in tax, you must be good at math.”
NO. DiRusso: my little boy is in elementary school and he did the math on this exam and got it
all right. So, there is no reason you can’t do it.
Misconception #4: “Only tax lawyers need to know tax law.”
NO. All lawyers need to know tax law. If you are structuring a settlement, you need to know the
tax consequences of it. If you are structuring a divorce/support agreement, there are tax
consequences to that. If you are doing a corporate merger, there are tax consequences to that. If
you are drafting a will, there might be tax consequences to that. So, it is important to at least
have a grasp of tax law.
THE TRUTH ABOUT ESTATE TAX: Understanding estate and gift tax laws allows you to
guide clients expertly through wealth management choices, justifying your HEFTY FEES!
POLICY & HISTORY: SHOULD WE HAVE AN
ESTATE TAX?
HISTORY OF THE ESTATE TAX
Ben Franklin once wrote, “in this world nothing can be said to be certain, except death and
taxes.” Not only are death and taxes certain, but they are also intertwined.
The first death tax in the U.S. came in the form of the Stamp Act of July 6, 1797, which imposed
an inheritance tax on the receipt of legacies and the probate of wills. The tax was repealed in
1802. Several inheritance taxes were imposed during the Civil War in order to raise revenue. A
Constitutional challenge was brought against the Civil War inheritance taxes in Scholey v. Rew
(1874), a case in which the Supreme Court upheld inheritance taxes as a constitutional excise
tax. Despite this, the Congress later repealed this tax. Again in 1900 an inheritance tax was
implemented. In 1902 Congress repealed the inheritance tax. Finally, in 1916, against a
background of the populist movement, the estate tax that is the basis for our current system was
enacted. Once more, a constitutional challenge was brought to the implementation of an estate
tax. In New York Trust Co. v. Eisner (1921) the Supreme Court upheld the tax as a constitutional
excise tax.
In 1924 Congress adopted a gift tax to supplement the estate tax. The gift tax was repealed in
1926, but subsequently re-enacted in 1932. The gift tax has been challenged as being an
unconstitutional direct tax, but the Supreme Court upheld it as a constitutional excise tax in
Bromley v. McCaughn.
In 1976, Congress integrated the gift and estate tax, providing one rate structure for both and a
unified credit. In 1981, Congress amended the marital deduction to allow an unlimited amount of
property to pass tax-free between spouses.
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In 1976, Congress also implemented a generation-skipping transfer tax. That tax was complex,
so it was repealed and a new generation-skipping tax was implemented in 1986.
POLICY DEBATE
Should we have an estate tax system? Is it fair? Should it be repealed?
ARGUMENTS FOR THE ESTATE TAX:

Inheritance is unfair. The people who stand to inherit did nothing productive in order to
earn it, it is a windfall to them. It is at base inherently unfair for you to get rich, just
because your relatives were rich. (But is it really that unfair?)

Inheritance promotes the concentration of and unequal distribution of wealth. America
was not founded to have an elite class of super wealthy people. Taxing inheritances
therefore may be seen as more democratic, it keeps the wealth from piling up in the hands
of an aristocracy. (But, isn’t this a Karl Marx class-warfare argument?)

Concentration of wealth brought about by inheritance leads to undue political power and
influence falling into the hands of the moneyed elite. So, inheritance may stifle the
democratic process. (But, this really isn’t a valid argument is it? People are allowed to
have money, people are allowed to use their money for political purposes (see e.g., the
First Amendment). So this argument seems silly.)

Negative Economic Effects (Incentives). People who stand to inherit oodles of money
may be less likely to make good, sound economic choices during their lifetime. Perhaps
taxing away their inheritance will change their behavior.

Effect on Charitable Giving. The Estate Tax allows for deductions for charitable giving.
These deductions encourage people to give to charities. Repealing the estate tax would
take this away and mean that less would be given to charities. (Probably true.)
ARGUMENTS AGAINST THE ESTATE TAX:

Taxing people at their death is unfair. Should death really be an event of realization? You
can’t escape taxes during your life, shouldn’t you get some respite upon the occasion of
your death? Does the Internal Revenue Service have no soul?

Inheritance taxes are unfair to the surviving beneficiaries of the decedent. The estate tax
is paid out of sums that would otherwise come to these people. They need money to pay
funeral expenses and medical bills that the decedent racked up at the end of life. Why do
we want to kick these people while they are still grieving?

Double-taxation. People pay taxes on the income they earn during their lives, why make
them pay another tax on the privilege of passing that same money at their death? Of
course, there is a counter argument here: One might argue that this money has
appreciated during the lifetime of the individual, and that new accumulated wealth has
not been taxed, so it should be taxed at death.

Complexity. The Estate Tax is just do dadgum complex.

Negative Economic Effects (Negative Incentives). The estate tax effects peoples choices.
People might be making less productive choices/less productive uses of their money
because they are attempting to avoid estate tax consequences. Therefore, they may make
investments that minimize their tax bill, rather than investments that maximize societal
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


wealth. To the extent that occurs, it is a dead-weight loss and nothing productive comes
out of it.
Costs of Compliance. The estate tax is some-what of a full employment act for lawyers
and accountants. It costs a lot of money to comply with the tax, you have to have legal
advice and accounting work. This gets expensive. Also, the cost of enforcement, i.e.
hiring IRS agents to enforce it is very high. All of these compliance costs are dead-weight
losses, in that the do nothing to create additional wealth in society.
Costs of Avoidance. Through careful planning, the estate tax can often be avoided.
However, it costs money to hire an attorney to do the planning. That is money that you
could otherwise have passed on to your heirs or devisees, but instead it goes to the
lawyer, so that it can someday become part of his or her gross estate for estate tax
purposes.
Really Doesn’t Hit the Super Rich. One argument against the estate tax is that the more
wealth you have, the easier it is to avoid the tax. So, the superrich may find it easier to
avoid/plan around the tax, while the upper middle class and those of first-generation
modest wealth may be hit. So, maybe the estate tax really encourages the pooling of
wealth into fewer hands. The superrich can plan to avoid it, while it taxes away the
wealth of the people who are seeking to join the ranks of the wealthy. Maybe it means
that the rich stay rich, and the people trying to get rich can’t ever get there.
DiRUSSO’S INTRODUCTION TO GIFT &
ESTATE TAX
The Estate and Gift Taxes work together.
-The Estate Tax is an excise tax that taxes you on the privilege of passing on wealth at your
death.
-The Gift Tax is an excise tax that taxes you on the privilege of making inter-vivos gifts. The
Gift Tax exists as a backstop to the estate tax. Before the gift tax, people would just make intervivos gifts so that they would avoid the estate tax. Congress wised up and put in the estate tax so
that you would get taxed either way: whether you made an inter-vivos gift or a transfer upon
your death.
Estate Tax Code Sections all begin with § 20-- and Gift Tax Code Sections all begin with § 25--.
Exemption Amount = amount you can pass tax free. $5 Million indexed for inflation (2013 it is
$5.25 million; for 2014 it will be $5.34 million.)
Married CouplesMarried couples can use both of their exemption amounts in estate planning,
for a total of 10 and ½ million in 2013.
Gift Tax Annual Exclusion = an amount that a donor may give to a donee in a given year and
still have it excluded from the gift tax. This is a per donee exclusion amount. That means that if
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A is a grandmother who has three grandchildren B, C, and D. A could give each of them a gift
equal to the gift tax annual exclusion without gift tax consequences. The exclusion is $10,000
indexed for inflation. (For 2013 the exclusion is $14,000; for 2014 the annual exclusion will
remain at $14,000).
Married Couples: Each spouse in a Married couple has their own gift tax exclusion. A couple
may elect to split-gifts.
Rate—The estate and gift taxes are progressive taxes, with progressive rates between 18%-55%.
When you consider the exemptions and exclusions, the top marginal rate is 40%.
THE ROLE OF STATE LAW ON THE ESTATE AND GIFT
TAXES
The Estate and Gift Tax System is a system of federal transfer taxes. The system focuses on and
taxes the transfer of property interests. However, Congress has not supplemented the tax code
with a system of federal property law. Instead, the tax system relies on state property law to
define the nature and extent of property rights.
-But how deferential should the federal tax authorities be in regards to a state law decision that
was intended to minimize the estate and gift tax?
Comm’n v. Estate of Bosch (1967)—State court made a determination of a property issue that
resulted in favorable estate tax treatment based on the marital deduction. Obviously, the IRS was
not enthralled and augured that they shouldn’t be bound by a decision which was intended to
help avoid estate tax.
RULE: Federal Courts look to state law to determine property rights, BUT a federal court is not
bound by a determination of state property rights made by a state trial court in a proceeding to
which the United States was not a party.
Analysis: The Court first determined that it was the legislative intent of the Congress that the
marital deduction be strictly construed. The Court then turned to the Erie Doctrine concerns that
where brought about by this issue. Under Erie, decisions of the highest court of the state
(typically the state supreme court) are given controlling weight. But, a state trial court decision is
different. A decision by a lower court is not necessarily controlling where the state’s highest
court has not spoken on the point. The opinion of an intermediate appeals court is generally
controlling, unless it is clear that the state supreme court would have held otherwise.
CHAPTER 4: THE DEFINITION OF
A GIFT
DiRusso: “I have a multiple choice question for you. How do you define a gift for gift tax
purposes?”
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a.
b.
c.
d.
With reference to the definition a normal person would use?
With reference to the same definition that applies in property law?
With reference to the same definition that applies in income tax law?
By blind adherence and loyalty to the Internal Revenue Code gift tax sections (and
associated regulations and case law holding)?
ANSWER: DiRussso: “It’s D. by blind adherence and loyalty to the IRC gift tax section and
associated regs and case law.”
The Point of the Question: The definition of a gift for gift tax purposes is unique. You look
only to the IRS Code, regs, and case law, you don’t look to what a reasonable, average person
would think a gift was, you don’t look at what the income tax code, regs, and cases say a gift is,
and you don’t look to your state’s property law concepts to see what a common law gift is. No,
what constitutes a gift for gift tax purposes is solely a question of what the Code, Regs, and case
law says constitutes a gift.
WHAT DO THE STATUES SAY A GIFT IS?
§ 2501. Imposition of tax
(a)
Taxable transfers
(1)
General Rule. A tax, computed as provided in section 2502, is hereby imposed for each
calendar year on the transfer of property by gift during such calendar year on the transfer
of property by gift during such calendar year by any individual, resident or non-resident.
(2)
– (5) [Exceptions to the general rule]
Are there some operative words here? Perhaps transfer, property, and by gift.
§ 2502. Rate of tax
(a)
Computation of tax.—The tax imposed by section 2501 for each calendar year shall be
an amount equal to the excess of—
1)
a tentative tax, computed under section 2001(c), on the aggregate sum of the taxable gifts
for such calendar year and for each of the proceeding calendar periods, over
2)
a tentative tax, computed under such section, on the aggregate sum of the taxable gifts for
each of the preceding calendar periods.
(b)
...
(c)
Tax to be paid by donor.—the tax imposed by section 2501 shall be paid by the donor.
Note about 2502: You take into account cumulative lifetime gifts when computing the gift tax
liability. Also, note that the gift and estate tax rates are unified.
Crucially, note that § 2502(c) specifies that the tax is imposed upon and is therefore the
liability of the donor. That doesn’t mean that the IRS can’t come after the donee, in fact they can,
up to the value of the gift, but the tax is principally owed by the donor. It is a tax on the privilege
of transferring property via inter vivos gifts.
§ 2511. Transfers in General.
(a)
Scope. Subject to the limitations contained in this chapter, the tax imposed by Section
2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or
indirect, and whether the property is real or personal, tangible or intangible; but in the
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case of a non-resident not a citizen of the United States, shall apply to transfers only if the
property in situated within the United States.
(b)
………….
Note: the gift tax applies “whether the transfer is in trust or otherwise, whether the gift is
direct or indirect, and whether the property is real or personal, tangible or intangible.” This is a
very broad. Under this, a lot of things will fall subject to the gift tax.
§ 2512. Valuation of gifts. -- DEFINITION
(a)
If the gift is made in property, the value thereof at the date of the gift shall be considered
the amount of the gift.
(b)
Where property is transferred for less than an adequate and full consideration in
money or money’s worth, then the amount by which the value of the property exceeded
the value of the consideration shall be deemed a gift, and shall be included in computing
the amount of gifts made during the calendar year.
DiRusso: “There it is. This is where the definition of gift for gift tax purposes is. It took
looking at quite a few statutes, but we finally found it.”
THE MEANING OF GIFT
Definition of Gift for Gift Tax Purposes: “[W]here property is transferred for less than an
adequate and full consideration in money or money’s worth, then the amount by which the value
of the property exceeded the value of the consideration shall be deemed a gift.”
FOCUS OF THE GIFT TAX: DONEE OR DONOR?
Is the focus of the gift tax on the donor (and the value of property he transferred) or on the donee
(and the value of property she received)?
Let’s do it with an example. Let’s assume there is a little girl named Morgan. Morgan has
minded her parents and been a good girl all year long. On Christmas Eve, Santa polishes his slay
and hooks Rudolph and the gang to the front and travels all around the world delivering presents
to good little boys and girls. Santa makes his stop to Morgan’s house and leaves her lots of
presents. Who pays the gift tax, Morgan or Santa? Are we taxing Morgan or Santa?
Santa, we are taxing Santa. The focus of the gift tax is the donor and the value of the
property the donor transferred. (Note: Unless Santa was particularly generous, his gifts would
likely fall under the annual exclusion and therefore would not be taxable, but more on that later.)
SO—For purposes of the gift tax, the primary consideration is a comparison of values—what the
donor gave up versus what the donor received. That is the touchstone for gift tax analysis.
Treas. Reg. § 25.2511-2. Cessation of Donor’s Dominion and Control.
(a)
The gift tax is not imposed upon the receipt of the property by the donee, nor is it
necessarily determined by the measure of enrichment resulting to the donee from the
transfer, nor is it conditioned upon ability to identify the donee at the time of the transfer.
On the contrary, the tax is a primary and personal liability of the donor, is an excise
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(b)
upon his act of making the transfer, is measured by the value of the property
passing from the donor, and attaches regardless of the fact that the identity of the donee
may not then be known or ascertainable.
……….
BUSINESS TRANSACTIONS
Example 4-1: Greg transfers Blackacre to Renee. If Greg receives nothing in return from Renee,
the transfer is a gift. If Greg receives $150,000 from Renee, the transfer is not a gift only if the
fair market value of Blackacre is $150,000.
But, what if you go to Publix, and you get a discount, so you get that Blue Bell Ice Cream you
were going to buy for less than its fair market value. Does Publix have to pay gift tax based on
the discount that they gave you? That wouldn’t seem logical. The answer is NO.
The regulations provide a safe harbor for business transactions. Treas. Reg. § 25.2512-8 defines
a business transaction as “a transaction that is bona fide, at arm’s length, and free from
donative intent.”
More specifically, the Regulations (§ 25.2512-8) state:
Treas. Reg. § 25.2512-8. Transfers for insufficient consideration.
Transfers reached by the gift tax are not confined to those only which, being without a valuable
consideration, accord with the common law concepts of gifts, but embraces as well sales,
exchanges, and other dispositions of property for a consideration to the extent that the value of
the property transferred by the donor exceeds the value in money or money’s worth of the
consideration given therefor. However, a sale, exchange, or other transfer of property made in
the ordinary course of business (a transaction that is bona fide, at arm’s length, and free from
donative intent), will be considered as made for an adequate and full consideration in money or
money’s worth.” Bona fide  the transaction is actually what it purports to be. Arm’s Length
 free negotiation between the parties and one that strangers would agree to.
Estate of Anderson v. Comm’n (Tax Court 1947)—Business men entered into a buy-sell
agreement whereby some senior executives agreed to transfer shares of stock to junior executives
as the individuals responsibilities in the corporation changed. The buy-sell agreement would
transfer the stock to the junior executives for less than they would otherwise be worth on the
open market. The mean ol’ Commissioner wanted to impose the gift tax in this situation.
Held: This is not a gift, it falls under the business transaction exception.
Analytical Framework: The pertinent inquiry for gift tax purposes is whether the transaction is
a genuine business transaction, as distinguished from the marital or family type of transaction.
The Court found that this was a transaction entered into in the ordinary course of business and of
the type that businessmen would make.
BUY-SELL AGREEMENTS--§ 2703.
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The tax consequences of buy-sell agreements are now governed by § 2703. Section 2703
provides that the buy-sell agreement will be ignored (and thus a gift will be found) unless
it is:
(1)
a bona fide business arrangement;
(2)
not a device to transfer property to members of the family at less than full and adequate
consideration in money or money’s worth;
(3)
comparable to arrangements made by parties in an arms’-length transaction.
DiRusso on the Business Transactions Safeharbor: The Business Transaction Exception is a
very fact specific analysis. The identities of the “players” are relevant. Is it two unrelated
businessmen, or is it a father and son. That can make a difference.
P. 107 Problem #1:Ann transfers ten shares of stock in XYZ, Inc. to Brad. Ann purchases the
ten shares of stock for $10,000 (adjusted basis); at the time of the transfer the stock has a fair
market value of $100,000.
a. Has Ann made a gift? If so, what is the amount of the gift?
b. What if Ann sells the stock to Brad for $25,000?
a. Do we have all the facts here? We don’t know, but let’s assume Brad provides nothing in
return. Is it a gift? Yes. Gift = $100,000 FMV—the FMV on the date of the transfer. Note: Basis
is not considered for valuation for gift tax purposes. Basis is an income tax concept.
b. Assuming no other facts or circumstances, then it is a part-gift, part-sale. You would have a
$75,000 gift. FMV-Consideration=Gift.
1. First question  Is this a transaction for less than full and adequate consideration?
P. 107 Problem #2: Car Dealer sells Customer a car listed at $35,000 for $23,000.
a. Has Car Dealer made a gift? If so, what is the amount of the gift?
b. What are the gift tax consequences if Car Dealer is Customer’s parent?
a. No, based on these facts there is no gift. First of all, list price is not determinative of FMV,
you need to look at the actual market price. Second, depending on the facts, this is likely to be a
arm’s length transaction that will fall under the Business Transactions exception.
b. It all depends on the facts, but in the Business Transaction analysis, the identity of the
parties is relevant, and a transfer of a vehicle for less than full and adequate consideration from a
parent to a child may lead to the conclusion that it was not an arm’s length transaction and
therefore not a business transaction. So, there may be some gift-tax liability here.
WHAT IS AN ADEQUATE AND FULL
CONSIDERATION?
Code § 2512(b) defines a gift as a transfer of property for less than an adequate and full
consideration in money or money’s worth.
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When you receive money or property, it is easy to determine the value of what you have gotten.
In those cases, determining the adequate and full consideration issue is easy. But, in cases when
you get something other than money or property, it gets difficult to figure out.
Treas. Reg. § 25-2512-1. Valuation of property; in general. (Willing buyer Willing Seller
Test)
Section 2512 provides that if a gift is made in property, its value at the date of the gift shall be
considered the amount of the gift. The value of the property is the price at which such property
would change hands between a willing buyer and a willing seller, neither being under any
compulsion to buy or sell, and both having reasonable knowledge of relevant facts. . . . Thus, in
the case of an item of property made the subject of a gift, which is generally obtained by the
public in the retail market, the fair market value of such item of property is the price at which the
item or a comparable item would be sold at retail.”
But, What is Money’s Worth?
Treas Reg. § 25-2512-8. Transfers for insufficient consideration.
Transfers reached by the gift tax are not confined to those only which, being without a valuable
consideration, accord with the common law concept of gifts. . . A consideration not reducible to
a value in money or money’s worth, as love and affection, promise of marriage, etc., is to be
wholly disregarded, and the entire value of the property transferred constitutes the amount of the
gift. Similarly, a relinquishment or promised relinquishment of dower or curtsey . . . or of other
marital rights in the spouse’s property or estate, shall not be considered to any extent a
consideration “in money or money’s worth.” See, however, section 2516 and the regulations
thereunder with respect to certain transfers incident to divorce.
Comm’n v. Wemyss (1945)—Mr. Wemyss proposed to Ms. More, a widow with one child. Ms.
More’s deceased husband had set up two trusts, the trusts provided that if she ever remarried, her
interest would cease and go to the child. Ms. More wanted to marry Mr. Wemyss, but did not
want to lose her trust income. So, Mr. Wemyss, transferred a block of stock to Ms. More in
return for her marrying him and losing her trust interest. The Commissioner said that this was a
transfer for less than an adequate and full consideration, and therefore gift tax was owed.
HELD: This is a transfer for less than full and adequate consideration.
Analysis: The Regulations state that consideration not reducible to a money value (such as love
and affection and promises to marry) are to be disregarded for gift tax purposes. So, the promise
to marry could not support an argument for full and adequate consideration in money or money’s
worth. So, Mr. Wemyss argued that Ms. More giving up her interest in the trust in exchange for
the stock was a full and adequate consideration. But, the Court rejected this contention, noting
that a detriment to the donee is not a full and adequate consideration, because the tax is not
concerned with the donee, rather it is concerned with the donor. The donor, Mr. Wemyss, got
nothing more than the warm and fuzzy feelings of getting to marry Ms. More, and unfortunately
for him the folks over at the Internal Revenue Service are not romantics, for them if you can’t
boil it down to money or money’s worth it is not a consideration at all.
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Merrill v. Fahs (1945)—Man and woman agree to marry. They draw up an ante-nuptial
agreement whereby the women agrees to give up her marital rights in the husbands property and
estate in exchange for the husband creating a trust for her benefit. The Commissioner says this is
a transfer for less than a full and adequate consideration, therefore it should subject to the gift
tax.
HELD: This is a transfer for less than a full and adequate consideration in money or money’s
worth. To have a full and adequate consideration in money or money’s worth, we need
something that is reducible to cash.
DiRusso: “We need to see a consideration that is reducible to cash. No matter how good they
may make you feel, warm and fuzzy feelings are not things that you can take to the bank.”
IMPORTANT NOTE: At the time Wemyss and Merrill were decided, there was no deduction
in the gift or estate tax for transfers to spouses. Sections 2056 and 2523 now allow for
deductions for transfers to spouses. As a result, antentuptial agreements conditioned on
marriage should not create gift tax consequences.
A Note on Net Gifts:
A net gift occurs when a donor transfers property to the donee on the condition that the donee
pay the resulting estate tax bill.
Assume that Uncle transfers $500,000 to Niece on the condition that Niece pay the $175,000
gift tax bill. What consequences? Is it two transfers one from Uncle to Niece of $500,000 and
one from Niece to Uncle of $175,000. Or, is it a net gift of $325,000.
The latter approach, it is a net gift.
How do you determine the value of a net gift? Revenue Ruling 75-72 provides a formula:

The gift tax due is equal to the tentative tax (computed on the full fair market value of the
property transferred) divided by one plus the rate of tax.

So, in the Uncle/Niece example—it would be $175,000/1.35 = $129,630.
Steinberg v. Comm’r
P. 118 Problem #2: Aaron promises to establish a trust for the benefit of his son, Brian, if Brian
will quit working as a lobbyist for the tobacco industry. Aaron does not restrict Brian’s
employment in any other way. Brian quits his job as a lobbyist and takes a position with the
consumer protection division of the attorney general’s office. Aaron then transfers $2,000,000 to
Friendly National Bank as Trustee, to pay the income to Brian during his life and, at his death, to
distribute the property to Brian’s issue. What are the gift tax consequences, if any, to Aaron?
This transfer was not for a full and adequate consideration in money or money’s worth. All
Aaron got was the satisfaction that his son was not working for Big Tobacco. This might have
made him subjectively feel good, but we can’t tax warm and happy feelings. So, we completely
ignore the consideration because it was not reducible to a money value, so all the money is a gift
subject to the gift tax.
P. 118 Problem #3: Amanda is in her 70s, is in good health, and lives in a large house in a rural
area. Amanda asks Bridget, the granddaughter of a close friend, to live in the house with her.
Amanda does not need nursing care, but wants someone for companionship and to help with
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housework and repairs. Amanda promises to transfer the house to Bridget if she will live with
her for five years. Bridget does so and continues to work full-time in a nearby town. Amanda
transfers title in the house to Bridget. Gift tax consequences to Amanda?
This looks essentially like a business transaction, and in that case, no gift tax consequences.
More facts would help. Donative intent would be important here because it could ruin the
business transaction exception.
P. 118 Problem #4: Adrian is divorced, has two children, and owns substantial assets. Adrian
and Beatrice are planning to marry and are considering an antenuptial agreement. Adrian would
transfer the stock (FMV $3,000,000 Adjusted Basis $500,000) to Beatrice.
a. Beatrice will lose substantial trust income established by her former husband upon her
remarriage. What are the gift tax consequences if Beatrice signs the antenuptial agreement?
Assume that she does not release any support or property rights. Her only promise in the
antenutpial agreement is to marry Adrian.
b. Instead, assume that Beatrice releases her rights to share in Adrian’s property upon death or
divorce. She does not release any support rights. What are the gift tax consequences of this
arrangement?
c. Instead, assume that Beatrice releases both her property and her support rights. What are the
gift consequences of this arrangement?
a. taxable gift, this is the Wyemms case essentially, the consideration is not reducible to a
money value, and is therefore ignored.
b. Taxable gift, this is the Merrill case essentially. It is valuable, but it is not adequate for gift
tax purposes.
c. This is a part gift, part sale. The release of lifetime support rights are an adequate
consideration; whereas the release of the property rights are not.
DISCHARGE OF SUPPORT OBLIGATIONS
Hypo: You have a kid. The kid needs a new pair of shoes. You buy the kid a new pair of shoes.
Do you have to report that as a gift on your gift tax returns? NO. Why? Because it is not a gift.
You have a legal obligation to support your child, therefore there is no gift.
The estate tax principle that a claim founded only on a promise or agreement must be supported
by adequate and full consideration in money or money’s worth has been judicially grafted onto
the gift tax. So, when someone has a legal obligation, it is not based on a promise or agreement,
and therefore need not be based on adequate and full consideration in money or money’s worth.
It is a legal obligation, not a gift.
DiRusso: “Satisfying your own legal obligations is not a gift, i.e. it is not taxable. Providing food
and lodging to your spouse or minor child is considered part of your support obligation. So,
taking your kids to McDonalds is not a taxable gift.”
§ 2516. Certain property settlements.
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Where a husband and wife enter into a written agreement relative to their marital and property
rights and divorce occurs within the 3-year period beginning on the date 1 year before such
agreement is entered into (whether or not such agreement is approved by the divorce decree), any
transfers of property or interests in property made pursuant to such agreement—
(1)
to either spouse in settlement of his or her marital or property rights, or
(2)
to provide a reasonable allowance for the support of issue of the marriage during
minority, shall be deemed to be transfers made for a full and adequate consideration in money or
money’s worth.
Breaking Down § 2516: Certain Property Settlements
►
Section 2516 excludes from the gift tax transfers made (1) in settlement of marital or
property rights or (2) to provide a reasonable allowance for child support.
►
To qualify, there must be a written agreement between the parties.
►
Divorce must occur within a period beginning one year before the agreement is signed or
two years afterwards.
►
BUT NOTE: If a couple uses the divorce settlement as a means on transferring property
in addition to that required to settle their marital or property rights or to provide a
reasonable allowance for support for a minor child, the gift tax may still apply.
Spruance v. Comm’n (Tax Court 1973)—Lea and Margaret got divorced. They entered into a
written agreement to settle their marital and property rights and their minor children’s support
rights. Lea was to transfer an income interest in stock, to be used for the benefit of the children,
and upon Lea and Margaret’s death, the remainder was to pass to their children. But, one of the
children had reached age of majority, and the others were 20, 17, and 10. The Commissioner
maintained that this was partially as scheme to pass a gift to an adult child, and therefore that
portion of the transfer should be subject to gift tax.
HELD: To the extent that part of the transfer was to put property in the hands of an adult child,
that part of the transfer is a taxable gift.
REASONING: Section 2516 excludes from gift taxation settlements of marital and property
rights if certain statutory conditions are met. However, Congress did not intend this to be an open
invitation for divorcing couples to be able to pass property tax free to their adult children. That
wouldn’t be right, if we allowed the transfer in this case to go tax free, we would be giving
special treatment for divorcing couples to give tax free gifts to their adult children, while married
couples could not get the same treatment.
Note: This case limits the safeharbor of 2516 to the benefit of spouses and minor children.
EXCLUSIONS/SAFE HARBORS TO MINIMIZE
TAX
The Biggest safeharbor from the gift tax is the annual exclusion.
The Gift Tax Annual Exclusion is provided for in § 2503(b).
§ 2503(b). Exclusions from Gifts.
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(1)
In general. In the case of gifts (other than gifts of future interests in property) made to
any person by the donor during the calendar year, the first $10,000 of such gifts to such
person shall not, for purposes of subsection (a), be included in the total amount of gifts
made during such year.

This annual exclusion is $10,000 indexed for inflation. So, in 2013 the exclusion is worth
$14,000.
The exclusion is per donee. So, A can give $14,000 to B, $14,000 to C and so on and so
forth.
Spouses may combine their exclusion for a total in 2013 of $28,000. (this is a valuable
planning tool).


§ 2505 provides a unified credit against the gift tax. To the extent that someone gives a gift in a
taxable year which exceeds the annual exclusion, the 5 million dollar credit (adjusted for
inflation) comes into play. So, over their life, a donor may give 5 million over amounts
applicable to the annual exclusion. So, in a year you make a gift over the annual exclusion you
have to report the gift, but you won’t actually have to pay any gift tax until you exceed the 5
million dollar gift tax credit.
The 5 million dollar credit is unified with the 5 million dollar credit of the estate tax, so as an
estate planning tool, it may be desirable to not tap into the 5 million dollar credit during your life,
and save it to credit against the estate tax at your death.
Another major exclusionary provision is the exclusion of gifts between spouses found in § 2523.
§ 2523. Gift to spouse.
(a)
Allowance of deduction.—Where a donor transfers during the calendar year by gift an
interest in property to a donee who at the time of the gift is the donor’s spouse, there shall
be allowed as a deduction in computing taxable gifts for the calendar year an amount
with respect to such interest equal to its value.
So, transfers to spouses are excluded under § 2523.
Two other important exclusions are found in § 2503(e).
§ 2503(e). Exclusions for certain transfers for educational expenses or medical expenses.
(1)
In general. Any qualified transfer shall not be treated as a transfer of property by gift for
purposes of this chapter.
(2)
Qualified Transfer. For purposes of this subsection, the term ‘qualified transfer’ means
any amount paid on behalf of an individual—
(A)
as tuition to an educational organization described in section 170(b)(1)(A)(ii) for the
education or training of such individual, or
(B)
to any person who provides medical care (as defined in section 213(d)) with respect to
such individual as payment for such medical care.
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Requires payment directly to the educational organization or provider of medical services.
Education means tuition, not room and board and other expenses of living while receiving an
education.
This is an unlimited exclusion.
P. 116 Problem # 2: What are the gift tax consequences to Alice if she buys her 16-year-old
child a car? What if the child is 19? 24? What if the car is an Aston Martin? What would you
advise the client who plans to buy a car for her child?
Buying a car for a 16yr. old is not a gift, Alice had a support obligation to support her
children, and buying a car is just part of supporting her child.
Buying a car for the 19 or 24 yr. old is not part of the support obligation; they are adult
children and the car is a gift, to the extent that the value of the car is over the amount of the gift
tax annual exclusion.
P. 116-117 Problem #3: What are the gift tax consequences in the following circumstances?
a. Alice pays the law school tuition for her 24-year-old child, Cara. Alice also sends Cara $1,500
per month for living expenses. She also pays for a laptop computer, books, and school supplies.
b. Same as 3.a., only Cara is Alice’s niece, not her child.
c. Alice pays the medical bills of: (1) Cara, her 24-year-old child; (2) her niece who is 24; (3) her
63-year-old mother; (4) her best friend.
d. Alice pays the rent, utilities, and food bills of the following individuals who do not live with
her: (1) her 24-year old child; (2) her mother; (3) her best friend.
a. Tuition if paid directly to the school is excluded under 2503(e), so not a gift. There is no
support obligation because the child is 24, but the living expenses and computer are not taxable
gifts to the extent that the amount does not exceed the gift tax annual exclusion.
b. same as a. Section 2503(e) and the gift tax annual exclusion apply equally to any donee,
whether they are the donor’s child, distant relative, or total stranger.
c. If paid directly to the medical provider, then no gift tax under 2503(e).
d. No gift tax to the extent that the payments do not exceed the gift tax annual exclusion.
Otherwise, these are taxable gifts.
TAXABLE TRANSFERS
The gift tax is imposed upon a gift of the transfer of property.
=>So, lack of consideration alone doesn’t make a gift, you also have to have a transfer of
property.
The terms “transfer” and “property,” as used in § 2511 and the regulations have been interpreted
very broadly. The Supreme Court has stated that the language of the gift tax statute “is broad
enough to include property, however conceptual or contingent.”
§ 2511. Transfers in General.
(a)
Scope. Subject to the limitations contained in this chapter, the tax imposed by section
2501 shall apply whether the transfer is in trust or otherwise, whether the gift is direct or
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indirect, and whether the property is real or personal, tangible or intangible; but in the
case of a nonresident not a citizen of the United States, shall apply to a transfer only if the
property is situated within the United States.
Example 4-4—Sam creates a joint bank account with Tom and transfers $50,000 into it. Sam
makes a gift to Tom whenever Tom withdraws fund from the account.
Example 4-5—Jane establishes an irrevocable trust with Friendly National Bank as Trustee to
pay the income to Ann for her life and, at Ann’s death, to distribute the property to Carol. Jane
has made a gift of the life income to Ann and a gift of the remainder interest to Carol.
Example 4-6—Bob owns a house, and he has a mortgage of $125,000 on it with Marble State
Bank. Anna pays Marble State Bank $125,000 to satisfy the mortgage. She has made a gift to
Bob equal to the amount she paid.
Example 4-7—Max transfers Blackacre, which has a fair market value of $100,000, to ABC,
Inc. and receives nothing in exchange. Max has made a gift equal to the amount she paid.
Dickman v. Comm’n (1984)—Paul Dickman gave several interest free demand loans to
members of his family. Paul died in 1976. At that time his estate was audited and it was
discovered that he had not paid gift tax on the demand loans. Dickman’s estate maintained that
these were loans that must be paid back on demand and therefore were not a gift. The IRS
maintained that to the extent that the loans were interest free, the foregone interest constituted a
gift.
Held: Gift. There was a transfer of a property interest here. The use of valuable property is an
interest in property.
Analysis: The legislative intent of the gift tax statutes make it clear that Congress intended the
gift tax to reach all gratuitous transfers of any valuable interest in property. These loans allow the
donees to have the use of money without interest. The use of valuable property is clearly a
legally protectable property interest. So, to the extent that these were interest free loans, we have
a gift.
DiRusso: “The free use of property is a gift, so the foregone interest here is a gift. So, if you let
someone use your condo at the beach for free, to the extent that the value exceeds the gift tax
annual exclusion (which is unlikely) it is a gift.”
INTEREST FREE/BELOW MARKET LOANS—§ 7872:
As a response to the issue of interest free or below market loans, Congress enacted § 7872.
Section 7872 creates two imputed transfers for gift loans and for loans payable on demand: (1) a
transfer from the lender to the borrower equal to the amount of forgone interest and (2) another
transfer from the borrower to the lender of the same amount.
Example: Parent loans Child $500,000, interest-free. Child signs a promissory note agreeing to
repay the loan 30 days after Parent makes a written request. Assume that the applicable federal
rate is 5 percent. On the last day of the calendar year, Parent is deemed to have made a transfer to
Child equal to the amount of foregone interest, i.e., $25,300. This transfer will be considered a
gift. While Child does not have to report it as income because of § 102, Parent will have made a
taxable gift of $25,300, assuming that Parent has already made gifts to Child that year equal to
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the amount of the gift tax annual exclusion. On the same day, Child is deemed to have made a
transfer to Parent equal to the $25,300 foregone interest. This deemed transfer is not gratuitous,
and, as a result, Parent will have interest income of $25,300.
THE PROVISION OF GRATUITOUS SERVICES—NOT A GIFT:
Comm’n v. Hogle (10th Cir. 1947)—Hogle created trusts for the benefit of his children. He
divested himself completely of any interest in the trusts. However, he did manage the assets in
the trust in a fiduciary fashion, deciding which securities to invest in to maximize the return. All
income from his investing activities in the trust were income to the trust and Hogle was not able
to personally benefit from them. The Commissioner insisted that it was a gift.
Held: The provision of gratuitous services do not constitute a transfer of property, and therefore
does not constitute a taxable gift.
P. 123-124 Problem #3: If you were a judge on the United States Tax Court, how would you
decide each of the following cases? The IRS claims that each of these transactions creates gift
tax liability.
a. Altheas allows Basil to use her summer cabin for one month without paying any rent.
b. Althea allows Basil to use her house for one year without paying any rent.
c. Anita allows her son, Ben, who is 22 and just graduated from college, to live with her for one
year. Ben contributes nothing to the household expenses.
d. Amelia owns a successful cosmetics company. Bess and Charles (her children) have been
employed by the cosmetics company for over ten years. When Amelia decides to produce a new
line of cosmetics, she has Bess and Charles form a new company to develop her idea. Amelia
consults with the new company for no fee, but she does not work for the company on a regular
basis. Bess and Charles resign their positions with Amelia’s company to work full time for their
own company.
e. Angela practices law as a sole practitioner. She hires Brad, a new law school graduate, to work
of her. Three years later she retires, and Brad takes over the practice.
a. Gift, this is a transfer of the use of property (but, it probably falls within the annual
exclusion)
b. Gift, this is a transfer of the use of property (but, it could fall within the annual exclusion)
c. Gift, this is a transfer of the use of property. The child is over the age of 18, so the support
obligation does not apply here. But, this probably falls within the gift tax annual exclusion.
d. No gift. The provision of gratuitous services is not a transfer of property.
e. Need more facts. Was consideration exchanged? If not—then it is a taxable gift. Intangibles,
like goodwill and client lists, can constitute a transfer of property = a taxable gift.
DISCLAIMERS
A disclaimer occurs when the recipient (donee) of property refuses to accept it or relinquishes
the right to it. Under the laws of the 50 states, the disclaimed property passes as if the recipient
predeceased the donor.
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Disclaimers can be a useful tool in estate planning.
-However, for gift tax purposes, a disclaimer is only effective if it is a “qualified disclaimer”
under § 2518.
Section 2518. Disclaimers.
(a)
General rule. For purposes of this subtitle, if a person makes a qualified disclaimer with
respect to any interest in property, this subtitle shall apply with respect to such interest as
if the interest had never been transferred to such person. . .
(b)
Qualified Disclaimer Defined. For purposes of subsection (a), the term “qualified
disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest
in property but only if—
(1)
such refusal is in writing,
(2)
such writing is received by the transferor of the interest, his legal representative, or the
holder of the legal title to the property to which the interest relates not later than the date
which is 9 months after the later of—
(A)
the day on which the transfer creating the interest in such person is made, or
(B)
the day on which such person attains age 21,
(3)
such person has not accepted the interest or any of its benefits, and
(4)
as a result of such refusal, the interest passes without any direction on the part of the
person making the disclaimer and passes either—
(A)
to the spouse of the decedent, or
(B)
to a person other than the person making the disclaimer.
(c)
Other rules. For purposes of subsection (a)—
(1)
Disclaimer of undivided portion of interest. A disclaimer with respect to an undivided
portion of an interest which meets the requirements of the preceding sentence shall be
treated as a qualified disclaimer of such portion of the interest.
(2)
Powers. A power with respect to property shall be treated as an interest in such property.
(3)
Certain transfers treated as disclaimers. A written transfer of the transferor’s entire
interest in the property—
(A)
which meets requirements similar to the requirements of paragraphs (2) and (3) of
subsection (b), and
(B)
which is to a person or persons who would have received the property had the transferor
made a qualified disclaimer (within the meaning of subsection (b)), shall be treated as a
qualified disclaimer.
Summary of § 2518: To be a qualified disclaimer for the purposes of the gift tax, the disclaimer
must be (1) an irrevocable and unqualified refusal to accept the property; (2) written; and (3)
received by the transferor or his representative within nine months of the date of creation of the
interest or the date the recipient turns 21. In addition, the person disclaiming cannot accept the
property interest or any of its benefits and cannot direct where the property goes.
What can be disclaimed?
1.
Entire interest in property.
2.
Undivided portion of property.
3.
Partial interest in property.
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4.
5.
Power of Appointment
Survivorship interest passing at the death of a joint tenant.
Example 4-10: Joan died, leaving her household property and art collection to Mary, the family
home to Paul, and $1,000,000 to Peter. Mary disclaimed her interest in Joan’s furniture and two
painting but not her interest in the rest of the art collection. Peter disclaimed his interest in
$400,000 of the $1,000,000 bequest. Assuming that the other requirements of § 2518 have been
met and that Mary and Peter will not acquire an interest in the disclaimed property pursuant to
state law, the disclaimers will be valid. The disclaimed property will pass as if Mary and Peter
had predeceased Joan.
Example 4-11 Part 1: Jacks creates an irrevocable trust to pay the income to Martha until she is
40 years old. When Martha is 40, the trust property will be distributed to her or, if she has died,
to her issue. Martha disclaims her interest in the remainder of the trust but retains her right to the
trust income. Assuming Martha’s disclaimer satisfies the other requirements of § 2518, the
disclaimer of the remainder interest is qualified.
Part 2: Instead, assume Martha disclaims her interest in the trust income but retains her interest
in the remainder. Assume that the income is then paid to her issue. Again, assuming that her
disclaimer satisfies the other requirements of § 2518, the disclaimer of the income interest is
qualified.
BUT NOTE: The disclaimers in Example 4-11 are qualified disclaimers because Jack, the
transferor, created separate interests in Martha. If instead, he had given her the property outright
in fee, her disclaimer of either a life estate or a remainder in the property would not have been a
qualified disclaimer. Treas. Reg. § 25.2518-3(b) requires that an undivided portion of property
consist of either a fraction or a percentage of each and every substantial interest or right in the
property.
Example 4-12: John and Mike purchased Blackacre in 1980 as joint tenants with the right of
survivorship for $50,000. Mike dies when the FMV is $200,000. Within nine months of Mike’s
death, John files a disclaimer of the interest in Blackacre that he would receive as a result of
Mike’s death. Assuming that the other requirements of § 2518 have been met, John will have
made a qualified disclaimer of the one-half interest in Blackacre that would pass to him as a
result of Mike’s death. John is still considered the owner of the interest he acquired in 1980.
P. 132-133 Problem #1: David’s will provides: “I leave Blackacre to my son, Abel. I leave
$1,00,000 to my daughter, Brenda. I leave my IBM stock to my daughter, Carol. I leave
Whiteacre to my son, Edward. I leave the residue of my estate to my spouse, Sandra. If any of
my beneficiaries predeceases me, or is treated as predeceasing me under state law, that
beneficiary’s share of my property will pass to that beneficiary’s issue.” Abel and Brenda each
have two children; Carol has one child; and Edward has four children. David dies survived by his
spouse, Sandra, his four children, and his nine grandchildren.
a. Abel wants to pass Blackacre to his two children immediately. If he disclaims his interest, will
that happen? What are the gift tax consequences of his disclaimer?
b. What are the gift tax consequences if Brenda disclaims an interest in $600,000?
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c. What are the gift tax consequences if Carol disclaims her interest in one-half of the IBM
stock?
d. What are the gift tax consequences if Edward wants to disclaim part of his interest in
Whiteacre? Can he make a qualified disclaimer of a specific portion of Whiteacre, for example
of the “south 40 acres”?
a. Yes, under the will it will pass to his children. If he does a qualified disclaimer, it will not
be a taxable transfer to his children, therefore no gift tax consequences.
b. None, partial disclaimers are allowed.
c. None, partial (fractional) disclaimers are allowed.
d. Partial disclaimer would be allowed here, were we can identify and separate the part of the
property being disclaimed.
P. 133 Problem #2: Debra died, leaving her stock portfolio to her neighbor, Ellen, her real estate
to her friend, Frank, and the residuary of her estate to Ellen and Frank in equal shares. Debra
makes no provision in her will for the distribution of property in the event of a disclaimer or if a
beneficiary predeceases her. Assume that under state law disclaimed property becomes part of
the residuary estate. What are the gift tax consequences if Ellen disclaims her interest in the
stock portfolio?
Can’t have a qualified disclaimer if the property passes to the person making the disclaimer.
So, she would have to disclaim both (1) interest in stock portfolio in will and (2) interest in the
residuary estate.
P. 133 Problem #3: On September 5, 2005, Grace established an irrevocable trust by
transferring property to Friendly National Bank as Trustee to pay the income to John for his life,
and at his death to distribute the trust property to Karen and Laura in equal shares. John dies on
March 10, 2012, and Karen sends the Trustee written notice on June 26, 2012, disclaiming her
interest in the trust property. Assume that Karen’s interest would pass to her heirs under state
law.
a. What are the gift tax consequences?
b. What if Karen was ten years old on September 5, 2005?
a. When does she need to make the disclaimer? Within 9 months of the creation of the interest.
The transfer was complete when the trust was created on Sept. 5, 2005. She would have needed
to disclaim within 9 months of that date.
b. But, if she was under 21, on Sep. 5, 2005, then she could now disclaim, because you have 9
months from turning 21 within which to make a qualified disclaimer.
CHAPTER 5: COMPLETION
DiRusso: “Why does it matter whether a gift is completed? Two reasons: (1) is it a gift tax
question or an estate tax question (if the gift is completed during life, then it is a gift tax
question, if the gift is incomplete, then the value will likely go into the gross estate and be
subject to the estate tax) and (2) to determine which taxable year the gift tax consequences attach
to (this especially matters in the context of the annual exclusion).”
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A transfer of property without adequate and full consideration in money or money’s worth will
not be subject to the gift tax until the transfer is complete.
But, when is a gift complete?

A gift is complete when the donor has “so parted with dominion and control as to
leave him no power to change its disposition, whether for his own benefit or the benefit of
another.”
THEORY: A common law gift required delivery to be completed. This is essentially the gift tax
code codifying the common law requirement of delivery. Until delivery, the donor could always
renege and there would be no gift at all to tax, so we wait to tax the gift until the donor has
completed the gift.
Treas. Reg. § 25.2511-2. Cessation of donor’s dominion and control.
(b)
As to any property, or part thereof or interest therein, of which the donor has so parted
with dominion and control as to leave in him no power to change its disposition, whether
for his own benefit or for the benefit of another, the gift is complete.
But if upon a transfer of property (whether in trust or otherwise) the donor reserves any power
over its disposition, the gift may be wholly incomplete, or may be partially complete and
partially incomplete, depending upon all the facts in the particular case.
Accordingly, in every case of a transfer of property subject to a reserved power, the terms of the
power must be examined and its scope determined . . .
Notice that the rule focuses on the donor and his or her loss of control over the property. This is
due to the fact that the gift tax is imposed on the transfer of property away from the donor—
rather than on any benefit flowing to the recipient.
Notice also that part of a gift may be complete, while another part of the gift may be
incomplete.
Example 5-1: Aunt tells Nephew, “I will send you $500 next week.” This is simply a promise; it
is not yet a gift. If Aunt never sends the $500, Nephew has no recourse because he has paid
nothing for the promise. If Aunt never sends the $500, she has not made a transfer—a
fundamental requirement of the gift tax.
P. 136 Problem # 1:
Ellen establishes a joint bank account with Ned, her nephew, depositing $100,000 in the Friendly
National Bank on November 17, 2011. Ned makes no deposits into the account, but he
withdraws $25,000 on March 15, 2012. Has Ellen made a gift to Ned? If so, when is the gift
complete?
Yes, Ellen has made a gift to Ned, because she made a transfer of property for less than full
and adequate consideration.
A gift of $25,000 is complete on March 15, 2012, when Ned withdraws the funds from the
account. On that day, Ellen parted with dominion and control.
21
P. 136 Problem #2:
Fred purchase Blackacre, taking title with Mary, his daughter, as joint tenants with the right of
survivorship. Has Fred made a gift? If so, when is it complete?
When they take title, Mary has a vested interest in to a portion of the property. So, this is a
complete gift. She owns an interest in the property, so her right to it is irrevocable.
PROMISES, CHECKS, AND NOTES
A promise to make a gift becomes complete when you no longer have the right to take it back
(i.e. you no longer have the right to renege on the promise).
A contract may constitute a gift, when the consideration is not sufficient or it is not money or
money’s worth. When is the contractual gift complete? When the contract becomes legally
enforceable. At that point, the donee could go into court and demand the court to give them what
is due to them. At that point, the donor can be said to have parted with dominion and control
over the gift.
However, under state laws, purely gratuitous promises are not legally enforceable. So, the
promisor could renege on the promise at any point prior to actual delivery. Thus, for gift tax
purposes, when a gratuitous promise is involved, the gift is not complete until delivery. Up until
the donor delivers the gift to the donee, the donor could change their mind, so until delivery the
donor has not parted with dominion and control.
Example 5-2: In 2007, Parent promises to pay Child $25,000 if Child graduates from college.
Child graduates in June 2011, and Parent sends Child $25,000 in January 2012. Parent has not
made a gift in 2007 because Parent merely promised to make a gift at some time in the future.
Parent is obligated to pay Child in June 2011, however, because Child has fulfilled the terms of
the agreement. There is now a contract that is legally binding on Parent. At this point, Parent has
made a completed gift to Child because Parent can no longer refuse to pay Child.
Example 5-3: Aunt gives Nephew $2,000. If Aunt hands Nephew $2,000 cash, the gift is
complete at that moment because Aunt has given up her ability to take the money back. If the
gift is made by check, it is not complete until the check is paid or is negotiated for value to a
third person because the payor can stop payment on the check at any time before the payee has
received payment.
RULE FOR CHECKS: The general rule as it relates to check is that a gift via check is not
complete until the check is paid or cashed. This is because up until that point, the donor could
stop payment on the check and the donee would have nothing but a worthless check.
***Sometimes, when a gift by check is completed becomes a major issue, due to the gift tax
annual exclusion:
Example 5-4: Donor makes gift equal to gift tax annual exclusion amount to each of his three
children each year. He sends the gifts as checks in December 2011 and then in March 2012. If a
recipient does not cash the December 2011 check until January 2012, the donor would have
made two gifts in 2012, only one of which will qualify for the gift tax annual exclusion.
22
Another issue: For estate tax purposes all property owned at death is included in the gross
estate. Only claims that are founded on adequate and full consideration may be deducted. When
a donor has made a gift immediately before death, the effective date of completion can determine
whether the property is included in the gross estate or escapes taxation under the gift tax annual
exclusion.
SO: It appears that the date the check is cashed has some major gift tax implications.
EXCEPTION TO THE CHECK RULE (THE RELATION-BACK DOCTRINE):
Metzger v. Comm’n (4th Cir. 1994)—
Albert Metzger made gifts via check, equal to the amount of the gift tax annual exclusion, to
several family members late in December 1985. One of the family members, John deposited his
check on December 31, 1985, but the check did not clear Albert’s account until January 2, 1986
due to some procedural matters at the bank and the New Year’s holiday. Albert also made
similar gifts to the family members, including John in 1986. After Albert died, his taxes were
audited and the Commissioner concluded that gift tax was due in 1986 for gifts made to John,
reasoning that the 1985 gift was not complete until January 2, 1986 (making it a gift for 1986).
Because the Commissioner deemed the 1985 gift incomplete until 1986, that gift would have
used all of the 1986 gift tax annual exclusion and because the 1986 annual exclusion was already
spent on that gift, it did not shield the 1986 gift, making that a taxable gift. Metzger’s Estate
argued that because the check was deposited in 1985 and it was only a bank procedure that kept
the check from clearing, the gift should relate back to the day the check was deposited into the
bank.
HELD: The relation-back doctrine should apply here and the 1985 gift, although not technically
completed until 1986, relates back to December 31, 1985 when it was deposited into the bank.
Analysis/Reasoning: Under the gift tax regulations, a gift is not complete until the donor has so
parted with dominion or control as to leave in him no power to change its disposition. Under
Maryland law, a gift by check is not complete until the check is honored by the drawee bank.
Thus, under the literal language of the law, this was not a completed gift until 1986. The court
cited to string of various cases in which courts had held that in similar situations, the gift was not
complete until the check cleared the bank. However, the court differentiated this case from all
the other on the basis that in the other cases, the checks were not deposited until after the donor
had died, lending to the possibility that they were part of a scheme to avoid estate tax. Here, at
the time the check was deposited, Albert Metzger was very much alive and well, so estate tax
avoidance was not a concern.
RULE: A relation-back doctrine may be applied to noncharitable gifts where the taxpayer is able
to establish:
(1)
The donor’s intent to make a gift,
(2)
Unconditional delivery of the check, and
(3)
Presentment of the check within the year for which favorable tax treatment is sought and
within a reasonable time of issuance.
23
The IRS acquiesced and agreed to follow Metzger. Revenue Ruling 96-56 provides the rule for
relation back:
Rev. Ruling 95-56:
[T]he delivery of a check to a noncharitable donee will be deemed to be a completed gift for
federal gift and estate tax purposes on the earlier of (i) the date on which the donor has so parted
with dominion and control under local laws as to leave in the donor no power to change it
disposition, or (ii) the date on which the donee deposits the check ([or cashes it]) or presents the
check for payment, if it is established that:
(1)
The check was paid by the drawee bank when first presented to the drawee bank for
payment;
(2)
The donor was alive when the check was paid by the drawee bank;
(3)
The donor intended to make a gift;
(4)
Delivery of the check by the donor was unconditional; and
(5)
The check was deposited, cashed, or presented in the calendar year for which completed
gift treatment is sought and within a reasonable time of issuance.
RULE FOR PROMISSORY NOTES: A promissory note is a negotiable instrument. Usually,
they are given in exchange for a loan of money or for the transfer of property. If a promissory
note is given in exchange for adequate and full consideration in money or money’s worth it is not
a gift. But, a promissory note may be given as a gift.
If the promissory note is a mere promise to pay, it is not a completed gift until the note is paid
or transferred for value.
If the promissory note creates a legally enforceable agreement that has a determinable value, it
is a completed gift on the date it is signed.
Bradford v. Comm’n (Tax Court 1960)—J.C. Bradford and Eleanor Bradford were man and
wife. They lived in Nashville, Tenn. where J.C. was a partner in a partnership involved in the
securities industry. The partnership was a member in the New York Stock Exchange. The New
York Stock Exchange began doing background checks on the financial status of all of its
members. J.C. knew that he was substantially indebted to American National Bank and that the
NYSE would be troubled by that and might pull his membership. His indebtedness to the bank
was evidenced by a promissory note. J.C. concocted a plan whereby the bank would substitute
his promissory note for a note signed by his wife. The wife had little or no income or personal
wealth, so the bank intended to collect from J.C.
Issue: Did the substitution of notes constitute a gift from Eleanor to J.C.?
Held: No. This was not a taxable gift.
Reasoning: To have a completed gift, you must have cessation of dominion and control. Eleanor
did not have any money or assets. You can’t have cessation of dominion and control if you don’t
have property over which to have dominion and control. Here, this is just a paper transaction. All
Eleanor did was make a promise to pay in the future if called upon to do so, she parted with
nothing at that moment.
24
EMPLOY DEATH BENEFITS AND COMPLETION:
Estate of DiMarco v. Comm’n (Tax Court 1986)—DiMarco was employed by IBM. During his
tenure at IBM, DiMarco married Joan. IBM maintained a non-contributory Group Life Insurance
and Survivors Income Benefit Plan for employees. The plan provided for life insurance and
survivors benefits. DiMarco had no control over the plan: he could not have altered, amended,
revoked, or terminated any part of the plan. Neither did he have any power to change the
beneficiary of the survivor benefit. The only way he could have terminated his coverage from the
plan was to resign from IBM. When DiMarco died, the plan began to pay survivor benefits to his
wife Joan.
Issue: Were the survivorship benefits within the plan, a gift from DiMarco to Joan for gift tax
purposes?
Held: No.
Reasoning: While the donee received something (survivor benefits), the donor never had control
over the death benefits, so the donor had no dominion or control over which to let go. DiMarco
never controlled the survivor benefits, so he never had dominion or control over them, therefore
he could not have a cessation of dominion or control, thus there was no gift here.
Death and Completion: “[T]ransfers of property do not become complete for gift tax purposes
by reason of the death of the donor.”
Valued at the Time of the Transaction: “The clear language of [the code and regs] requires
that transferred property be valued for gift tax purposes at the time the transfer becomes
complete . . . As a result, property must be valued and the gift tax imposed at the time a
completed transfer of the property occurs.”
P. 150 Problem # 1: On August 1, 2011, Agnes promises to send Ned, her nephew, $50,000.
Agnes sends the check on March 1, 2012. What are the gift tax consequences?
This is a gratuitous promise to make a gift. It is not enforceable. Therefore, the gift is not
complete. If she sends the check & he cashes/deposits it, then the gift is complete.
P. 150 Problem # 2: On April 15, 2009, Arthur promises to pay Nancy, his niece, $50,000 if
Nancy refrains from smoking for two years. Nancy agrees to do so, and she keeps her promise.
Arthur sends Nancy the check for $50,000 on May 1, 2011.
a. What are the gift tax consequences?
b. Instead, what are the gift are the gift tax consequences if Arthur does not send the check until
March 5, 2012?
a. Gift, yes. The consideration here can’t be reduced to a money value, so it is completely
ignored. The gift is complete on April 15, 2011 when she upheld her end of the bargain, only
then did the gift become enforceable.
b. No different, the gift tax consequences attach on April 15, 2011 when the gift is completed.
P. 150-151 Problem # 3: On December 15, 2011, Amanda sends Peter, her son, a check for an
amount equal to the § 2503(b) gift tax annual exclusion.
a. Peter deposits the check in his bank on December 29, 2011. The check clears Amanda’s bank
on January 3, 2012. What are the gift tax consequences?
25
b. Instead, Peter deposits the check in his bank on January 2, 2012. The check clears Amanda’s
bank on January 5, 2012. What are the gift tax consequences?
c. Peter deposits the check in his bank on December 28, 2011. Amanda dies on December 29,
2011. The check clears Amanda’s bank on January 2, 2012. What are the gift tax consequences?
a. Complete gift in Dec. 2011. Though this is technically not a complete gift until 2012, it
satisfies the requirements of the relation back doctrine, so it is treated as complete in 2011.
b. Complete gift in Jan. 2012. He didn’t present it for deposit in 2011, so relation back doesn’t
apply.
c. This is not a gift for gift tax purposes, no annual exclusion if you are dead. So, this goes into
Amanda’s gross estate and we have a estate tax issue. It would not satisfy the relation back
doctrine, because Amanda died in the interim.
P. 151 Problem #4: Alex sends Paul a letter on October 15, 2009, promising to transfer
Blackacre as a wedding present. Alex transfers title to Paul on February 25, 2011, the day after
Paul was married.
a. What are the gift tax consequences?
b. What if Alex does not transfer title until March 5, 2012?
a. 2011 completed gift—deliver title in 2011.
b. Assuming that this is a gratuitous gift, it is a completed gift in 2012, when title is delivered.
REVOCABLE TRUSTS AND RETAINED
INTERESTS
A gift is complete when the donor has “so parted with dominion and control as to leave him no
power to change its disposition, whether for his own benefit or for the benefit of another.”
One way to structure a gift is to set up a revocable trust.
But, a revocable trust is not a complete gift. You can take it back therefore, there is no
completion. Where a donor retains the power to revoke the gift, it is not a completed
transfer.
The determination of when a gift is complete turns more on the change of economic benefits
more than with technicalities of title.
But, can a revocable trust never constitute a completed gift?
o
It can, if you set it up right.
o
It all depends on the level of control that the donor retains. You got to look at the Code
and the Treas. Reg’s to determine whether the donor has retained too much control.
Treas. Reg. § 25.2511-2. Cessation of donor’s dominion and control.
(c)
A gift is incomplete in every instance in which a donor reserves the power to revest the
beneficial title to the property in himself. A gift is also incomplete if and to the extent that
a reserved power gives the donor the power to name new beneficiaries or to change the
26
interests of the beneficiaries as between themselves unless the power is a fiduciary power
limited by a fixed and ascertainable standard . . .
What does this mean?

Where a donor reserves the power to revest title to himself/herself then the gift is
incomplete.

To the extent a donor reserves the power to name new beneficiaries or change the
interests of the beneficiaries, the gift is incomplete. Unless: the power is a fiduciary
power limited by a fixed and ascertainable standard, then it is considered complete.
Treas. Reg. § 25.2511-2. Cessation of donor’s dominion and control.
(d)
A gift is not considered incomplete, however, merely because the donor reserves the
power to change the manner or time of enjoyment. Thus, the creation of a trust the
income of which is to be paid annually to the donee for a period of years, the corpus
being distributable to him at the end of the period, and the power reserved by the donor
being limited to a right to require that, instead of the income being so payable, it should
be accumulated and distributed with the corpus to the donee at the termination of the
period, constitutes a completed gift.

What does this mean?

A gift is not incomplete just because the donor reserves the power to change the manner
or time of enjoyment. So, When we have determined who gets it & we are just picking
when they get it, then it is complete.
CO-HOLDERS OF POWER:
Treas. Reg. § 25.2511-2. Cessation of donor’s dominion and control.
(e)
A donor is considered as himself having a power if it is exercisable by him in conjunction
with any person not having a substantial adverse interest in the disposition of the
transferred property or the income therefrom. A trustee, as such, is not a person having an
adverse interest in the disposition of the trust property or its income.
What does this mean?
o
The general rule is that a grantor is deemed to have a power over trust property even if
she can only exercise the power in conjunction with another person. But, if the other
person has an interest in the trust that is both substantial and adverse, then the
grantor will not be considered to have a retained power.
Example 5-5: Gretchen establishes an irrevocable trust, appointing herself and her brother, Ben,
as Trustees. The Trustees have discretion to distribute income to, or for the benefit of Gretchen’s
nieces and nephews or to accumulate the income and add it to the principal. The Trustees also
have discretion to distribute corpus to any income beneficiary if the Trustees determine that the
distribution is necessary for their comfort and happiness. At the death of the last of Gretchen’s
nieces and nephews, the trust property is to be distributed to Gretchen’s surviving heirs. Both
Trustees must agree on distributions of income or corpus.
The gifts to Gretchen’s nieces and nephews as well as to her surviving heirs are incomplete.
Gretchen has retained the power to change the beneficial enjoyment of the trust property. This is
sufficient to make the gifts incomplete, even though Gretchen cannot receive trust property
27
herself. It is irrelevant that Ben must consent. His interest as Trustee is not adverse to the
exercise of discretion, either over income or over corpus.
BUT SEE Example 5-6: If we change the facts such that Ben was the beneficiary that received
the trust income, then he would have a substantial adverse interest. Then, the gift would be
complete.
FIXED AND ASCERTAINABLE STANDARD:
Treas. Reg. § 25.2511-1. Transfer’s in general.
(g)(2). If a trustee has a beneficial interest in trust property, a transfer of the property by the
trustee is not a taxable transfer if it is made pursuant to a fiduciary power the exercise or
nonexercise of which is limited by a reasonably fixed or ascertainable standard which is set forth
in the trust instrument. A clearly measurable standard under which the holder of a power is
legally accountable is such a standard for this purpose. For instance, a power to distribute corpus
for the education, support, maintenance, or health of the beneficiary; for his reasonable support
and comfort; to enable him to maintain his accustomed standard of living; or to meet an
emergency, would be such a standard. However, a power to distribute corpus for the pleasure,
desire or happiness of a beneficiary is not such a standard . . .
Textbook on Fixed and Ascertainable Standard: The grantor may retain control over trust
property as long as the control is a fiduciary power and is limited by a fixed and ascertainable
standard. An ascertainable standard is an objective, external standard that a beneficiary can force
the trustee to exercise. It is one that is related to health, education, support, or maintenance
or one designed to maintain the beneficiary’s accustomed standard of living.
--BUT NOTE: Conversely, an ascertainable standard makes a gift in trust incomplete where the
grantor is the trust beneficiary.
DiRusso on The Policy of Ascertainable Standard: “The idea with the whole ascertainable
standard thing is that an objective 3rd party could figure out a set amount. So, the concept is that
the beneficiary could go into court and have a judge order the trustee to pay a certain amount
based on the standard.”
DiRusso on What Constitutes an Ascertainable Standard:
o
The Regs. specifically note that the HEMS standard is an ascertainable standard—Health,
Education, Maintenance, & Support—under a HEMS standard the gift is complete,
because the donor doesn’t have complete & unfettered control.
o
The Regs. also mention reasonable support and comfort as an ascertainable standard.
o
The Regs. make accustomed standard of living an ascertainable standard.
o
The Regs. make meeting an emergency an ascertainable standard.
o
BUT—the pleasure, happiness, or desire of the beneficiary is not an ascertainable
standard.
Example 5-7: Greg establishes an irrevocable trust with Friendly National Bank as Trustee. The
Trustee has discretion to pay the income to Greg or his children during Greg’s life. At his death,
the trust property will be distributed to Greg’s surviving issue. The gifts of income and principal
are complete because Greg has not retained the power to change the beneficial enjoyment of the
trust property.
28
CHANGE THE FACTS: Assume instead that the Trustee has discretion to distribute either
income or corpus for the health and maintenance of Greg. This is an ascertainable standard. Greg
can force the Trustee to distribute trust property to him for these needs. As a result, the transfer is
not a completed gift (remember when the grantor is a beneficiary; an ascertainable standard
makes the gift incomplete.)
P. 156 Problem # 1:
Gail establishes a trust to pay the income to Eric for ten years, with the remainder to Faith.
a. What are the gift tax consequences if the trust is irrevocable?
b. What are the gift tax consequences if the trust is revocable?
c. What are the gift tax consequences if the trust is irrevocable but the corpus reverts to Gail after
ten years rather than going to Faith?
a. We have two taxable gifts here. Both are completed because the trust is irrevocable, the
donor has no control left.
b. If the trust is revocable, it is not a completed gift, so no gift tax consequences.
c. Completed gift to Eric of the income from the trust for a period of ten years. The remainder
is not a gift (you can’t give yourself a gift.)
P. 156 Problem #2:
Gail establishes an irrevocable trust with Friendly National Bank as Trustee to pay the income to
Eric for life with the remainder to Faith. What are the gift tax consequences in each of the
following situations?
a. Gail retains the power to add or delete beneficiaries.
b. Gail retains the power to alter only the remaindermen.
c. Same as 2.a., only Gail must obtain the consent of Calvin (her spouse) to alter the
beneficiaries.
d. Same 2.c., only the remainder is to be paid to Calvin.
e. What, if, instead, Gail is the Trustee and has the discretion to distribute income or to
accumulate it? Accumulated income is added to the trust principal.
f. What if, instead, Gail as Trustee retains the power to distribute trust principal for the education
of Eric?
g. What if, instead, Gail as Trustee retains the power to distribute trust principal to Eric in an
emergency?
h. What if, instead, Gail as Trustee retains the power to distribute trust principal to Eric for his
comfort and happiness?
a. Not a completed gift—the power to change beneficiaries = incomplete.
b. Gift to Eric is complete, Gail has departed with all dominion and control over the property.
The Gift to Faith is incomplete, Gail has retained substantial dominion and control over the
property.
c. Gifts are incomplete—Calvin’s interests are not adverse so the Treas. Regs. treat the power
as if it were Gail’s alone.
d. Gift to Eric = incomplete. Gift to Calvin = complete, Calvin has a substantial adverse
interest.
e. Remainder to faith is a completed gift. Income interest to Eric is incomplete because Gail
retains the power to alter beneficial interests.
29
f. The gift to Eric is completed, because the education of Eric is an ascertainable standard.
g. The gift to Eric is completed, because an emergency is an ascertainable standard.
h. The gift to Eric is incomplete, Eric’s comfort and happiness is not an ascertainable standard.
INSTALLMENT SALES AND LOANS
Estate of Kelley v. Comm’n (Tax 1974)—J.W. and Margaret Kelley executed five warranty
deeds transferring tracts of land in Texas to their three children and two grandchildren. In the
deeds, J.W. and Margaret reserved to themselves the full possession, benefits, and use of the
property for both of their lives. Each deed was given in consideration for a stated cash payment
and a vendor’s lien note. None of the notes were actually paid, J.W. and Margaret forgave each
note as it came due.
Issue: When were the gifts complete? When land was transferred or when the notes were
foregiven?
Note: This is important, because only a completed gift qualifies for the annual exclusion. The
note forgiveness was in the amount of the annual exclusion. If the gift is complete only when the
note is forgiven, then the donors were able to transfer a large, very valuable piece of property
and take advantage of the annual exclusion for it over many years.
HELD: Not a completed gift at the time of the transfer of the land, it only became a gift when
the notes were forgiven.
REASONING: The notes constituted full and adequate consideration at the time of the transfer,
i.e. no gift. Thus, it was not until the notes were forgiven that any gift was made. The court noted
that family gifts are closely scrutinized. But, if a family transaction is legitimate, then it is ok.
Here, the notes were legally enforceable obligation, and at any time prior to the forgiveness of a
note J.W. and Margaret could have actually enforced their rights.
BUT: Revenue Ruling 77-299: Facts are very similar to those in Estate of Kelly v. Comm’n
except that it was established that the donor gave the notes intending to forgive each note before
it became due. Here, the Service said that they would not follow Estate of Kelley under these
circumstances. The Service said that this was really just a disguised gift, it was not a bona fide
transaction. In cases like this, whether it was a disguised gift or a real bona fide transaction turns
on whether the donor went through with the transaction intending to forgive the notes.
Substance over form here. (the touchstone of tax law is substance over form).
DiRusso’s Analysis of Estate of Kelley and Revenue Ruling 77-299: “The donor has to retain
the choice to choose each year whether to forgive; if there is evidence up front that they intended
to forgive, then it is a gift upfront, because the donor didn’t really have any dominion or control
over the property. The Service and the Courts will look at the Substance of a transaction over its
form.”
30
Estate of Berkman v. Comm’n (Tax Court 1979)—Berkman transferred $275,000 to his
daughter and son-in-law in exchange for five promissory notes. One of the transfers was above
the prime rate, the other four were below the prime rate.
Issue: Valid sales or gifts?
Held: To the extent that the four notes were below market rate, there was a gift, because they
were not arm’s length transactions The one note above the prime rate was an arm’s length
transaction and therefore fell under the “ordinary course of business exception,” meaning that it
was not a gift.
Analysis: The Commissioner argued that the notes did not constitute full and adequate
consideration for the transfer because they were not valid obligations. The Court rejected this
argument, noting that the notes were valid and legally enforceable. The Commissioner then
argued that the transaction shouldn’t fall into the business transaction safe harbor because the
transactions were not entered into at arm’s length. The Court agreed with the Commissioner that
the four notes at a below market rate were not transferred in an arm’s length transaction. They
did constitute consideration to the extent of their fair market values, but the amount between the
amount of the transfer and the fair market value of the notes, constituted a gift. The fifth note
was at above market rate, so it was an arm’s length transaction.
LOANS: For gift tax purposes, whether a loan will cause gift tax consequences is similar to the
promissory note issue. Relevant factors include: (1) did the loaning party intend to enforce the
terms; (2) did the borrower give security? (3) were the terms of the loan discussed; (4) is interest
charge? (5) are payments actually made; (6) whether the borrower had the means to repay; (7)
the lender’s health; (8) how the lender reported the transaction for income and gift tax purposes.
P. 164-165 Problem #1: Angela owns Greenacre (FMV $100,000; adjusted basis $20,000).
What are the gift tax consequences of the following arrangments?
a. Angela gives Greenacre to Nina, her niece.
b. Angela sells Greenacre to Nina for $50,000.
c. Angela sells Greenacre to Nina for $100,000. Nina signs a promissory note for $100,000 plus
interest at the applicable federal rate. Nina also gives Angela a mortgage on the property. The
mortgage is recorded. Angela forgives each payment of principal and interest ($12,000) as it
comes due.
a. This is a taxable gift. It is a transfer of property for less than an adequate and full
consideration (actually no consideration here). Also, it is complete because the donor has
released all dominion and control over the property.
b. This is a part gift/part sale. There was a consideration for $50,000 of the transfer, so that
portion was a sale. However, the FMV of Greenacre was 100,000, so the other $50,000 was a
gift. It was a taxable gift, because the donor had released dominion and control (making it
complete).
c. DiRusso says that this look solidly structured, probably not a gift upfront. The gift will be
complete as the notes are forgiven. But, really need more information here, did they dot all their
I’s and cross all their T’s?
P. 165 Problem #2: Angela loans Nina, her niece, $500,000 to start a business. Nina signs a
promissory note. What are the gift tax consequences of the following arrangements?
31
a. Angela charges Nina no interest. She secures the promissory note with liens against the
business property. Nina pays each installment of principal as it comes due.
b. Angela charges Nina 5 percent interest.
c. Angela charges Nina interest at the applicable federal rate. She forgives each payment as it
comes due.
a. Taxable gift to the extent that it is interest free. Foregone interest can be a taxable gift.
b. Depends on what the applicable federal rate is.
c. No gift upfront, Completed gift of forgiven payments at the time they are forgiven.
CHAPTER 6: THE ANNUAL
EXCLUSION
The gift tax annual exclusion is a huge deal in transfer tax planning.
--For high net worth clients, you want to max our the gift tax annual exclusion every year.
The gift tax annual exclusion automatically regenerates every year.
The gift tax annual exclusion is in addition to the $5 million unified lifetime credit and the
education and healthcare exclusions.
ANALYTICAL POINT: Note that we first concentrate on whether there is a completed gift.
Then after we find that we do have a completed gift, we turn to deciding whether it falls under
the gift tax annual exclusion.
The annual exclusion is codified in § 2503(b).
Section 2503(b). Exclusions from Gifts.
(1)
In general. In the case of gifts (other than gifts of future interests in property) made to
any person by the donor during the calendar year, the first $10,000 of such gifts to such
person shall not, for purposes of subsection (a), be included in the total amount of gifts
made during such year. Where there has been a transfer to any person of a present interest
in property, the possibility that such interest may be diminished by the exercise of a
power shall be disregarded in applying this subsection, if no part of such interest will at
any time pass to any other person.
(2)
[The Gift tax annual exclusion is indexed for inflation in increments of $1,000.]
Notice something about the gift tax annual exclusion. The annual exclusion applies to each
recipient. This makes it a very valuable tool in diminishing tax liability.
Example 6-1: Taxpayer has 2 children, each of whom is married and has 2 children. Taxpayer
can give $14,000 each year to each child, to each child-in-law, and to each grandchild for a total
of $112,000 per year. This amount is in addition to the applicable exemption amount in § 2505
as well as transfers for tuition and medical expenses excluded by § 2503(e).
32
NOTE: The taxpayer, does not need to report gifts that qualify for the annual exclusion
ALSO: If the taxpayer does exceed the annual exclusion as to any donor, they will have to file a
gift tax return. However, they will likely not have to pay any tax. Anything that exceeds the gift
tax annual exclusion will just eat away at the $5 million lifetime unified credit against the gift &
estate taxes.
GIFT SPLITTING
Married taxpayers may elect to gift split. Section 2513 allows the taxpayer to treat gift as if made
one-half by the husband and one-half by the wife, with the consent of both spouses.
When is this particularly useful? When one spouse is the primary income earner. This allows
both individuals to max out their annual exclusions, despite the fact that the property may only
belong to one of them.
Requirements under § 2513:
1.
Spouses must split all of their gifts for that year
2.
Both spouses have consented to gift splitting.
3.
Must file a gift tax return to elect gift splitting.
4.
Both spouses must be citizens or residents.
5.
The donor must not give the spouse a general power of appointment over the property.
6.
The donor must be married to the spouse at the time the gift is made and not remarry
during the calendar year if they divorce or one dies.
P. 169 Problem #1: Jack and Jill are unrelated.
a. Jack gives Jill $10,000 on May 1. What are the gift tax consequences?
b. Jack also gives Jill $10,000 on September 1. What are the gift tax consequences?
c. Same as 1.b., except that Jack and Jill are married.
a. This is a completed gift, but there are no gift tax consequences because this falls under the
gift tax annual exclusion.
b. Completed gift, but due to the May 1st, gift, this gift exceeds the gift tax annual exclusion.
Some of it will fall under the exclusion, but the part that exceeds the exclusion will need to be
reported on a gift tax return. The overage amount will chip into the $5 million unified tax credit.
c. Not a taxable gift—there is an unlimited marital deduction.
P. 170 Problem #4: Teresa gives her daughter, Sally, stock valued at $14,000. On the same day,
Teresa gives her ten nieces and nephews stock in the same company; each gift of stock is valued
at $13,000. One week later all ten nieces and nephews transfer the stock to Sally. What are the
gift tax consequences?
The gift to Sally is a completed gift, but it will not be taxable because it falls within the gift tax
annual exclusion. The gifts to nieces and nephews are okay, they fall under the gift tax annual
exclusion. BUT: The gifts from nieces and nephews to Sally are not okay. When we look at the
substance of this, over its form, the transfers from nieces & nephews to Sally look like an
indirect gift form Teresa to Sally. So, they are treated as a gift from Teresa to Sally, meaning that
his exceeds the gift tax annual exclusion for gifts to Sally.
33
THE PRESENT INTEREST REQUIREMENT
The annual exclusion is only available for gifts of present interest—those that give the recipient
the “unrestricted right to the immediate use, possession, or enjoyment of [the] property or the
income form [the] property.”
This is due to the fact that § 2503(b) specifically excludes gifts of future interests from
qualifying for the gift tax annual exclusion. Also, Treas. Reg. § 25.2503-3(a) states that “[n]o
part of the value of a gift of a future interest may be excluded in determining the total amount of
gifts.”
What is a present interest in property?
Treas. Reg. § 25.2503-3. Future interest in property.
(a)
...
(b)
An unrestricted right to the immediate use, possession, or enjoyment of property or the
income from property (such as a life estate or term certain) is a present interest in
property.
So, what types of property interests qualify as present interests?

A gift of cash is a present interest.

A gift of a fee interest in Blackacre is a present interest.

A gift of a remainder in Blackacre, even a vested remainder, is not a present interest,
because the recipient does not have unrestricted right to the immediate use, possession, or
enjoyment of the property.

A gift of a life insurance policy qualifies as a present interest in property if the donor
gives all their interest in the property to the donee.

A gift of corporate stock may be a gift of a present interest. You just have to look at the
attributes of ownership to figure it out. If it is publicly traded stock, then you can sell it
now, meaning that it is a present interest. If it is the stock of a closely held corporation,
you need to look at the stockholders agreements. Is there a substantial restriction on
selling, such as a buy-sell agreement? Then it is probably not a present interest.

A gift of a partnership interest is generally a present interest, even if it is a limited
partnership interest. But, again we must look at the attributes of ownership to figure out
whether it is a present interest.
Example 6-4: David sells an automobile to Bert for $25,000. Bert gives David $5,000 cash and a
promissory note for $20,000 with payments of $5,000 due each year. The first payment is due 12
months from the date of the sale. David gives the promissory note to his son Simon. The gift is
one of a present interest. It is the nature of the property itself that delays the use or enjoyment
and not any restrictions placed on the property by the donor.
*****DiRusso: “If it is just some aspect of the property that generates a future benefit, it is still a
present interest. For instance, a gift of a life insurance policy can be a gift of a present interest,
because it is just the nature of life insurance that you don’t get the benefit until sometime in the
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future. So, if it is something that adheres in the nature of the asset, that causes the benefit to be
delayed until the future, that does not keep it from being a present interest. However, if the
grantor places restrictions on the property, that restrict present benefit, then it is a future
interest.”******
Hackl v. Comm’n (7th Cir. 2003)—The P’s made gifts to their children and grandchildren of
interests in LLC membership units in Treeco, LLC. Treeco owned various forest plantations for
the purpose of tree farming. Treeco expected to generate losses for some time and make no
distributions for a number of years. The LLC’s operating agreement severely curtailed the
members rights to transfer membership units or receive economic benefits. The Commissioner
claimed that the membership units were future interests in property and therefore did not qualify
for the gift tax annual exclusion.
Issue: Were interests in Treeco, LLC present interests in property or future interests?
Held: The membership units in Treeco, LLC constitute future interests and therefore do not
qualify for the gift tax annual exclusion.
Reasoning: Clearly, title to the membership units passed. But simply acquiring paper title does
not necessarily mean you have a present interest. The focus is on the use and enjoyment of the
property. Because of the restrictions in the operating agreement, the individuals did not have the
right to the present enjoyment of the shares, they could not sell them to third parties or force
income distributions.
3 Part Test to Determine Whether Rights to Income are Present Interests:
(1)
Income
(2)
Some Portion of the income will flow steadily to the beneficiary
(3)
Portion of income flowing to the beneficiary can be ascertained.
GIFT TAX ANNUAL EXCLUSIONS AND TRUSTS:
One issue with the gift tax annual exclusion and trusts is whether the donor is making a transfer
to the trustee or the beneficiary. The Supreme Court has held that the beneficiary and not the
trustee is the recipient of a gift in trust.
Example 6-5: David creates an irrevocable trust to pay the income to Ann for life, then the
income to Beth for life, with the remainder to Carol. Carol’s interest is a vested remainder and a
future interest because she does not have the immediate use, possession, or enjoyment of the
property. Ann and Beth each have a life estate. Beth’s life estate is a future interest because it
will not begin until Ann’s death. Whether or not Ann’s life estate is a future interest will depend
on the terms of the trust.
The Supreme Court held that a trust instrument that directed the trustee to accumulate income
for ten years before distributing was a gift of a future interest. It was determined to be a future
interest because the beneficiaries had no right to the present enjoyment of the property or income
from it unless they survived the ten year period.
Also, gifts in trust where the trustee had discretion to distribute income for a grandchild’s
“comfort, support, maintenance, and welfare” were gifts of future interest.
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REASONING: The issue is not the time when title vests, it is when enjoyment begins.
Anything that puts a barrier of a substantial period of time between the will of the beneficiary or
donee now to enjoy what has been given him and that enjoyment makes the gift one of a future
interest.

For an income interest in trust to qualify as a present interest for purposes of §
2503(b), there must be mandatory payments of income on a periodic (at least once a year)
basis; the trust property must produce income; and the interest of each income beneficiary
must be ascertainable and capable of being valued.
P. 176 #2: Andrew transfers a term life insurance policy on his life to his niece, Nancy.
a. What are the gift tax consequences, assuming Andrew has a life expectancy of 15 years?
b. What are the gift tax consequences if Andrew transfers the policy to Friendly National Bank
as Trustee for the benefit of Nancy?
a. Gift of a present interest here. Niece gets all rights to the property at the time of the transfer.
While it is true that she will not benefit until Andrew dies, that restriction is based on the nature
of the asset, not on an limitation that the donor placed on the asset.
b. This is likely a gift of a future interest, unless the trust is designed such that Nancy has the
ability to access it. But, if it is a basic trust, then it is a future interest.
P. 176 Problem #3:
Agnes transfers Blackacre (FMV $200,000) to RST, Inc., whose shareholders are her five nieces
and nephews. What are the gift tax consequences?
This is a gif to a corporation. You don’t get an annual exclusion for a gift to a corporation.
(DiRusso: If this was allowed, we’d all just create oodles and oodles of little corporations to
make transfers to.) Instead, it is an underlying gift to the shareholders. But, the property belongs
to the corporation, thus the corporation has the rights to the property, the shareholders only have
indirect rights to the property. So, nieces and nephews only have rights as shareholders, so they
don’t have rights to immediate use or enjoyment. This won’t qualify for the gift tax annual
exclusion.
P. 176 Problem #5: Gwen establishes an irrevocable trust and transfers $1,000,000 to Friendly
National Bank as Trustee. What are the gift tax consequence of the following alternatives?
a. Income to Alex for life, remainder to Evan.
b. Income to Alex for life, remainder to Evan. The Trustee has complete discretion whether to
distribute income to Alex or to accumulate it. Accumulated income will be paid to Alex’s issue.
c. Income to Alex and Betsy in equal shares, remainder to Evan.
d. The Trustee has complete discretion to distribute income in whatever proportion to Alex,
Betsy, Claude, and Dinah. The remainder goes to Evan at the death of the last income
beneficiary.
e. Income to Alex for life, remainder to Evan. Alex is 25 years old when the trust is established.
The Trustee has discretion to accumulate income or distribute it to Alex for health, education, or
an emergency.
a. Taxable gift? Yes, we have two complete, taxable gifts: (1) income to Alex; (2) remainder
to Evan.
Annual Exclusion? The remainder to Evan is a gift of a future interest, so that will not qualify for
the gift tax annual exclusion. On the other hand, the income interest to Alex is probably a present
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interest. A few more facts to show us immediate enjoyment & use would be good, but it most
likely qualifies as a present interest. The Value must be split up between the interests, with part
attributable to the income interest and part attributable to the remainder interest.
b. Taxable gifts? Yes. 2 complete gifts, both income to Alex and remainder to Evan.
Annual Exclusion? No. The income interest to Alex is a future interest. Alex doesn’t have the
present right to the income due to the discretion placed in the trustee, Alex can’t force it. So, this
is a future interest and does not qualify for the gift tax annual exclusion. The remainder interest
is a future interest and therefore doesn’t qualify for the gift tax annual exclusion.
c. Taxable gifts = yes, both.
Annual exclusion? Not the remainder, it is a future interest. Income interest = yes, that is a
present interest. Both Alex and Betsy have a present right to 50% share.
d. Annual exclusion? No. This is not a present interest. The discretion in the Trustee means no
one has a guaranteed present right to anything.
e. Present interest? No. This is a future interest. We don’t know whether the facts will trigger
the right. The ascertainable standard goes to the completion of the gift, not whether it is a present
interest or not. We don’t know whether the standard will ever be triggered, so no annual
exclusion for this gift.
GIFTS TO MINORS
Many people wish to give gifts to minors. However, there are some issues with giving gifts to
minors. No parent or grandparent wants to give a child control over a substantial amount of
money (it is a bad idea) and state laws sometimes restrict minors from owning certain property
interests.
-
You need to be managing the assets for their continued benefit.
You can make modest amounts of property transfers
o Uniform transfers to minors act.
 Age 21
Every state has adopted either the Uniform Gifts to Minors Act or the Uniform Transfers to
Minors Act. Both statutes give broad powers to custodians to deal with property without court
supervision. Because the statutes require the custodian to use the property of the minor child,
these gifts are completed gifts of present interests. But, there are potential income tax
consequences for the parent based on this approach, so it is not the most advisable approach.
So, to avoid many of these problems, many people elect to establish trusts for the benefit of
minors.
§ 2503(c) sets up special rules for gifts to minors in trust.
§ 2503(c). Taxable Gifts. Transfers for the benefit of minor. No part of a gift to an individual
who has not attained the age of 21 years on the date of such transfer shall be considered a
gift of a future interest in property for purposes of subsection (b) if the property and the
income therefrom—
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(1)
may be expended by, or for the benefit of, the donee before his attaining the age of 21
years, and
will to the extent not so expended—
pass to the donee on his attaining the age of 21 years, and
in the event the donee dies before attaining the age of 21 years, be payable to the estate of
the donee or as he may appoint under a general power of appointment as defined in
section 2514(c).
(2)
(A)
(B)
-
2503c trusts – (2503b is the present interst exclusion)
o 2503c creates a safe harbor for these present interest trusts.
o You must authorize it to be expended
o The assets will be put into the estate of the minor if they die before 21.
o “Minor trust” “2503c Trust”
o Crummey Trusts may be better for delaying payments.
Ross v. United States (5th Cir. 1965)—Ross set up trusts for the benefit of her minor
grandchildren. The trust gives the trustee the discretion to use all or part of the trust income for
the “support, maintenance, and education” of the grandchildren. The trust documents also
specified that upon turning 21 the principal was to be paid to the grandchildren and that if the
grandchildren died before 21, the principal was to go to the grandchild’s estate. The trust
instrument gave the Trustee all the powers available to a guardian of a minor under Texas law.
However, Texas law severely limited the powers held by a guardian of a minor. The
Commissioner argued that because the powers of the Trustee were so limited by Texas law, that
the gift did not qualify under § 2503(c).
Issue: Whether a gift in trust to a minor, under a trust agreement authorizing the trustee to
exercise all the powers of a guardian, must be “considered” a gift of a future interest for purposes
of section 2503(c)?
Held: No, even though state law placed some restrictions on the power of the trustee, it still
qualified under 2503(c). Here, the taxpayers can get the gift tax annual exclusion.
DiRusso: “It is enough that the funds are available for the minor, they don’t actually have to be
taking it out.”
Estate of Levine v. Comm’n (2nd Cir. 1975)—Levine set up irrevocable trusts for the benefit of
his minor grandchildren. The Trustee was to accumulate all income until the grandchildren
reached the age of 21, at that point the income would be distributed. After 21, the beneficiaries
would receive payments at least annually of all income earned by the trust. If the grandchild died
before 21, all accumulated income would go to the grandchild’s estate. Control of the corpus was
placed in the discretion of the Independent Trustee. Really, the gift was split into two parts, a
pre-21 income interest to comply with 2503(c) and a post 21 interest income. The Commissioner
allowed the pre-21 interest income to qualify for the annual exclusion. The Commissioner said
that the post-21 interest income was a future interest and therefore did not qualify. Levine argued
that the pre-21 interest and post-21 interests were really part of the same interests, a unitary life
estate.
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Issue: Does the post-21 interest qualify as a present interest and therefore the gift tax annual
exclusion?
Held: No. Post-21 income interest is a future interest. The right to receive income beginning at
21 is not a present interest.
CRUMMEY TRUSTS
Many grantors are not satisfied with the constraints of a § 2503(c) trust. Grantors often want to
delay distribution until well beyond age 21 and still take advantage of the annual exclusion.
SOLUTION: CRUMMEY TRUSTS: How does it work? The grantors creates a present interest
in the minor by giving the minor a general power of appointment. A general power of
appointment is the right to withdraw, demand, or appoint property for the benefit of one’s self,
one’s creditor’s, one’s estate, or the creditors of one’s estate.
DiRusso on Crummey Trusts: “Crummery Trusts are wonderful things. They are structured so
that the beneficiary has the immediate right to access the gift property. They do this by creating a
withdrawal right (general power of appointment) in the beneficiary. But, the incentive is for the
beneficiary not to exercise the power, so that the property will go into the trust. The beneficiary
knows that they will probably not get the gift next year if they exercise their power.”
Crummey v. Comm’n (9th Cir. 1968)—
Rev. Crummey executed an irrevocable trust for the benefit of his 4 children. The trust contained
a demand provision, whereby after any addition to the trust, any of the children could demand to
be paid the amount of the gift, instead of having the gift go into the trust, so long as they made
their demand before the 31st of December. The Commissioner argued that Crummey was entitled
to only one gift tax annual exclusion for the transfers to the trust. Crummey argued that each
contribution should be eligible for the annual exclusion because the gifts were present interests in
property due to the substantial power given to the children by the demand right.
Issue: Future or present interest?
HELD: The demand provision turns these into present interests in property.
Analysis: It is the right to use or enjoy property immediately, not the exercise of that right that
determines whether it is a present or future interest. Here, the beneficiaries could immediately
demand to get cash. So, even though they didn’t demand the cash, the fact that they could have
was enough.
IRS REQUIREMENTS FOR CRUMMEY TRUSTS:
The IRS requires that the beneficiary receive actual notice of the contribution (a Crummey
Letter) to the trusts as well as the right to withdraw the contributions. When the beneficiary is a
child, the notice must be given to the parent or legal guardian. The beneficiary must have a
reasonable period of time to exercise the withdrawal right (private letter rulings have held that 30
days is a reasonable time, but shorter amounts may also work, hard to tell.) The trust must have
sufficient liquid assets to satisfy any demand made pursuant to a Crummey power. Finally, and
certainly very importantly there must not be any agreement that the beneficiaries will not
exercise their powers.
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Estate of Cristofani v. Comm’n (Tax Court 1991)—
Cristofani set up a Crummey trust for his two children and five grandchildren. His children were
the primary beneficiaries, the grandchildren were secondary beneficiaries. When the trust ended,
the children were to take if they were then living. The grandchildren were only to take if the
children were not then living when the trust terminated. Thus, the grandchildren had only a
contingent remainder. However, both the children and the grandchildren had a demand right. The
Commissioner argued that the gifts to the grandchildren were future interest because they were
only contingent beneficiaries.
ISSUE: Can a withdrawal right in a contingent beneficiary qualify as a present interest in
property?
HELD: Yes, these were present interests. The beneficiaries of a Crummey trust need not have a
vested present interest or vested remainder, a continent remainder is fine as long as they do have
the withdrawal rights.
REASONING: The grandkids, despite the fact that their right to the trust is a contingent right,
do have the withdrawal right. Therefore, they have the present right to withdraw, this gives them
the present right to the use and enjoyment of the property.
DiRusso on Crisifano: “You can safely create withdrawal rights in contingent beneficiaries. But,
you likely couldn’t create a withdrawal right in people who have no interest in the trust, the IRS
would not let it go that far.”
-
They still have the right to that property and can take it out when they want.
GIFT TAX CONSEQUENCES OF THE POWER OF APPOINTMENT:
Because of the substantial control that a general power of appointment gives to the holder, the
IRC treats the exercise or release of a general power of appointment as a transfer of property by
the power holder. In other words, the power holder is the virtual owner of the property.
- The right to determine who the owner of the property will be
- A beneficiary of a crummy power has “Power of Appointemnt”
o Tax consiquences for those people who have apoers of appointments that have
lapsed.
§ 2514. Powers of appointment.
(a)
...
(b)
Powers created on or after October 21, 1942. The exercise or release of a general power
of appointment created after October 21, 1942 shall be deemed a transfer of property by
the individual possessing such power.
(c)
Definition of General Power of Appointment. For purposes of this section, the term
‘general power of appointment’ means a power which is exercisable in favor of the
individual possessing the power, his estate, his creditors, or the creditors of his estate;
except that—
40
(1)
(d)
(e)
(1)
(2)
A power to consume, invade, or appropriate property for the benefit of the possessor
which is limited by an ascertainable standard relating to the health, education, support, or
maintenance of the possessor shall not be deemed a general power of appointment.
...
Lapse of power. The lapse of a power of appointment created after October 21, 1942,
during the life of the individual possessing the power shall be considered a release of
such power. The rule of the preceding sentence shall apply with respect to the lapse of
powers during any calendar year only to the extent that the property which could have
been appointed by exercise of such lapsed powers exceeds in value the greater of the
following amounts:
$5,000, or
5 percent of the aggregate value of the assets out of which, or the proceeds of which, the
exercise of the lapsed power could be satisfied.
WHAT DOES THIS MEAN?
This is saying that the person who allows their power of appointment to lapse will be treated as
having made a gift of that property to the extent that it exceeds the 5 or 5 standard of (e) or the
power is not limited by an ascertainable standard relating to health, education, support or
maintenance.
-5 for 5 standard: If the gift was for more than $5,000 or more than 5% of the corpus of the trust,
and you allow your right to withdraw to lapse, then you are treated as releasing it.
Example: Assume gift tax exclusion is $14,000. At first, the gifts can be no larger than $5,000 or
you will create gift and estate tax consequences for the beneficiary. Larger gifts are ok once the
corpus exceeds $100,000. (because 5% of 100,000 is 5,000, after you hit the 100,000 mark you
may make gifts above that under the 5% rule, to the extent of the corpus, and still be OK, up to
the amount of the gift tax annual exclusion.) To take advantage of the gift tax annual exclusion
of 14,000 this year, the corpus of the trust would need to be $280,000.
P. 193 Problem #2:
Gil establishes an irrevocable trust for the benefit of his minor child, Alan. The Trustee is
required to distribute all income annually to, or for the benefit of, Alan. When Alan is 50, the
Trustee is to distribute the principal to Alan. If Alan dies before age 50, the principal is to be
distributed to whomever Alan designates in his will. Gill transfers $14,000 to the trust each year
for five years.
a. What are the gift tax consequences?
b. What if the Trustee has discretion whether to distribute income to Alan or to accumulate it?
c. Same as 2.b., only Gil also gives Alan the right to withdraw the lesser of (1) the amount
contributed to the trust or (2) $14,000.
a. Completed gift—donor has ridded himself of dominion and control. Annual exclusion? Just
the income portion qualifies for the annual exclusion, some portion is attributable to the
remainder interest that will pay out to Alan at the end.
b. No right to income = future interest = no gift tax annual exclusion.
c. Annual exclusion = yes, to the whole amount, this is a Crummey Trust = present interest.
P. 193 Problem #3:
41
Gil establishes an irrevocable trust for the benefit of his minor child, Alan. The Trustee has
discretion to use the income and the principal for the benefit of Alan until Alan is 21. At that
time the principal is to be distributed to Alan. Gil transfers $14,000 to the trust.
a. What are the gift tax consequences to Gil if the principal is to be paid to Alan’s brother, Brad,
if Alan dies before 21?
b. What if the principal is to be paid to Alan’s heirs at law?
c. What if, in the event of Alan’s death before 21, the principal is to be paid to whomever Alan
designates and in default of appointment to Brad?
d. Assume that the principal goes to Alan’s estate if Alan dies during the term of the trust. The
Trustee is not to distribute principal to Alan until age 35. What are the gift tax consequences?
e. Assume that the principal goes to Alan’s estate if Alan dies during the term of the trust. The
Trustee is instructed to use the income and principal only for Alan’s health, education, support,
and maintenance. What are the gift tax consequences? What if the Trustee is to use the income
and principal only for Alan’s comfort and happiness?
a. Doesn’t qualify as a 2503(c) trust because under code it must go to child’s estate or child
under power of appointment if he dies before 21.
b. Doesn’t qualify, must go to his estate or power of appointment. This doesn’t qualify under
2503(c), so no present interest, so no gift tax annual exclusion.
c. Qualifies under 2503(c), he has the right to appoint himself or his estate, the default
provision has no effect on the question. Present interest = annual exclusion.
d. This doesn’t qualify, under 2503(c) it must distribute at age 21.
e. HEMS standard creates a substantial restriction on the Trustee’s ability to give it to Alan, so
no present right to use or enjoyment, so no annual exclusion. But, the comfort and happiness
language is not an issue, it does not create a substantial restriction, but the language is
unnecessary, why put unnecessary language in a document?
OTHER EXCLUSIONS TO BE AWARE OF
§ 2523—outright gifts to citizen spouses are gift tax neutral. Such gifts are offset by a deduction
in the same amount. Unlimited.
§ 2522—deduction for gifts to charities.
CHAPTER 7: PROPERTY OWNED AT
DEATH
INTRODUCTION TO THE ESTATE TAX—

The estate tax is an excise tax on the transfer of property at death.

The tax is imposed on the value of the gross estate less certain deductions.
o
WHAT IS THE GROSS ESTATE?
o
The Gross Estate includes those property interests transferred by the decedent to another
at, or as a result of, the decedent’s death.
42
Section 2031. Definition of Gross Estate.
(a)
General. The value of the gross estate of the decedent shall be determined by including
to the extent provided for in this part, the value at the time of his death of all property,
real or personal, tangible or intangible, wherever situated.
The true work horse of the estate tax is Section 2033:
Section 2033. Property in which the decedent had an interest.
The value of the gross estate shall include the value of all property to the extent of the interest
therein of the decedent at the time of his death.
Section 2033 includes in the gross estate “the value of all property to the extent of the interest
therein of the decedent at the time of his death.”

This includes property that will be subject to probate in state courts.

This also reaches beyond the decedent’s probate estate and captures any property the
decedent has an interest in at the moment before his death and that passes from the
decedent to another as a result of his death.
DiRusso: “The language is vague, but generally, this section reaches probate property.”
Treas. Reg. § 20.2031-1. Definition of Gross Estate.
(a)
Definition of gross estate. Except as otherwise provided in this paragraph the value of the
gross estate of a decedent who was a citizen or resident of the United States at the time of
his death is the total value of the interests described in sections 2033 through 2044 . . .
(1)
Sections 2033 and 2034 are concerned mainly with interests in property passing through
the decedent’s probate estate. Section 2033 includes in the decedent’s gross estate any
interest that the decedent had in property at the time of his death. Section 2034 provides
that any interest of the decedent’s surviving spouse in the decedent’s property, such as
dower or curtesy, does not prevent the inclusion of such property in the decedent’s gross
estate.
Estate of Fortunato v. Comm’r (Tax Court 2010)—
Bobby Fortunato is the decedent. Bobby led a troubled life. After a stint in Sing Sing Prison,
Bobby became the founder and president of Container Oversees. In 1984, Container Overseas
failed. At the time of the business failure, Bobby owed penalties to the IRS in the amount of
$490,000. Bobby also owed significant sums to creditors. After Container Overseas closed,
Bobby went into hiding, sleeping on a couch in his parent’s home in order to avoid creditors.
Bobby’s brother Anthony founded a container freight company. Bobby was not an investor.
However, Bobby worked full time and assumed leadership in the business. He had significant
authority and influence in the company, but was paid under the table. Bobby actually referred to
himself as the “CEO.” Eventually, Bobby come out of the black market as part of an IRS
amnesty program, he became a paid employee. In fact, the companies accountant believed Bobby
to be the owner, recording payments to Bobby as “officers salary.” However, Bobby did not own
a single share of stock or any other form of interest or security in the company. When he died,
43
the Comm’r argued that Bobby owned an ownership interest in the corporation that must be
included in Bobby’s gross estate.
HELD: No ownership interest in the corporation, so nothing to include in the gross estate.
REASONING: Generally, it does not take perfect legal title to have it included in your gross
estate, the Service will look to see the substance, are you the owner in substance? Here however,
in substance there was no ownership interest. This came down to a question of intent. Did he
intend to acquire an ownership interest in the corporation and did the corporation intend him to
be an owner? Here, the answer was no. No ownership interest, no inclusion in gross estate.
TAM 9152005—
Decedent stole art while he was serving in the U.S. Military in France and Germany. Decedent
brought the art back to the U.S. with him. Technically, it was stolen, so the rightful owner could
have sued and taken back the property at any point. Does this stolen property have to be included
in the decedent’s gross estate?
HELD: YES. Included in the gross estate.
ANALYSIS: Section 2033 includes in the gross estate “the value of all property to the extent of
the interest therein of the decedent at the time of his death.” Here, despite the fact that the
decedent did not possess technical legal title, the decedent had the economic equivalent of
ownership. The 35 years of exclusive possession, enjoyment, and actual command of the stolen
art amounted to ownership of the art.
Policy Rationale: Note the policy implications. If stolen property was not included in the gross
estate, that would create perverse incentives: If you work hard to earn the property and own it at
death, you are taxed; but, if you steal it, you can pass it to your heirs tax free. So, stolen property
must be included in the gross estate. We don’t want anyone to receive a tax benefit from their
own crime.
BUT—Not all property passing to the decedent’s heirs and estate will be included in the gross
estate.
Wrongful death benefits—wrongful death benefits paid directly to the decedent’s heirs or next
of kin are excluded because the decedent did not have an interest in that benefit before his death.
Also, this extends to wrongful death benefits paid directly to the estate of the decedent.
HOWEVER: any recovery for pain and suffering or expenses incurred before death are
included in the gross estate because the decedent would have recovered those amounts had he
survived (I.e. the decedent actually had the claim at the time of death).
P. 205 Problem #1:
Are the following included in the gross estate? Why? At what value?
--House in Vermont? Real estate. FMV.
--Condo in Acapulco owned as TIC? Yes. Real estate, wherever situated. FMV of interest.
--Apartment in Boston, generating income? Yes. Real estate. FMV.
--Car? Yes. FMV.
--Sailboat? Yes. FMV.
--IBM Stock? Yes. FMV (§ 20.2031-2 valuation of stocks and bonds)
--Tax Exempt Bonds? Yes. (DiRusso: “By tax-exempt, we mean that they get special treatment
for income tax purposes, but the tax-exemption does not have anything to do with inclusion in
the gross estate for estate tax purposes, so includable.”).
44
--Money? Yes. (§ 20.2031-5 valuation).
--Cemetery plot? NO. It does not pass to another by reason of the decedent’s death. The decedent
has plans to make use of the cemetery plot for a very long time.
--Household items? Yes. FMV (willing buyer, willing seller) (valuation § 20.2031-6).
--Earned, unpaid salary? Yes.
--Rental income? Yes (up to the time of death).
--Personal Injury Lawsuit for wrongful death? No. The decedent did not have a right to it prior to
death.
--Patent Infringment Lawsuit? Yes. If the patent infringement happened during the Decedent’s
lifetime, they had a cause of action during their lifetime, so the judgment is included in the gross
estate.
P. 206 Problem #3: Six months before her death, Debra sent checks equal to the amount of the
gift tax annual exclusion to Adrian, Bruce, and Claire. None of the checks had been presented for
payment before Debra’s death.
a. Are the checks included in Debra’s gross estate?
b. What if Adrian, Bruce, and Claire had deposited the checks in their respective bank accounts
two days before Debra’s death but the checks had not cleared Debra’s bank before her death?
a. Yes. These are included in the gross estate. The checks were not presented before the
decedent’s death, so the value is in the gross estate.
b. Yes. This is included too; the donor was not alive when the checks cleared. So, inclusion is
mandated.
P. 206-207 Problem #5: At the time of his death, David was the beneficiary of three trusts. Are
any of these trusts in his gross estate?
a. A trust was established by David’s maternal grandmother that provided income to David for
his life and distribution of the trust property to David’s children at his death. The trust property
had a value of $2,000,000 at the time of David’s death. What if David also had the power to
appoint the trust property in his will to anyone, including his own estate? Does it matter whether
David exercised this power in his will or not?
b. A trust was established by David’s uncle to pay the income to his spouse for her life with the
remainder to David or his estate. The trust was irrevocable. At the time of David’s death, the
trust property had a value of $6,000,000, and both David’s uncle and aunt were still living.
c. A trust was established by David’s aunt to pay the income to Mary for life with the corpus to
Nancy if she was living at Mary’s death, otherwise to David or his estate. At the time of David’s
death, the value of the trust property was $8,000,000, and Mary and Nancy were still alive.
David’s aunt was dead.
a. No, he was only receiving income during his life. He didn’t have anything to transmit at
death, so § 2033 doesn’t bring this into his gross estate. But, if he had a testamentary GPOA,
then yes.
b. Yes, the remainder interest in included in his gross estate.
c. This is a contingent remainder, but it is still includable. The contingency does effect the
valuation though.
A FEW NOTES ON VALUATION
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Treas. Reg. § 20.2031-1. Definition of Gross Estate; valuation of property.
(a)
...
(b)
Valuation of property in general. The value of every item of property includable in a
decedent’s gross estate under Sections 2031 through 2044 is its fair market value at the
time of the decedent’s death, except that if the executor elects the alternate valuation
method under section 2032, it is the fair market thereof at the date, and with the
adjustments, prescribed in that section. The fair market value is the price at which the
property would change hands between a willing buyer and willing seller, neither
being under any compulsion to buy or to sell and both having reasonable knowledge of
relevant facts . . . Thus, in the case of an item of property includible in the decedent’s
gross estate, which is generally obtained by the public in the retail market, the fair market
value of such an item of property is the price at which the item or a comparable item
should be sold at retail . . .
Treas. Reg. § 20.2031-2. Valuation of Stocks and Bonds.
(a)
In general. The value of stocks and bonds is the fair market value per share or bond on
the applicable valuation date.
(b)
Based on selling prices.
(1)
In general, if there is a market for stocks or bonds, on a stock exchange, in an over-thecounter market, or otherwise, the mean between the highest and lowest quoted selling
prices on the valuation date is the fair market value per share or bond . . .
(2)
....
(f)
Where selling prices or bid and ask prices are unavailable. If the provisions of paragraphs
(b), (c), and (d) of this section are inapplicable because actual sale prices and bona fide
bid and ask prices are lacking, then the fair market value is to be determined by taking the
following factors into consideration:
(1)
In the case of corporate or other bonds, the soundness of the security, the interest yield,
the date of maturity, and other relevant factors; and
(2)
In the case of shares of stock, the company’s net worth, prospective earning power and
dividend-paying capacity, and other relevant factors.
Treas. Reg. § 20.2031-5. Valuation of cash on hand or on deposit.
The amount of cash belonging to the decedent at the date of his death, whether in his possession
or in the possession of another, or deposited with a bank, is included in the decedent’s gross
estate. If bank checks outstanding at the time of the decedent’s death and given in discharge of
bona fide legal obligations of the decedent incurred for an adequate and full consideration in
money or money’s worth are subsequently honored by the bank and charged to the decedent’s
account, the balance remaining in the account may be returned, but only if the obligations are not
claimed as deductions from the gross estate.
Treas. Reg. § 20.2031-6. Valuation of household and personal effects.
(a)
General rule. The fair market value of the decedent’s household and personal effects is
the price which a willing buyer would pay to a willing seller, neither being under any
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(b)
compulsion to buy or to sell and both having reasonable knowledge of relevant facts. A
room by room itemization of household and personal effects in desirable. All the items
should be named specifically, except that a number of items contained in the same room,
none of which have a value in excess of $100, may be grouped. A separate value should
be given for each article named . . .
Special rule in cases involving substantial amount of valuable articles. Notwithstanding
the provisions of paragraph (a) of this section, if there are included among the household
and personal effects articles having marked artistic or intrinsic value of a total value in
excess of $3,000 . . . the appraisal of an expert or experts, under oath, shall be filed with
the return . . .
ALTERNATE VALUATION—General rule is that we value property for purposes of the estate
tax as of the date of the decedent’s death. However, section 2032 provides that in certain
circumstances an executor may elect an alternate valuation date. The section 2032 alternate
valuation date is 6 months after the decedent’s death. It may only be elected if the valuation goes
down and it decreases your estate tax payment.
§ 2032. Alternate Valuation.
(a)
General. The value of the gross estate may be determined, if the executor so elects, by
valuing all the property included in the gross estate as follows:
(1)
In the case of property distributed, sold, exchanged, or otherwise disposed of, within 6
months after the decedent’s death such property shall be valued as of the date of
distribution, sale, exchange, or other disposition.
(2)
In the case of property not distributed, sold, exchanged, or otherwise disposed of, within
6 months after the decedent’s death such property shall be valued as of the date 6 months
after the decedent’s death . . .
(b)
...
(c)
Election must decrease gross estate and estate tax. No election may be made under this
section with respect to an estate unless such election will decrease—
(1)
the value of the gross estate, and
(2)
the sum of the tax imposed by this chapter and the tax imposed by chapter 13 with
respect to property includible in the decedent’s gross estate (reduced by credits allowable
against such taxes).
MARITAL INTERESTS IN PROPERTY
Community Property: In community property jurisdictions, the surviving spouse has an interest
in the decedent’s community property. The community property share of the surviving spouse is
owned by that spouse and is, therefore, excluded from the decedent’s gross estate.
Common Law Property: Elective share laws in common law property jurisdictions provide a
benefit similar to community property. However, rights such as the elective share do not
diminish the value of the decedent’s gross estate.
Section 2034 specifically includes the value of such rights in the decedent’s gross estate.
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Note: Property passing to a surviving spouse under an elective share statute will qualify for the
marital deduction in § 2056 (so long as it is not a non-deductible terminable interest).
§ 2034. Dower and Curtesy Interests.
The value of the gross estate shall include the value of all property to the extent of any interest
therein of the surviving spouse, existing at the time of the decedent’s death as dower or curtesy,
or by virtue of a statute creating an estate in lieu of dower or curtesy.
P. 208 Problem: Willa is married to Harold, and they have four adult children. At the time of her
death, Willa owns the following property in her own name: a house (FMV $60,000); clothes,
jewelry, car, and similar items (FMV $150,000); investment real estate (FMV $6,000,000); and a
bank account (Balance $250,000). Willa does not own any other property.
1. What is the value of Willa’s gross estate if she leaves all of her property to Harold, her
spouse?
2. What is the value of Willa’s gross estate if she leaves half of her property to Harold and the
remainder in equal shares to her children?
3. What is the value of Willa’s gross estate if she leaves all of her property in equal shares to her
children, and Harold elects against the will. Under state law, Harold receives an undivided onehalf interest in each asset.
1. All assets are included. So, the value is $12 million. But later, it will get the marital
deduction, so no tax. (DiRusso: “The point of this question is to show you that it is included,
regardless of later deductibility.”).
2. Still $12 million.
3. Still $12 million.
Gross Estate
1. 2033-2044
Unified Transfer tax credit - the amount that
CHAPTER 8: JOINT OWNERSHIP
A.
GENERAL PRINCIPLES
Three forms of joint ownership property:
(1)
Tenancy in common—In a TIC, each owner has the current right to use and possess the
property. Unequal interests in the property are permissible in TICs. A TIC has no right of
survivorship, so each tenant may transfer their interest by will or intestacy.
The estate tax consequences of tenancy in common are governed by § 2033.
(2)
Joint tenancy with right of survivorship (JTWROS)—In joint tenancy each owner has the
current right to use and possess the property, owning an equal, undivided interest. However,
JTWROS, has a survivorship feature whereby the surviving tenant takes the entire property by
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operation of law. So, the Joint-tenancy property is not devisable or inheritable, it passes by
operation of law to the survivor, who owns it in fee simple.
General Joint-Ownership: § 2040(a) treats the first joint tenant to die as having paid the full
consideration for the property—meaning the entire value of the property will be included in their
gross estate unless it is shown that the surviving joint tenant contributed consideration.
Spousal Joint-Ownership: § 2040(b) governs the estate tax consequences, bringing in ½ of
the value into the estate of the first spouse to die. Note on Income Tax: Because of this rule,
only ½ of the property qualifies for the stepped-up basis allowed by § 1014.
Joint Bank Accounts—Joint bank accounts can have various characterizations for tax
purposes, it all depends on how state law defines such accounts.
(3)
Community property—under community property, all property acquired during a
marriage belongs to the husband and wife as community property. Each spouse owns an
undivided one-half interest. So, at death, each spouse has the ability to dispose of their
one-half by will or intestacy.
§ 2033 brings the decedent’s share of community property into the gross estate.
The full value of the community property is not brought into the gross estate, even if the
decedent paid all of the consideration and held the property in his or her sole name, because the
surviving spouse has a present interest in ½ of the property.
Example 8-1—Mary and Joan are sisters and own Blackacre as equal tenants in common. Joan
dies without a will. Joan’s interest will pass to her two children in equal shares under intestacy.
The children become tenants in common with Mary. Mary owns a ½ interest in the property and
the two children each own a ¼ interest in the property.
Example 8-2—John and Luke own Greenacre as joint tenants with right of survivorship. Luke
dies. In his will, he leave his interest in Greenacre to his daughter. Luke owns Greenacre in fee
simple absolute. The will could not pass any interest to the daughter, because Luke’s interest was
terminated at the moment of his death, so he had nothing to devise to his daughter.
B.
CREATION AND TERMINATION OF JOINT INTEREST DURING
LIFE
§ 2512. Valuation of Gifts.
(a)
If the gift is made in property, the value thereof at the date of the gift shall be considered
the amount of the gift.
(b)
Where property is transferred for less than an adequate and full consideration in money or
money’s worth, then the amount by which the value of the property exceeded the value of
the consideration shall be deemed a gift, and shall be included in computing the amount
of gifts made during the calendar year . . .
§ 25.2511-2. Cessation of donor’s dominion and control.
(a)
...
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(b)
As to any property, or part thereof or interest therein, of which the donor has so parted
with dominion and control as to leave in him no power to change its disposition, whether
for his own benefit or for the benefit of another, the gift is complete . . .
The creation of a joint tenancy is a gift to the extent that the joint tenant does not provide any
consideration for their interests.
The gift is complete at the time of the property transfer because the Donor has given up the
power to retract the gift.
Exception: Joint-Bank Accounts—not a completed gift until the money is withdrawn.
The value of the gift depends on whether the joint tenancy can be severed unilaterally (which
is a question of state law). If any tenant can server the tenancy without consent of the other joint
tenants, then the value of each joint tenants interest is the same.
But, if the joint tenant must get the consent of the other joint tenants in order to sever, the
value of each tenant’s interest depends on his age in relation to the age of the other joint tenants.
(Notice why: The younger you are, the more likely you are to survive and inherit the property,
thus the youngest person’s interest is more valuable, the older people’s is not as valuable).
A gift which creates an joint tenancy interest is a present interest—so it will qualify for the
gift tax annual exclusion.
The creation of a joint tenancy by one spouse with another will qualify for the unlimited
marital deduction of § 2523.
Note: The termination of a joint tenancy during the life of all the tenants, creates no further gift
tax consequences as long as each joint tenant receives his or her proportionate share of the
property or proceeds.
C.
TERMINATION OF JOINT INTERESTS BY DEATH
Section 2033 include in the gross estate all property owned at death that passes from the
decedent to another as a result of death. However, joint tenants with right of survivorship (and
tenancy by the entirety) passes to the survivor at death by operation of law. As a result, § 2033
does not bring that into the gross estate. SO—Congress had to create a special code section to
bring these property interests into the gross estate:
§ 2040. Joint Interests.
(a)
General rule. The value of the gross estate shall include the value of all property to the
extent of the interest therein held as joint tenants with right of survivorship by the
decedent and any other person, or as tenants by the entirety by the decedent and spouse,
or deposited, with any person carrying on the banking business, in their joint names and
payable to either or the survivor, except such part thereof as may be shown to have
originally belonged to such other person and never to have been received or acquired by
the latter from the decedent for less than an adequate and full consideration in money or
50
money’s worth . . . Provided, That where such property . . . is shown to have been at any
time acquired by such other person from the decedent for less than an adequate and full
consideration in money and money’s worth, there shall be excepted only such part of the
value of such property as is proportionate to the consideration furnished by such other
person: Provided further, That where any property has been acquired by gift, bequest,
devise, or inheritance, as a tenancy by the entirety by the decedent and spouse, then to
the extent of one-half of the value thereof, or, where so acquired by the decedent and any
other person as joint tenants with right of survivorship and their interests are not
otherwise specified or fixed by law, then to the extent of the value of a fractional part to
be determined by dividing the value of the property by the number of joint tenants with
right of survivorship.
1.
The Tracing Rule of § 2040(a) – “for non-spouses”
Section 2040(a) provides that “[t]he value of the gross estate shall include the value of all
property to the extent of the interest therein held as joint tenants with right of survivorship by the
decedent and any other person . . . except such part thereof as may be shown to have
originally belonged to such other person and never to have been received or acquired by
the latter form decedent for less than an adequate and full consideration in money or
money’s worth.”
Explanation: This section creates a rebuttable presumption that the first joint tenant to die
provided all of the consideration of the acquisition of the property.
The surviving joint tenant bears the burden of proving his contribution.
IMPORTANT TO NOTE: This presumption does not apply if all the joint tenants received
their interests in the property by gift, bequest, or inheritance form a third party. If this is the case,
only the decedent’s fractional interest is brought into the gross estate by 2040(a).
SO: Presumption is that the first to die provided all of the consideration by himself. The survivor
must put on evidence to prove they contributed consideration.
THE FORMULA:
Amount excluded = value of property X survivor’s consideration/total consideration paid
Example 8-3—Decedent and Survivor acquired Greenacre as JTWROS. Decedent paid $80,000
and Survivor $20,000. At the time of Decedent’s death Greenacre has a fair market value of
$200,000. The amount excluded form Decedent’s gross estate is:
$200,000 X (20,000)/(100,000) = $40,000 excluded (so $160,000 will be included in gross estate
under 2040(a)).
Estate of Fratini v. Comm’r (Tax Court 1998)—
Albert and Marion co-habitated for 18 years before Albert’s death. They owned several pieces of
property together as joint tenants with right of survivorship. Evidence showed that Marion
provided consideration for some and not for others. A rebuttable presumption arises that the first
joint tenant to die provided all the consideration for the property. The presumption is rebuttable.
But, the estate bears the burden of showing the surviving tenant provided part of the
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consideration in money or money’s worth. As to a few of the pieces of property Marion was able
to show that she contributed consideration, thus, to the extent she contributed consideration,
those interests were not included in Albert’s gross estate.



Improvements paid for by one of the joint tenants are considered a contribution toward
the acquisition of the property.
Mortgage payments as well as joint liability for a mortgage are also deemed equal
contributions by the joint tenants.
BUT: NOT ALL CONTRIBUTIONS BY THE SURVIVING JOINT TENANT qualify
for the exclusion—any money or other property received from the decedent as a gift will
not be considered a contribution—SO: Basically if the decedent made a gift to you, from
which you paid the consideration for the interest, that doesn’t count, we treat it like the
decedent paid the whole thing.
Example 8-4—Decedent purchases Whiteacre as joint tenants with her Son. If Decedent pays
the entire purchase price of $100,000, the full date-of-death value will be in her gross estate.
Instead, Decedent gives her Son $50,000, and they purchase Whiteacre together. Both pay
$50,000 cash. Section 2040(a) prevents this obvious attempt at tax evasion by including the full
value of Whiteacre in Decedent’s gross estate.
Example 8-5—Decedent and Son exchange Whiteacre from Example 8-4 for new property,
Greyacre, to be held as joint tenants. This is considered a mere change in form, and Son is
deemed to have contributed nothing toward the purchase of Grayacre.
Also: If Decedent and her Son sell Whiteacre and use the proceeds to purchase Grayacre, the
same rule applies. (This assumes that Whiteacre has not increase in value.)
BUT—a different rule applies if Son uses his own resources as a contribution to the purchase of
property held jointly with the Decedent. Income earned on property, even property originally
given to Son by Decedent, qualifies as the Son’s contribution.
Example 8-6—Decedent gives her Son stock in XYZ, Inc. Son uses the dividends he has
received on the stock to purchase Greenacre as joint tenants with Decedent. When Decedent dies,
the amount that Son paid is considered his contribution.
MUCH THE SAME—a similar rule applies to appreciation in value realized by Son.
Example 8-7—The XYZ, Inc. stock in Example 8-6 was worth $10,000 when Decedent gave it
to Son. When the stock had appreciated in value to $15,000, Son sold it. He used the $5,000
appreciation to purchase stock in ABC, Inc., with Decedent as joint tenants. The $5,000 taxable
gain will be considered Son’s contribution.
NOTE: If Son had contributed the entire $15,000 of sales proceeds to the purchase of ABC, Inc.
stock, then only $5,000 would qualify as his contribution.
THE SERVICES EXCEPTION—
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Services contributed by the surviving joint tenant may count as consideration toward the
acquisition of the jointly owned property.
Services provided in a business context between unrelated parties generally will qualify as
adequate consideration.
Services provided by related parties may also qualify as adequate consideration if they are
performed in a business context. (Note: Services rendered within the context of marriage are
specifically excluded).
2. SPOUSAL JOINT INTERESTS: § 2040(b)
Section 2040(b) provides that only one-half the value of a “qualified joint tenancy,” i.e., joint
tenancy property owned only by a husband and wife or property owned by them as tenants by the
entirety, will be included in the decedent’s gross estate.
§ 2040(b). Certain Interests of husband and wife.
(1) Interests of spouse excluded from gross estate. Notwithstanding subsection (a), in the
case of any qualified joint interest, the value included in the gross estate with respect to
such interest by reason of this section is one-half of the value of such qualified joint
interest.
(2) Qualified joint interest defined. For purposes of paragraph (1), the term “qualified joint
interest” means any interest in property held by the decedent and the decedent’s spouse
as—
(A) tenants by the entirety, or
(B) joint tenants with right of survivorship, but only if the decedent and the spouse of
the decedent are the only joint tenants.
HOW IT WORKSUnder § 2040(b) only ½ of the date-of-death value of the jointly owned
property will be in the gross estate of the first to die. (Notice also that the estate will receive the
marital deduction under § 2056).
P. 221 Problem #1: David owns Blackacre, FMV $120,000, and deeds it to his two children,
Adam and Beth.
a. What are the gift tax consequences?
b. What are the estate tax consequences in this situation when Adam dies first?
c. What are the gift tax consequences if David deeds Blackacre to Adam and Beth as joint
tenants?
d. What are the estate tax consequences in this situation when Adam dies?
e. What are the gift tax consequences if David deeds Blackacre to himself, Adam, and Beth as
joint tenants?
f. Some years later, they sell Blackacre for $150,000, and each receives $50,000. Are there any
gift tax consequences?
g. What if David received nothing on the sale and Adam and Beth each received $75,000?
a. Yes, there is a gift here. A $60,000 gift to each. But, the unified credit and annual exclusion
may work to wipe this out.
b. His interest is included in his gross estate. (This is a tenancy-in-common).
53
c. Same as a.
d. Gift, so only Adam’s fractional interest in property will go into his gross estate.
e. Gift to the others (can’t give yourself a gift). So, gift of $80,000.
f. No gift tax consequences, post gift appreciation is not a gift as long as the get it in
proportion to their proportional interests.
g. Gift Tax of David’s interest. $50,000 gift.
P. 221 Problem #3: Doris establishes a joint savings account with Ellen. Doris deposits $50,000
in the savings account.
a. What are the gift tax consequences?
b. What are the gift tax consequences when Doris withdraws $5,000?
c. What are the gift tax consequences when Ellen withdraws $15,000?
d. What are the estate tax consequences when Doris dies and there is $35,000 in the account?
a. No gift. It is not completed because Doris could revoke it and take it back at any time.
b. None, it is her money.
c. $15,000 completed gift.
d. All $35,000 included in Doris’s gross estate.
P. 222 Problem #5: Debra and Sam are siblings and purchase Farmacre as joint tenants with the
right of survivorship. The down payment of $10,000 is made from Debra’s prior earnings. Debra
and Sam both work on the farm. Proceeds from farming are used to pay off the mortgage on the
farm. There is no formal business agreement between Debra and Sam. Debra dies when
Farmacre has a FMV of $500,000. How much is included in Debra’s gross estate?
We need to know the value of the property at the time of purchase. How do we value the
contribution of services? To the extent that we can value it, we credit it.
CHAPTER 9: RETAINED INTERESTS
Sections 2035—2038 include in the gross estate property that the decedent transferred during his
life if he retained an interest in, or power over, that property.
THE CODE SECTIONS:
§ 2036. Transfers with retained life estate.
(a) General rule. The value of the gross estate shall include the value of all property to the
extent of any interest therein of which the decedent has at any time made a transfer
(except in the case of a bona fide sale for an adequate and full consideration in money or
money’s worth), by trust or otherwise, under which he has retained for his life or for any
period not ascertainable without reference to his death or for any period which does not
in fact end before his death—
(1) the possession or enjoyment of, or the right to the income from, the property, or
(2) the right, either alone or in conjunction with any person, to designate the persons
who shall possess or enjoy the property or the income therefrom.
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(b) [Voting Rights]
§ 2037. Transfers taking effect at death.
(a) General rule. The value of the gross estate shall include the value of all property to the
extent of any interest therein of which the decedent has at any time after September 7,
1916, made a transfer (except in the case of a bona fide sale for an adequate and full
consideration in money or money’s worth), by trust or otherwise, if—
(1) possession or enjoyment of the property can, through ownership of such interest,
be obtained only by surviving the decedent, AND
(2) the decedent has retained a reversionary interest in the property . . . and the value
of such reversionary interest immediately before the death of the decedent exceeds
five percent of the value of such property . . .
§ 2038. Revocable transfers.
(a) In general. The value of the gross estate shall include the value of all property—
(1) Transfers after June 22, 1936. To the extent of any interest therein of which the
decedent has at any time made a transfer (except in the case of a bona fide sale for
an adequate and full consideration in money or money’s worth), by trust or
otherwise, where the enjoyment thereof was subject at the date of his death to any
change through the exercise of a power (in whatever capacity exercisable) by the
decedent alone or by the decedent in conjunction with any other person (without
regard to when or from what source the decedent acquired such power), to alter,
amend, revoke, or terminate, or where any such power is relinquished during the 3year period ending on the date of the decedent’s death . . .
§ 2035. Adjustments for certain gifts made within 3 years of decedent’s death.
(a) Inclusion of certain property in gross estate. IF—
(1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or
relinquished a power with respect to any property, during the 3-year period ending on
the date of the decedent’s death, and
(2) the value of such property (or an interest therein) would have been included in the
decedent’s gross estate under section 2036, 2037, 2038, or 2042 if such transferred
interest or relinquished power had been retained by the decedent on the date of his
death, the value of the gross estate shall include the value of any property (or interest
therein) which would have been so included.
(b) [Inclusion of gift tax on gifts made during 3 years before decedent’s death]
THE RIGHT TO INCOME
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If the decedent transfers property during his life and retains the right to the possession or
enjoyment from it or the right to income form it, § 2036(a)(1) will bring the property into the
decedent’s gross estate.
Here, we include the property in the decedent’s gross estate because they are only transferring
a remainder interest, they reserve the right to enjoy the economic benefits of the property until
they die. Essentially, this has the “ring” of a testamentary transfer.
Section 2036(a)(1) applies when the decedent retains possession or enjoyment of the property or
the right to income from it:
(1) for his life,
(2) for a period which does not in fact end before his death, or
(3) for a period that is not ascertainable without reference to his death.
Example 9-2—Debra establishes an irrevocable trust with Friendly National Bank as Trustee to
pay income to her for 15 years. At the end of 15 years, the Trustee is to distribute the trust
property to Debra’s issue. Debra dies in year 12. The value of the trust property is in her gross
estate because she retained the right to the income for a period that did not in fact end before her
death.
BUT: If Debra lived for 16 years, nothing would be in her gross estate because she did not
retain the right to income for any of the periods specified in § 2036(a)(1).
Example 9-3—David establishes an irrevocable trust with Friendly National Bank as Trustee to
pay the income to him each quarter. The right to income terminates with the quarterly payment
immediately preceding his death. Any income generated between the last payment and the
termination of the trust will be distributed, along with the trust property, to David’s surviving
issue. Section 2036(a)(1) forecloses this tax avoidance scheme by including in the gross estate
transfers where the decedent retained the right to income “for a period not ascertainable without
reference to his death.”
Section 2036(a)(1) also applies to the reservation of a secondary life estate, even if the primary
life tenant is still alive at the decedent’s death.
Example 9-4—Doris creates an irrevocable trust with Friendly National Bank as Trustee to pay
the income to Adam for life. After Adam’s death, the Trustee is to pay the income to Doris for
her life. After the death of both Adam and Doris, the Trustee is to distribute the trust property to
Ben. Doris dies before Adam. The value of the trust property, less the value of Adam’s life
estate, is in Doris’s gross estate under § 2036(a)(1).
VALUATION IN THIS REALM—
When the decedent makes a transfer and reserves a life estate, either in trust or otherwise, the
decedent makes a taxable gift of the remainder interest.
GENERAL RULE: The value of the remainder depends on the decedent’s age and the applicable
interest rate.
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BUT—Section 2702 preempts the basic rule if (1) the remainder interest is transferred to a
member of the decedent’s family and (2) the decedent or any applicable member of his family
retains an interest in the trust.
§ 2702. Special Valuation Rules in Case of transfers of interests in trusts.
(a) Valuation rules.
(1) In general. Solely for purposes of determining whether a transfer of an interest in
trust to (or for the benefit of) a member of the transferor’s family is a gift (and the
value of such transfer), the value of any interest in such trust retained by the
transferor or any applicable family member . . . shall be determined as provided in
paragraph (2).
(2) Valuation of retained interests.
(A) In general. The value of any retained interest which is not a qualified interest
shall be treated as being zero.
(B) Valuation of qualified interests. The value of any retained interest which is a
qualified interest shall be determined under Section 7520.
(3) Exceptions.
(A) In general. This subsection shall not apply to any transfer—
(i) if such transfer is an incomplete gift,
(ii) [“QPRT”] if such transfer involves the transfer of an interest in trust all
the property in which consists of a residence to be used as a personal
residence by persons holding term interests in such trust . . .
(b) Qualified Interest. For purposes of this section, the term ‘qualified interest’ means—
(1) any interest which consists of the right to receive fixed amounts payable not less
frequently than annually, (GRAT—Grantor Retained Annuity Trust)
(2) any interest which consists of the right to receive amounts which are payable not
less frequently than annually and are a fixed percentage of the fair market value of
the property in the trust (determined annually), and (GRUT—Grantor Retained
Unitrust)
(3) any noncontingent remainder interest if all of the other interests in the trust consist
of interest described in paragraph (1) or (2). (Non-Contingent Remainder)
WHEN DOES 2702 apply?
 It applies to transfers to the decedent’s spouse, siblings, and lineal descendants (children,
grandchildren, great-grandchildren).
 It does not apply to gifts to nieces, nephews, cousins, or unrelated individuals.
Example 9-5—Daniel creates an irrevocable trust with Friendly National Bank as Trustee to pay
the income to himself for life. At his death, the Trustee is to distribute the trust property to
Daniel’s daughter, Sally, and if she predeceases him, to her surviving issue. Because Daniel has
retained an interest in the trust and transferred the remainder to a family member, § 2702 applies.
If Daniel’s income interest is not a qualified annuity interest or unitrust interest, it will be valued
at zero. As a result, the full value of the trust property will be treated as a completed gift.
Because the gift is a future interest, it will not qualify for the gift tax annual exclusion. When
Daniel dies, the full value of the trust property will be in his gross estate under § 2036(a)(1)
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because he has retained the right to the income for his life. It is irrelevant that the full value
of the trust was taxed as a completed gift.
ON THE OTHER HAND:
If Daniel’s income interest is a qualified annuity interest or unitrust interest, the interest is valued
using standard valuation techniques. The value of the remainder will be the difference between
the value of the trust property and the value of Daniel’s retained interest. This difference will be
the value of the taxable gift. When Daniel dies, the trust property will still be in his gross
estate under § 2036(a)(1) because he has retained the right to the income for his life, but it will
be limited to the amount of trust property needed to produce the income distributed to Daniel.
EXCEPTIONS TO § 2036(a)(1)—
There are a number of exceptions to § 2036(a)(1).
(1) 2036(a)(1) does not apply to bona fide sales for adequate and full consideration in money
or money’s worth.
(2) 2036(a)(1) does not apply to private annuities.
(3) 2036(a)(1) does not apply where decedent establishes a trust giving the trustee absolute
discretion to accumulate income or to distribute it to the decedent. (Here—the decedent
does not have a right to income; he has given the trustee the right to determine what
happens with the $$$).
HOWEVER—(3) does not apply if there is an understanding, express or implied, between
the decedent and trustee that the trustee will distribute income to the decedent whenever he
requests—or if the decedent is the trustee.
(3) does not apply if state laws provides that the decedent’s creditors can reach the trust
income even though the trustee has discretion as to whether to distribute it to the decedent, in
this case—it comes in under § 2036(a)(1), because the decedent can force a distribution by
not paying his creditors.
(3) does not apply if the trustee discretion is limited by an ascertainable standard—if it is,
then the property will come in under § 2036(a)(1).
DiRusso Question and Answers on 2036(a)(1):
Q1. “Trust says pay income to D for life, remainder to Son.”
A1. The whole thing will be in D’s gross estate.
Q2. Trust gives Trustee discretion to give income to D, remainder to Son.
A2. Maybe included—what are the actual controls D has over income stream? Also, is D the
trustee? Is there a wink and a nod agreement between D and the trustee? If in reality you have a
right to the income, it is in your gross estate.
Q3. Income to A for life, then to Donor, remainder to Son.
A3. The corpus of the trust is included in the gross estate, minus the value of the life estate if A
survives D.
Q4. The trust produces no income.
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A4. Included, you have a right to use and enjoyment of income, despite the fact that it is not
actually producing anything.
Q5. Transfer real property to son, retain the right to live there for life.
A5. Included in the gross estate.
RETAINED POSSESSION OR ENJOYMENT
Section 2036(a)(1) applies if the decedent retains the possession or enjoyment of property even
if it does not produce any income.
One Situation this applies: Often, a decedent will transfer title to the residence to their children
during their lifetime.
The transfer is a taxable gift if the decedent relinquishes all right to revoke the transfer.
But: The residence will be in the decedent’s gross estate if there is an agreement, even an
implicit one, allowing the decedent to remain there.
==How do we know if there is such an agreement? Well, it is fact specific. But, where we see
that the decedent continued to occupy the residence until death, that is a pretty good clue that
there was an agreement.
Estate of Rapelje v. Comm’r (Tax Court 1979)—
Decedent made a transfer of his house in 1969. It was a gratuitous transfer for which he reported
as a taxable gift. Later in 1969, the decedent spent some time traveling in Florida, at one point
considering purchasing a home there, however he never purchased the home. He returned home
in 1970. He continued to live in his house. Later in 1970, he has a stroke, after which he lived in
his home until the end of his life.
Issue: Is the value of the house included in his gross estate?
Held: Yes.
Reasoning: On paper he transferred the entire interest. In reality he kept a life estate. He lived in
the house until the day he died. The taxpayer has the burden of showing that there was not an
implied agreement or understanding. The taxpayer failed to prove that an implied agreement did
not exist. Looking at all the facts and circumstances, it appear that there was an implied
agreement that the decedent would live in the house for the rest of his life. This veiled attempt at
tax avoidance will not be tolerated and 2036(a)(1) will bring the entire value of the property into
the decedent’s gross estate.
A NOTE ON QPRT’S: What is a QPRT? A QPRT is a qualified personal residence trust.
How does a QPRT work? You transfer your residence to others in trust, under which you reserve
the right to live in the residence for a certain term. (This has a gift tax benefit—the gift tax value
is the value of the residence when it is put into the trust, not the value when the beneficiaries take
possession). At the end of the term you have to move out. If you survive the term, then the
property is not included in your gross estate. However, if you fail to outlive the term, then the
entire value of the property is included in the decedent’s gross estate.
When you set it up, just make sure you can outlive the term, cause if not, there will be gross
estate inclusion.
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Is 2036(a)(1) always going to bring in the value of a residence in which the decedent continues
to live until death?
NO. NOT ALWAYS.
 Under 2036(a)(1)—the decedent’s continued occupancy must be adverse to that of the
new owners.
o SO: a husbands transfer of a family home to the wife, where the husband
continues to reside for the rest of his life, is not adverse to the wife. A husband
and wife residing together is a natural use which did not diminish the wife’s
enjoyment. Estate of Gutchess, 46 T.C. 554 (1966).
 HOWEVER, Gutchess is probably limited to married couples—in
Revenue Ruling 78-409—the Service held that joint occupancy did not
prevent the entire date of death value from being included in the
decedent’s gross estate.
 A transfer that creates a TIC (tenancy in common) may prevent the entire date-of-death
value from being included in the decedent’s gross estate.
 Where the decedent was paying rent, 2036(a)(1) may not apply.
Estate of Riese v. Comm’r (Tax Court 2011)—
Decedent created a QPRT. After her term ended, her children would get the property. After the
QPRT ended, decedent agreed to pay rent to live in the house. However, before she ever made a
rent payment, she had a stroke. Thus, she was never able to actually make a rent payment.
However, she had intended to make rent payments (i.e. it was not a sham deal).
Issue: Is the property included in decedent’s gross estate?
HELD: No.
Reasoning: We see a properly structured QPRT. Plus, the agreement to pay rent negated the
existence of any implied agreement. So, here we would not see inclusion under 2036(a)(1). The
decedent did not retain the enjoyment of the property. The decedent was having to pay rent to
live there, so she was paying to use the property. The court took the taxpayers at their words as
far as the “intending to pay rent,” issue was concerned.
WHAT IS APPROPRIATE RENT?
FMV = willing-buyer, willing-seller test.
It can’t be just a nominal rent.
There must be an enforceable right to collect.
SALES FOR FULL AND ADEQUATE CONSIDERATION TO AVOID 2036(a)(1)—
A sale for full and adequate consideration will allow the decedent to avoid 2036(a)(1). But, such
sales in the family context are closely scrutinized to determine if they are bona fide arm’s-length
transactions.
Estate of Maxwell v. Comm’r (2nd Cir. 1993)—
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Lydia Maxwell conveyed her residence to her son Winslow. Following the transfer Lydia
continued to live in the residence until her death (about 2 years). Lydia forgave a lot of the
purchase price, for the rest of the price, Winslow executed a mortgage note in favor of Lydia.
Lydia was obligated to pay rent to Winslow. The mortgage interest that Winslow had to pay each
month and the rent Lydia owed to Winslow each month virtually canceled each other out.
Commissioner looked at it and said that it appeared that this was not a bona fide transaction at
arm’s length.
HELD: This is included in the decedent’s gross estate. This was not a bona fide sale and arm’s
length for money or money’s worth. This was gift hidden as a sale, so the substance over form
doctrine comes into play to cause gross estate inclusion.
LEGAL OBLIGATION OF SUPPORT
The decedent is deemed to have retained possession or enjoyment or the right to income from
property if the property, or its income, is to be used to discharge his legal obligations or for his
pecuniary benefit. This includes the legal obligation to support a dependent during the decedent’s
lifetime. See Treas. Reg. § 20.2036-1(b)(2).
DiRusso: “With the legal obligations thing, if you have the right to use the funds to satisfy your
legal obligations, then it will be included in your gross estate.”
Estate of Gokey v. Comm’r (Tax Court 1979)—In 1961 Gokey created an irrevocable trust for
the benefit of his three children. Gokey was the sole trustee. The trust agreement provided that
the income from the trust should be used for the support, care, welfare, and education of the
children until they reached 21. Once the children turned 21, they would receive the money. At
the time of Gokey’s death, one child was 18, one was 15 and one was 13. The Commissioner
argued that as far as the 15 and 13 year old were concerned, Gokey had retained the possession
or enjoyment of the trust property, because the property could be used to satisfy Gokey’s legal
obligations.
HELD: Included in the gross estate.
TREAS. REG. § 20.2036-1(b)(2)—the use, possession, right to the income, or other enjoyment
of the transferred property is considered as having been retained by or reserved to the decedent
within the meaning of 2036(a)(1) to the extent that the use, possession, right to the income, or
other enjoyment is to be applied toward the discharge of a legal obligation of the decedent which
includes an obligation to support a dependent.
REASONING: Gokey had a legal obligation under state law to support her minor children. The
terms of the trust stated that the income and property from the trust were to be used for the
support of the children. So, it has to be included in her gross estate. Why? Because if not, then
every parent in America could set up such a trust and as long as the money was earmarked to
support their children, they would completely avoid the estate tax. Essentially, she was trying to
keep the money in reality, while divesting herself of the money on paper and for tax purposes.
NOTE:
 2036(a)(1) also applies to the decedent’s obligation to support a spouse.
 2036(a)(1) also applies when the decedent creates a trust that will satisfy other legal
obliations
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P. 251 Problem 1: What are the gift and estate tax consequences if Donald establishes the
following irrevocable trust with Frineldy National Bank as the Trustee?
a. Income to Donald for life, remainder to Ann.
b. Income to Donald for ten years, remainder to Ann. Donald dies in year 12. What if Donald
dies in year 8?
c. Income to Ann for life, then income to Donald for life, remainder to Bob. Donald predeceases
Ann.
a. Included in Donald’s gross estate under § 2036(a)(1).
b. In yr. 12 no inclusion; in yr. 8 included under § 2036(a)(1).
c. Included in gross estate under § 2036(a)(1).
P. 251 Problem 2: Donald establishes an irrevocable trust with Friendly National Bank as
Trustee to pay the income to Ann and Bob until the youngest is 21. The Trustee has the
discretion to either accumulate the income or use it for the support, care, welfare, health, and
education of Ann and Bob. After an income beneficiary becomes 21, the Trustee must distribute
the beneficiary’s share of trust income to the beneficiary. When the oldest beneficiary turns 21,
the trust is to be divided into two shares. Each beneficiary will receive half of his or her share of
the corpus at age 30 and the other half at age 40.
a. What are the estate tax consequences if Donald dies when Ann and Bob, his children, are eight
and ten?
b. What if Donald dies when his children are 18 and 20 and they are both attending college?
a. Probably, this is probably a mandatory obligation to pay/discharge the support obligation.
DiRusso: “The wording of this makes it a close call, but this is probably included because of the
support obligation issue.”
b. No. They are over 18, so no support obligation. Note: the age the support obligation ends is
a matter of state law, so check.
P. 253 Problem 6: Diane transferred property to Friendly National Bank as Trustee. The Trustee
has absolute discretion to distribute income to, or for the benefit of, Diane during her life. At her
death, the Trustee is to distribute the trust property to Diane’s surviving issue.
a. What are the estate tax consequences?
b. What if the trustee distributed trust income to Diane on a quarterly basis?
a. There is no inclusion in the gross estate. She does not have a right to anything under this
setup. However, if we see a wink and a nod agreement on the behalf of the Trustee to distribute
to Diane, then it would be included.
b. This could indicate an implied agreement. May make it more likely to find a retained
interest in Diane.
THE RIGHT TO DETERMINE ENJOYMENT OF
PROPERTY
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§ 2036. Transfers with retained life estates.
(a) General rule. The value of the gross estate shall include the value of all property to the
extent of any interest therein of which the decedent has at any time made a transfer
(except in case of a bona fide sale for an adequate and full consideration in money or
money’s worth), by trust or otherwise, under which he has retained for his life or for any
period not ascertainable without reference to his death or for any period not ascertainable
without reference to his death or for any period which does not in fact end before his
death—
(1) the possession or enjoyment of, or the right to income from, the property, or
(2) the right, either alone or in conjunction with any person, to designate the persons
who shall possess or enjoy the property or the income therefrom.
(b) [Voting Rights]
§ 2038. Revocable transfers.
(a) In general. The value of the gross estate shall include the value of all property—
(1) Transfers after June 22, 1936. To the extent of any interest therein of which the
decedent has at any time made a transfer (except in case of a bona fide sale for an
adequate and full consideration in money or money’s worth), by trust or otherwise,
where the enjoyment thereof was subject at the date of his death to any change
through the exercise of a power (in whatever capacity exercisable) by the decedent
alone or by the decedent in conjunction with any other person (without regard to
when or from what source the decedent acquired such power), to alter, amend,
revoke, or terminate, or where any such power is relinquished during the 3-year
period ending on the date of the decedent’s death . . .
(b) . . .
As far as the estate and gift tax system is concerned, when a decedent makes a transfer of
property and reserves the right to revoke that transfer, there is not a completed gift and therefore
the property must be in the decedent’s gross estate.
Section 2038 does that, and goes even further—reaching to any power to alter, amend, revoke,
or terminate as long as the decedent has the power at the time of death.
DiRusso: “The point here is that the continued ability to shift beneficial enjoyment means that
we are going to bring the property into the gross estate.”
Porter v. Comm’r (1933)—
Porter transferred bonds into trust for the benefit of his children and grandchildren. The trust
agreements provided that Porter could alter or modify the trusts in any manner (except, that he
could not change the disposition to be in favor of himself or his estate). The Commissioner
argued that the reserved power to alter and amend caused the corpus of the trust to be included in
the gross estate. Porter’s estate argued that since he could not revest the property in himself or
his estate, that it should not be included.
Held: Included in the gross estate.
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Reasoning: Porter kept too much control over the trust property. He kept enough such that the
estate tax system treated him as the owner. Porter limited himself, in that he could not revest title
in himself or his estate. But, despite this limitation, he retained substantial power over the trust.
The power to pick who gets the corpus and income (a power which Porter retained) is a very
substantial power. Enough power, such that gross estate inclusion was justified.
Testamentary Nature of the Retained Powers: Other than revesting property to himself or his
estate, Porter was free to decide who got what and how much they got and when they got it. His
control over picking the beneficiaries would only terminate upon his death. This seems
testamentary in nature, a will substitute one might say. If he passed this property via his will, it
would certainly be included in his gross estate under § 2033. So, would we let him get around
that by using the form of this trust? No. That would make tax avoidance far too easy. If it looks
and smells like a testamentary disposition, we will treat it as such, to the extent that Congress
said we can in the Estate Tax Code provisions.
FOCUS of 2038: Section 2038 focuses on the power that the decedent has at the moment of
death to alter, amend, revoke, or terminate a transfer of property.
FOCUS of 2036(a)(2): Section 2036(a)(2) includes in the decedent’s gross estate any property
transferred by the decedent when the decedent retains the right to designate the person
who will possess or enjoy the property or income from it.
UNDER BOTH 2038 and 2036(a)(2)—application requires that the decedent make a
“transfer” of property.
United States v. O’Malley (1966)—
Fabrice created five irrevocable trusts (two each for his two daughters, and one for his wife). He
was one of three trustees. Each trust document specified that the trustees, in their sole discretion,
could pay trust income to the beneficiaries or accumulate it, in which event it became part of the
principal. The Commissioner argues that this is enough power to be included under 2036(a)(2)
and 2038(a)(1). The estate (not surprisingly) disagrees. The district court held for the
Commissioner. The Court of Appeal held that the original corpus of the trust contributed by the
decedent was includable, but that the trust principal which was from accumulated income was
not “transferred” from Fabrice to the beneficiaries, so it should not be included.
Issue: Was the accumulated income “transferred” from Fabrice to the beneficiaries such that it is
included in his gross estate?
HELD: YES.
Reasoning: The accumulated income only existed because Fabrice transferred the principal to
the trust, if not for that, there would be no accumulated income. Thus, the accumulated income is
traceable to Fabrice. Fabrice kept the power to either accumulate that accumulated income in the
trust or distribute the accumulated income. This is a power that falls under § 2036(a)(2), so
included in the gross estate.
THE CO-HOLDER ISSUE AND 2036(a)(2) and 2038: Both § 2036(a)(2) and § 2038 apply
whether the decedent can exercise the power alone or in conjunction with any other person.
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DiRusso: “Co-holders of power don’t matter here.”
SO: It doesn’t matter whether the co-holder has an adverse interest, if you have the forbidden
powers, either alone or in conjunction with any other person, the property will be included in
your gross estate.
Example 9-6—Decedent creates an irrevocable trust to pay the income to her children for their
lives. After the death of all Decedent’s children, the trust property is to be distributed to her
descendants. There are three Trustees, one of whom is decedent. Decedent has discretion to add
or delete income or remainder beneficiaries as long as all Trustees agree. The trust will be in
Decedent’s gross estate under §§2036(a)(2) and 2038(a)(1) because Decedent has retained for
her life the right to determine who will enjoy the trust property and has, at the moment of her
death, the power to alter or amend the trust. It is not relevant under either 2036(a)(2) or
2038(a)(1) that decedent can only act in conjunction with the two other Trustees.
Example 9-7—Decedent creates an irrevocable trust, transferring property to himself as Trustee
to pay the income to his son, Adam for his life. At Adam’s death, the trust property is to be
distributed to Adam’s surviving issue. Decedent retains the right to revoke the trust, but only
with Adam’s consent. Upon revocation, the trust property reverts to Decedent. The trust property
will be in Decedent’s gross estate under § 2036(a)(2) and § 2038(a)(1). It is irrelevant that Adam
must consent to the exercise of the power and that Adam, as the income beneficiary, has a
substantial adverse interest to the exercise of the power.
WHAT ARE THE DIFFERENCES BETWEEN 2036(a)(2) and 2038?
 § 2036(a)(2) applies to the right to designate enjoyment if the decedent retains the right
for his life, for a period that is not ascertainable without reference to his death, or for a
period that does not in fact end before his death.
 § 2038 applies to a power that exists on the date of decedent’s death.
Under 2038, the decedent need not have specifically retained the power (i.e. it need not be an
expressed reservation). For instance, decedent might obtain it as a successor trustee.
NOTE: 2038 will not apply to a power that can be exercised only if a specified contingency
happens AND that contingency does not in fact occur before the decedent’s death.
BUT: This limit does not apply to 2036
Example 9-8—Dwight establishes an irrevocable inter vivos trust with himself as trustee for the
benefit of his son, Sam. The trustee is required to pay the income to Sam at least quarterly. At
Sam’s death, the trustee is to distribute the trust property to Sam’s issue. The trustee has sole and
absolute discretion to distribute some or all of the trust property to Sam after his marriage. Sam
does not marry before Dwight’s death. The ability to distribute corpus is a power to determine
who will enjoy the trust property and § 2036(a)(2) applies. It is immaterial that the power to
distribute the trust property is subject to a condition that has not in fact occurred and over which
the decedent had no control. BUT, 2038 would not apply because the contingency had not
occurred before Dwight’s death. SEE THE DIFFERENCE.
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ASCERTAINABLE STANDARDS AND 2036(a)(2) and 2038
What is an ascertainable standard?
An ascertainable standard is an objective, external standard that will be enforced by a court.
Gifts and Ascertainable standards—
If a donor transfers property and retains the power to distribute income or corpus, the gift is
incomplete. However, if the Donor’s power is restricted by an ascertainable standard, the gift is
complete because the beneficiaries can successfully force a distribution.
§§ 2036(a)(2) & 2038 and ascertainable standards:
Neither 2036 nor 2038 nor any of the regulations relating thereto make any mention of the
ascertainable standard exception. BUT, the courts have grafted the ascertainable standard
exception onto 2036(a)(2) and 2038.
When we have the ascertainable standard, we deem you not to have meaningful control to shift
the beneficial interest = NOT IN GROSS ESTATE.
Jennings v. Smith (2nd Cir. 1947)—
Decedent set up two trusts for the families of his children. The trusts were irrevocable. The
decedent and his two sons were named as trustees. The trustees were to accumulate the net
income and add it to the corpus of the trust at the end of each year, provided that in the absolute
discretion of the trustees, the trustees could distribute income to beneficiaries if they determined
that a distribution was “reasonably necessary to enable the beneficiary in question to maintain
himself and his family, if any, in comfort and in accordance with the station in life to which he
belongs.” The weasely old Commissioner wanted to include the trust property in Decedent’s
gross estate.
HELD: Not included in the gross estate.
REASONING: Here, we see an ascertainable standard that constrains the discretion of the
trustees. Therefore, we will not include it in the decedents gross estate. Because of the
ascertainable standard, the trustees discretion was not completely unfettered, so the decedent
hadn’t kept too much control over the trust.
Old Colony Trust Company v. United States (1st Cir. 1970)—
Decedent created a trust. The initial life beneficiary was his son. Subsequent beneficiaries were
the son’s widow and then his issue. Eighty percent of the income was to be paid to the son, then
the rest was to be added to the principal. The trust provided that the trustees had discretion to
cease paying income and add it to the principal, if the trustee decided it was in the son’s “best
interests.” Additionally, the trust gave the trustee broad administrative powers relating to
investments and in determining what should be charged to principal and income. The
Commissioner inevitably argued that the powers retained mandated inclusion in the gross estate
under both 2036(a)(2) and 2038.
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HELD: Includable in gross estate because of the discretion to cease paying income. The
administrative powers, however, do not mandate inclusion, but the discretion makes it
includable.
REASONING: When a settlor reserves to himself a power that is inconsistent with full
termination of ownership, the property will be included in the settlor’s gross estate. As far as the
administrative powers were concerned, there was no problem. Purely administrative powers of
investment don’t bring about gross estate inclusion. However, in regard to the discretion to cease
paying income and add it to principal, this is a major power. Under this power, the trustee can
vary the time and manner of enjoyment of the trust property. The Decedent’s estate tried to argue
that the “best interests” standard was an ascertainable standard that limited the trustees
discretion. This argument was to no avail, best interests is an amorphous standard, clearly not
such that a court could objectively determine what it means. This power led to the inclusion of
the trust property in the decedent’s gross estate. The power had the plain indicia of ownership
and control.
FIDUCIARY POWERS
In Estate of Jordahl v. Comm’r the decedent created a trust and reserved the power to substitute
other property for that originally transferred into the trust. The Tax Court held that the property
was not included in the decedent’s gross estate because decedent was bound by fiduciary
obligations and was accountable to the beneficiaries for his actions. As a result, he did not have
enough control to justify inclusion.
In Revenue Ruling 2008-22 the decedent retained the power to substitute property, but he was not
a trustee nor was he restrained by any fiduciary obligations. However, the trustee (who was
bound by fiduciary obligations) had to certify that the properties switched were of equivalent
value. Thus, he could no reduce the value of the trust assets. So, there was no inclusion under
2036(a)(2) or 2038.
DiRusso: “Fiduciary powers come in two flavors: (1) distributionary powers and (2)
administrative powers. Distributionary powers cause property to be included in the gross estate
unless they are limited by an ascertainable standard. Administrative powers, which include
selecting investments, managing the trust, etc., do not cause gross estate inclusion because they
are limited by fiduciary obligations.”
Leopold v. United States (9th Cir. 1975)—
Leopold created trusts for the benefit of his daughters. Leopold reserved the right to distribute
the principal of the trust at any time. Leopold was authorized to distribute income form the trust
to his daughters for their support, education, and welfare.
INCLUDED IN GROSS ESTATE? The principal of the trust must be included in the gross
estate. The income is not included in the gross estate.
REASONING: The distribution of income was subjected to the standard of “support, education,
and welfare.” This is an ascertainable standard that limited Leopold’s discretion. So, he did not
have substantial control over income. Once the income was accumulated and not distributed, the
trustee could not touch the income, so it was beyond his control. So, no control, no inclusion.
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But, the decedent had nearly unfettered control over the principal. This reserved power was
sufficient to bring about gross estate inclusion.
DIRUSSO LECTURE ON THE MOMENT THAT 2036(a)(2) and 2038 are concerned
with:
“2036 and 2038 are looking at different times. 2038 looks at the time of death, it is a snapshot, it
is looking at what the decedent had in the moment before death. 2036 is more like a movie/film,
it is more expansive as far as the time period it is looking at. 2036 looks at the period between
the transfer and the decedent’s death.”
DIRUSSO ON 2038: “2038 looks at the time of death. Under 2038, we ask what power did the
decedent hold at the time of death? At death, did the decedent hold the power? If so, then it will
be included.”
DIRUSSO on 2038 & CONTINGENCIES: “With 2038, if there is a real contingency that
hasn’t happened at the date of death, the power doesn’t count, so it is not included in the gross
estate. But, if it is a ‘fake’ power (a power within the decedent’s control) then it does count, so it
will be included in the gross estate.” –See Treas. Reg. § 20.2038-1(b) below.
Treas. Reg. § 20.2038-1. Revocable Transfers.
(a) . . .
(b) Date of existence of power. A power to alter, amend, revoke, or terminate will be
considered to have existed at the date of the decedent’s death even though the exercise of
the power was subject to a precedent giving of notice or even though the alteration,
amendment, revocation, or termination would have taken effect only on the expiration of
a stated period after the exercise of the power, whether or not on or before the date of the
decedent’s death notice had been given or the power had been exercised. In determining
the value of the gross estate in such cases, the full value of the property transferred
subject to the power is discounted for the period required to elapse between the date of
the decedent’s and the date upon which the alteration, amendment, revocation, or
termination could take effect . . . However, section 2038 is not applicable to a power the
exercise of which was subject to a contingency beyond the decedent’s control which did
not occur before his death (e.g., the death of another person during the decedent’s life).
See however, section 2036(a)(2) for the inclusion of property in the decedent’s gross
estate on account of such power.
Treas. Reg. § 20.2036-1. Transfers with retained life estate.
(a) . . .
(b) . . .
(1) . . .
(2) . . .
(3) The phrase “right . . . to designate the person or persons who shall possess or enjoy
the transferred property or the income therefrom” includes a reserved power to
designate the person or persons to receive the income from the transferred property,
or to possess or enjoy nonincome-producing property, during the decedent’s life or
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during any other period described in paragraph (a) of this section. With respect to
such power, it is immaterial (i) whether the power was exercisable alone or only in
conjunction with another person or persons, whether or not having an adverse
interest; (ii) in what capacity the power was exercisable by the decedent or by another
person or persons in conjunction with the decedent; and (iii) whether the exercise of
the power was subjected to a contingency beyond the decedent’s control which did
not occur before his death . . . The phrase, however, does not . . . apply to a power
held solely by a person other than the decedent. But, for example, if the decedent
reserved the unrestricted power to remove or discharge a trustee at any time
and appoint himself as trustee, the decedent is considered as having the power of
the trustee.
POWER TO APPOINT TRUSTEES
RULE: When the trustee has discretion to retain or distribute income or the power to designate
beneficiaries, the trust property will not be in the decedent’s gross estate if the decedent is not
the trustee.
Alas, like any good rule, there is always an exception:
Estate of Farrel v. United States (Court of Claims 1977)—
Farrel established an irrevocable trust for her grandchildren. Two trustees were named. The
trustees had the discretion to pay or apply all or part of the income and principal to or for the
benefit of the beneficiaries or their issue. The trust called for two trustees at all times. Farrel
could not discharge a trustee. However, Farrel could pick the successor trustees (theoretically,
she could have even picked herself).
Inclusion in her Gross estate under § 2038? No inclusion under 2038. Farrel did not have the
power at the time of her death. Under 2038, if the power is subject to a condition outside of the
decedent’s control (like a trustee resigning as trustee) which had not come to pass, the decedent
is not charged as having the power at the time of death. Therefore, no inclusion in the gross
estate under 2038.
Inclusion in her Gross estate under § 2036(a)(2)? Yes, included under 2036(a)(2). Farrel had
the ability to appoint a new trustee if a trustee resigned. Noted, she never exercised the power
because the contingency never arose that would have allowed her to exercise it. The fact that it
was never exercised is irrelevant. The issue is whether she actually possessed the power at any
point relevant for 2036(a)(2)—here, she kept the power throughout her life, so it is included in
her gross estate, despite never actually being exercised.
ANALYTICAL POINT: This case once again points out the difference in the analysis between
2038 and 2036(a)(2). Under 2038 you look at the moment of death. Under 2036, you look
forward from the time the transfer was made to see whether the decedent retained any interest (1)
for his life, (2) for any period not ascertainable without reference to his death, or (3) for any
period which does not in fact end before his death.”
Estate of Wall v. Comm’r (Tax Court 1993)—
Mrs. Wall created a trust. She retained the right to remove the corporate trustee and replace it
with another corporate trustee, provided however, the new trustee must be “independent” of the
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grantor. The trustee had discretion to distribute principal and income, not limited by any
ascertainable standard.
Issue: Did the right to replace the corporate trustee encompass the right to exercise the powers of
the trustee?
Held: No. This is not included under 2036(a)(2) or 2038.
Reasoning: The power to remove and replace an independent trustee is not the type of power
which is envisioned in 2036(a)(2) or 2038. The ability to replace the trustee is ok so long as the
trustee is “independent,” i.e. not under the donor’s thumb. Because the corporate trustee here was
independent, and any substitute trustee she picked likewise had to be independent, she did not
retain the level of control that would cause inclusion under 2036(a)(2) or 2038. Thus, the powers
of the trustee will not be imputed to the donor here.
Revenue Ruling 95-98: If a decedent transfers property into trust while retaining the
power/discretion as trustee to distribute the principal and income, the trust property is included in
the decedent’s gross estate. Even where the decedent themself is not the trustee, they may be
treated as having retained the powers as trustee (i.e. the trustees powers are imputed to the
decedent) when they retain control over the trustee, i.e. where the trustee is subordinate to the
decedent. However, where the decedent retains the power to remove and appoint an successor
trustee who is independent of the decedent, the decedent will not have the trustee’s powers
imputed to them.
What is a subordinate individual for purposes of 2036 and 2038? See § 672(a) & (c).
A related or subordinate individual is someone who does not have a substantial beneficial
interest in the trust which would be adversely affected by exercise or nonexercise of the power
and who is either (1) the grantor’s spouse (if living with grantor), parent, issue, sibling, or
employee; (2) a corporation or employee of a corporation in which the grantor has significant
voting control; or (3) an employee of a corporation in which the grantor is an executive.
Example 9-9—Dan establishes an irrevocable, inter vivos trust and gives the trustee absolute
discretion to accumulate income or distribute it to Dan’s children. Dan appoints Friendly
National Bank as trustee but reserves the right to remove the trustee and replace the trustee with
anyone other than himself or his spouse. Dan dies without ever exercising his reserved power to
replace the trustee. The trust property will be in Dan’s gross estate under 2036(a)(2) and
2038. Dan can appoint his parents or his siblings as trustee, both are related or subordinate
parties, so inclusion in the gross estate results.
RECIPROCAL TRUSTS
The courts developed the reciprocal trust doctrine to thwart attempts to avoid § 2036 and § 2038.
The reciprocal trusts doctrine is a substance vs. form issue.
GENERAL RULE: The form of the transaction selected by the taxpayer will govern. The
taxpayer has no duty to pay more taxes than he need and the taxpayer has a right to structure his
affairs to minimize the tax bill.
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HOWEVER: When taxpayers ignore the formalities or subvert the form, the courts will exalt
the substance of the transaction over the form of the transaction—preventing tax evasion.
United States v. Grace (1969)—Joseph Grace, a wealthy man, married Janet Grace in 1908, at
the time of marriage, Janet had no serious material wealth, she was seemingly a penniless
pauper. Between 1908 and 1931, Joseph transferred a large amount of property to Janet. Joseph
retained control over the property he transferred to his wife, managing it on his own. In 1931,
Joseph set up a trust for the benefit of Janet, the trust provided that Janet could designate the
remainder beneficiary in her will. Also in 1931, Janet executed a trust with the same terms, with
Joseph as beneficiary. The facts indicated that Janet executed the trust at Joseph’s direction.
When Joseph died, the Comm’r wanted to treat the trusts as reciprocal and place the value of
both within Joseph’s gross estate. The Commissioner asserted the doctrine of reciprocal trusts.
The Commissioner argued that the reciprocal nature of the trusts amounted to control being left
in Joseph for his life.
HELD: Included in Joseph’s gross estate.
REASONING: The taxability of the trust corpus depends not on the motives of the settlor, but
on the effect (substance) of the transfer. The reciprocal trust doctrine will apply when the trusts
are interrelated AND the arrangement leaves the settlors in approximately the same
economic position as they would have been in had they created trusts naming themselves as
life beneficiaries.
Page 278 Problem 1:
Derrick transfers $10,000,000 to Friendly National Bank to pay the income to Anita for life with
the remainder to Ben. What are the gift and estate tax consequences in the following situations?
(a). Derrick retains the right to revoke the trust.
(b). The trust is irrevocable, but Derrick retains the right to add or delete beneficiaries.
(c). The trust is irrevocable, but Derrick retains the right to alter the amount of income or corpus
allocated to any beneficiary, including the right to add beneficiaries.
(d). The trust is irrevocable, but Derrick retains the right to add income or remainder
beneficiaries to the trust in his will.
(e). The trust is irrevocable, but Derrick retains the right to terminate the trust. Upon termination,
the corpus goes to Ben.
(f). The trust is irrevocable, but Derrick retains the right to regain title and possession of trust
assets if he transfers new assets of equal value to the trust.
(g). The trust is irrevocable, but Derrick as Trustee retains the right to invest funds, to sell trust
property, and to borrow money.
(h). The trust is irrevocable, but Derrick as Trustee retains the right to distribute income to or
among trust beneficiaries.
a. Gift Tax = Not a completed gift = no gift tax.
Estate Tax = included in gross estate under §§ 2036 and 2038 due to the right to revoke.
b. Gift Tax = not a completed gift = no gift tax.
Estate Tax = included in gross estate under 2036 and 2038 due to the right to alter beneficial
enjoyment.
c. Gift Tax = not a completed gift = no gift tax.
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Estate Tax = included in gross estate under 2036 and 2038 because he can change the
beneficiaries and how much each receives.
d. Gift Tax = not a completed gift = no gift tax.
Estate Tax = included in gross estate under 2038. The only way he may alter the trust is by his
will at the moment of his death.
e. Gift Tax = this is a completed gift as to the remainder interest—this is not a completed gift
as to the income interest. So, gift tax on remainder, but no gift tax on income interest.
Estate Tax = includable in the gross estate, the decedent has the right to shift the beneficial
interests.
f. Gift Tax = completed gift = so—gift tax.
Estate Tax = not included in gross estate. The ability to swap stuff is ok as long as you are
restricted under state law (fiduciary).
g. Gift Tax = completed gift = gift tax.
Estate Tax = No included. These are administrative powers, so no inclusion.
h. Gift Tax = not completed = no gift tax.
Estate Tax = includable in Gross Estate. If you can pick who gets it, it is a retained interest to
alter, amend, etc. and is included in the gross estate.
Page 279 Problem 2:
Same facts as Problem 1.a., except that Derrick may revoke only with the consent of Emma, his
spouse. What if Derrick can only revoke with the consent of Ben?
Gift Tax = as far as co-holding the power with the wife, she doesn’t have a substantial adverse
interest, so the gift is not complete. But, Ben has a substantial adverse interest, so the gift is
complete if his approval is required.
Estate Tax = included either way, co-holders don’t matter for estate tax purposes.
Page 280 Problem 6:
Diane establishes an irrevocable trust and appointed herself as one of three Trustees. The
Trustees have discretion to accumulate income or distribute it to Diane’s three children.
Accumulated income is added to the trust property. The Trustees must agree on any
accumulation or distribution of income. At the death of all Diane’s children, the trust property is
to be distributed to their issue. There is a provision for appointment of Successor Trustees if any
Trustee should die or resign.
(a). What are the estate tax consequences if Diane is serving as Trustee at the time of her death?
(b). What if Diane had not appointed herself as Trustee but was appointed by the other Trustees
as a Successor Trustee and was serving as Trustee at the time of her death?
a. Sections 2036 and 2038 bring this into the gross estate because she had the power to
determine who got the stuff (i.e. the power to shift beneficial enjoyment).
b. This is included in the gross estate under 2038, because she had the right at the time of her
death. She didn’t have the right under 2036, but it doesn’t matter, because one code section is
enough to bring it into the gross estate.
RETENTION OF BUSINESS INTERESTS
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United States v. Byrum (1972)—
Byrum set up a trust for some beneficiaries. He transferred shares of stock in three closely held
corporations to the trust. However, he retained in himself the right to vote those shares of stock.
The dadgum ol’ Commissioner argued that the retention of the stock voting rights amounted to
the retention of control that would cause gross estate inclusion under either or both 2036 and
2038. The dang Commissioner argued that the ability to vote the shares would allow him to
control the board of directors, in effect allowing him to control the corporation. The
Commissioner argued that this was inconsistent with the termination of ownership in control, in
effect the taxpayer had put the corporation into the trust for estate tax avoidance reasons, while
keeping control of the corporation for all practical reasons.
ISSUE: Should the retention of voting rights cause inclusion in the decedent’s gross estate?
HELD: NO. The Court found that even if the taxpayer could control the board with the voting
rights, the board had fiduciary obligations to the corporations shareholders not to fall to the whim
of the decedent.
Finally—a pro-taxpayer decision. But as Lee Corso would say “Not so fast my friend.” Neither
the IRS nor Congress was pleased with this outcome. So what did they do? They passed a law.
Congress passed § 2036(b) in response to Byrum.
§ 2036(b). Voting Rights.
(1) In general. For purposes of subsection (a)(1), the retention of the right to vote (directly or
indirectly) shares of stock of a controlled corporation shall be considered to be a retention
of the enjoyment of transferred property.
(2) Controlled Corporation. For purposes of paragraph (1), a corporation shall be treated as a
controlled corporation if, at any time after the transfer of the property and during the 3year period ending on the date of the decedent’s death, the decedent owned . . . or had the
right (either alone or in conjunction with any person) to vote, stock possessing at least 20
percent of the total combined voting power of all classes of stock.
(3) Coordination with Section 2035. For purposes of applying section 2035 with respect to
paragraph (1), the relinquishment or cessation of voting rights shall be treated as a
transfer of property made by the decedent.
Is Byrum completely dead after 2036(b)?
No. It doesn’t have much of a heartbeat still left, but there is a pulse there. Courts still use it in
relation to other business interests other than voting rights.
RETENTION OF INCOME FROM BUSINESS ASSETS
Section 2701 governs the valuation of transfers of specified interests in corporations and
partnerships.
Section 2701 applies to:
(1) The transfer of an interest in a corporation or partnership,
(2) To a member of the transferor’s family,
(3) Where the transferor or an applicable family member,
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(4) Retains “any applicable retained interest”,
(5) Except—for interests for which market quotations are readily available.
SO: 2701 applies to the transfer of interests in closely held businesses from older-generation
family members to younger-generation family members, but only when the older-generation
family member retains a distribution right (i.e. right to dividends) or a liquidation, put, call, or
conversion right.
SECTION 2701 specifies that the applicable retained interest will have a zero value unless it is
the right to a qualified payment, which is a dividend payable on a periodic basis under
cumulative preferred stock determined at a fixed rate.
FAMILY LIMITED PARTNERSHIPS
The family limited partnership or limited liability company has become a valuable estate
planning tool to decrease the value of the decedent’s property and thus minimizing or eliminating
transfer tax consequences.
This devise allows the taxpayer to establish a limited partnership, transfer property to it, and
then give partnership interests to younger-generation family members.
The Family Limited Partnership concept makes use of the willing-buyer/willing-seller test.
How does it work? By making gifts of the partnership interest, the decedent gets the interest in
the business out of his or her Gross Estate.
When you set it up, you have everybody contribute and give everybody a share proportional to
their contribution. As time goes by, the older members of the family make gifts of their shares to
the younger members.
WHY IS THIS DESIRABLE? WHAT BENEFIT?
There is a valuation benefit in classifying this as a gift. For gift tax purposes, valuation occurs at
the date of the gift, the FMV on the date of the gift is the valuation of the gift. If you give a
minority interest in the partnership, the value under the willing-buyer, willing-seller test will be
smaller (a minority interest is less valuable). So, you can be more generous with your gifts.
If you did not gift the interests in partnership, you would have them included in your gross
estate, for which valuation typically occurs at the date of your death (by which time the interest
may have increased in value).
BUT: THE IRS DOES NOT LIKE FAMILY LIMITED PARTNERSHIPS. So, you face a high
risk of audit.
Turns on substance v. form. If there is no substance in your gift, then the IRS will not
respect the form of the transaction.
Heckerman v. United States (W.D. Wash. 2009)—
In 2001, David Heckerman set up trusts for his minor children. He then set up LLC’s to which he
made a gift of substantial portions of his property. A two-step process. The Commissioner
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wanted to treat this as one-unified transaction under the “step-transaction doctrine.” He argued
that there was no reason for the setting up of the LLC’s except to evade taxes.
HELD: The Court uses the step-transaction doctrine here. The value of the interests in the
partnership will be included in the decedent’s gross estate.
REASONING: In substance, this was one unified transaction to artificially lower the estate tax
bill by gaining the advantage of the minority share valuation. Unless they see a sale for full and
adequate consideration and that the taxpayer did not retain the right to income or possession, the
IRS and courts will include this in the decedent’s gross estate.
STEP-TRANSACTION DOCTRINE TESTS:
1) Binding Commitment Test—collapses a series of transactions into one “if at the time the
first step is entered into, there was a binding commitment to undertake the later step.”
2) End Result Test—asks whether the “series of formally separate steps are really
prearranged parts of a single transaction intended from the outset to reach the ultimate
result.”
3) Interdependence Test—inquires whether “ on a reasonable interpretation of the objective
facts,” the steps were “so interdependent that the legal relations created by one
transaction would have been fruitless without a completion of the series” of transactions.
The interdependence test focuses on the relationships between the steps, not the end
result. The real question is would any one step have been undertaken but for the donor’s
contemplation of the later acts.
Estate of Jorgensen v. Comm’r (Tax Court 2009)—
Colonel and Mrs. Jorgenson set up a family partnership. After the Colonel died, Mrs. Jorgenson
had control of the partnership for her gift giving endeavors. The partnership really didn’t have
any business, it just held passive investments, the income from which Mrs. Jorgenson could
distribute as gifts at her pleasure. The Commissioner argued that value should be included in
Mrs. Jorgenson’s estate.
HELD: Included in gross estate.
REASONING: The partnership is solely for Mrs. Jorgensen’s benefit, this is a shell. We will
not exalt form over substance here. The Court found that there was no arm’s length transaction
for a full and adequate consideration.
DiRusso On Funding the FLP: How you fund the FLP matters. If you just put marketable
securities in it, it is hard to argue that there is a non-tax reason for the partnership.
POINT: FLP cases are heavily facts and circumstances based. What is clear, is that there must
be a benefit to the decedent other than the gift and estate tax savings.
Page 305 Problem 1: Peter owns 25 percent of the stock of XYZ, Inc. Peter establishes an
irrevocable trust for the benefit of Chester, his child.
(a). Peter appoints Thomas as Trustee. Peter then transfers the stock of XYZ, Inc. to the trust, but
he retains the right to vote the stock. What are the estate tax consequences?
(b). Instead, Peter appoints himself as Trustee, and he is serving as Trustee when he dies. Peter
does not explicitly retain the right to vote the stock. What are the estate tax consequences?
(c). Same as 1.a., except that Peter only owns 10 percent of the stock.
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(d). Same as 1.a., except that two years before his death, Peter relinquishes the right to vote the
stock.
a. Under 2036(b) this is going to be included in his gross estate. He has 25% voting control
(this exceeds the 20% threshold established in 2036(b)). Note: He made a completed gift, so
there is a gift tax consequence, but 2036(b) also brings it into the gross estate, so double-taxation
bummer.
b. Included under 2036(b). Under 2036(b), the right to vote causes inclusion, regardless of the
role that gives the decedent the right to vote the shares.
c. Not included under § 2036(b). But, we’d probably want to know who the other shareholders
are and whether those shareholders’ interests can be attributed to Peter for purposes of 2036(b).
d. Included under § 2036(b). His release of the right was within three years of his death. §
2036(b) has a three year look back.
Page 306 Problem 3: Patrick establishes Family Limited Partnership (FLP) and transfers his
house, rental real estate, and his stock portfolio, with a total value of $15,000,000, to the
partnership. Patrick’s children, Claire and Carl, each transfer $100,000 cash to FLP. Patrick
receives a limited partnership interest, and Claire and Carl receive limited and general
partnership interests; these interests are proportionate to their contributions to FLP. In the year of
formation and each subsequent year, Patrick transfers limited partnership interests, equal in value
to the amount of the gift tax annual exclusion, to Claire, to Henry (Claire’s husband), to Carl, to
Wanda (Carl’s wife), and to Patrick’s five grandchildren. Patrick is the managing partner of FLP,
and he continues to live in the house until his death.
(a). What are the gift tax consequences on formation of the partnership?
(b). What are the gift tax consequences on the subsequent transfers of limited partnership
interests?
(c). What are the estate tax consequences if Patrick dies two years after FLP is formed? What if
he dies five years later?
a. No gift tax on formation because everybody is buying their own interest. Full and adequate
consideration is being paid here.
b. Gift tax consequences will accrue on the subsequent gifts of interests in the partnership. The
gifts will probably not qualify as gifts of present interests in property, so the gift tax annual
exclusion will probably not apply. But, you will benefit from a valuation discount. A steep
discount on valuation will probably limit the gift tax consequences of this transaction. (Of
course, because of the lifetime 5million credit, you may never pay a cent of gift tax).
c. It depends on whether the technique worked. If it did work, then what he has left is included
in his gross estate with a steep valuation discount. If it did not work, then the entire partnership is
included in his gross estate without the benefit of the valuation discount. Here, the facts look as
though it won’t work. He continued to live in the house and manage the partnership, so it appears
that he retained all of the partnership assets.
TRANSFERS AT DEATH
§ 2037. Transfers taking effect at death.
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(a) General rule. The value of the gross estate shall include the value of all property to the
extent of any interest therein of which the decedent has at any time after September 7,
1916, made a transfer (except in case of a bona fide sale for an adequate and full
consideration in money or money’s worth), by trust or otherwise, if—
(1) Possession or enjoyment of the property can, through ownership of such interest, be
obtained only by surviving the decedent, AND
(2) The decedent has retained a reversionary interest in the property . . . and the value
of such reversionary interest immediately before the death of the decedent exceeds
5 percent of the value of such property . . .
TEXTBOOK EXPLANATION OF 2037:
Section 2037 applies if:
(1) The decedent has made a transfer in trust or otherwise,
(2) The possession or enjoyment of the property can be obtained only by surviving the
decedent, AND
(3) The decedent retains a reversionary interest and the value of that reversionary interest
immediately before the decedent’s death exceeds 5 percent of the value of the property.
Note:
 § 2037 incorporates the same transfer requirement as 2036 and 2038.
 § 2037 includes an exception for bona fide sales for adequate and full consideration in
money or money’s worth.
SURVIVORSHIP REQUIREMENT: § 2037 issues turn on the survivorship issue.
The Question under § 2037: Can possession or enjoyment of the property be obtained only by
surviving the decedent?
 If the answer is yes (and the other requirements of the statute are met)—then the property
is included in the gross estate.
TWO SITUATIONS TO CONTRAST:
1. D creates a trust to pay income to A for life and at A’s death to distribute the property to
B if living, otherwise to return to D.
a. Here, B need not survive D to get the property. So, 2037 does not apply.
b. However, because of the reversion, it is possible that D’s heirs or beneficiaries
might receive the property as a result of D’s death. Therefore, it is included in D’s
gross estate under § 2033.
2. D creates an irrevocable trust to pay the income to A for life and at A’s death to distribute
the trust property to D if living, otherwise to distribute it to B.
a. Here, B will obtain possession of the trust property only if B survives D.
Therefore, inclusion will occur under § 2037.
b. However, the value of what is included will not include A’s life estate (that value
will be subtracted out—A’s life estate is not dependent on surviving D, so it is not
included under § 2037.)
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RETENTION OF REVERSIONARY INTEREST EXCEEDING 5 PERCENT OF VALUE
OF PROPERTY:
In order for there to be inclusion under § 2037, the decedent must retain a reversionary interest
that exceeds 5 percent of the value of the property.
WHAT TYPE OF REVERSION WILL COUNT?
The reversion may be one that is retained explicitly by the decedent or it may be one that arises
by operation of law because the decedent has not transferred the entire interest if the property.
TIME OF VALUATION OF REVERSION—The value of the reversion is determined
immediately before the death of the decedent. Do you see why? If we valued it at the moment of
death, the value would be 0. A reversion is worthless if you are dead. So, we value it at the
moment before death. You can go to the IRS actuarial tables and determine the value of the
interest based on the decedent’s life expectancy.
Estate of Roy v. Comm’r (1970)—
In October 1959, decedent, then 41, and his brother transferred property in trust for the benefit of
her father, then 69. At her father’s death, the corpus was to revert to the grantors if they were
living. If either grantor predeceased the father, that grantors share of the corpus was to be
administered for the benefit of his surviving family. The decedent was in good health when the
trust was created. But, eventually her was diagnosed with glomerulonephritis. Decedent died in
1969. The October 1959 transfers were made after he had been diagnosed and it was apparent
that he had a limited life span. After he died, it came time to settle up with Uncle Sam on the
estate tax side of things. The trust contained the survivorship requirement for his family to
benefit. So, 2037 hit this. The Commissioner asserted that the decedent’s reversion should be
valued specially because of his terminal illness. The Estate argued that the reversion should be
valued based on the actuarial tables.
HELD: You use the actuarial tables to value the decedent’s reversionary interest, you don’t take
into account the special circumstances of each particular decedent.
DIRUSSO: General rule is still that you use the actuarial tables, but after this case, the IRS put
in a narrow exception whereby some terminally ill individuals reversions must be valued
specially.
P. 310 Problem 2: Della establishes an irrevocable trust with Friendly National Bank as Trustee,
to pay the income to Henry for life. At Henry’s death, the Trustee is to distribute the trust
property to Della if she is alive. If Della predeceases Henry, the Trustee is to distribute the trust
property to Isaac.
(a). What are the gift tax consequences?
(b). What are the estate tax consequences if Henry dies before Della?
(c). What are the estate tax consequences if Della dies before Henry?
(d). What are the estate tax consequences if Issac dies before Della or Henry?
(a). Gift tax consequences of income interest to Henry: completed gift, subject to gift tax. To
Issac? The gift to Issac is a completed gift of a contingent remainder. The reversion to herself is
by definition, not a gift.
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(b). Nothing is included in Henry’s gross estate (he isn’t making a transfer). So, Della gets all
her money back outright. When Della dies it will be included in her gross estate under § 2033.
(c). § 2037 would include the property in Della’s gross estate if the value of the reversion
exceeds 5% of the value of the property.
(d). The contingent remainder is included in Issac’s gross estate because if Della predeceases
Henry, the property could go to Issac’s estate.
TRANSFERS WITHIN THREE YEARS OF DEATH OR
FOR CONSIDERATION
GENERAL RULE: Gratuitous transfers, even those made on the decedent’s death bed, are not
included in the decedent’s gross estate.
§ 2035. Adjustments for certain gifts made within 3 years of decedent’s death.
(a) Inclusion of property in gross estate. IF—
(1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or
relinquished a power with respect to any property, during the 3-year period ending on
the date of the decedent’s death, and
(2) the value of such property (or an interest therein) would have been included in the
decedent’s gross estate under section 2036, 2037, 2038, or 2042 if such transferred
interest or relinquished power had been retained by the decedent on the date of his
death,
the value of the gross estate shall include the value of any property (or interest
therein) which would have been so included.
(b) Inclusion of gift tax on gifts made during 3 years before decedent’s death. The amount of
the gross estate (determined without regard to this subsection) shall be increased by the
amount of any tax paid under chapter 12 by the decedent or his estate on any gift made by
the decedent or his spouse during the 3-year period ending on the date of the decedent’s
death.
(c) . . .
(d) Exception. Subsection (a) . . . shall not apply to any bona fide sale for an adequate and
full consideration in money or money’s worth.
DIRUSSO ON 2035(a)—“2035(a) includes in the gross estate the release of any interest or
power within 3 years of the decedent’s death, if the power would have been included under 2036,
2037, 2038, or 2042. Only those particular transfers are brought back into the gross estate.
2035(d) provides a bona fide sale exception to 2035(a).”
DIRUSSO ON 2035(b)—“2035(b) brings in the gift tax actually paid in the 3 year period before
the decedent’s death, into the decedent’s gross estate. Basically, this is a 3 yr. look back rule for
gift tax paid.”
DIRUSSO ON WHY 2035(b) is necessary: Gift tax is tax exclusive while estate tax is tax
inclusive. By tax exclusive, it means that you pay the gift tax from funds separate from the fund
that comprise the gift. The estate tax, is tax inclusive, that is the entire amount of the gross estate,
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even that which will be used to pay the estate tax bill, is included in the gross estate. So, there is
a substantial advantage to making lifetimes gifts as far as estate tax liability is concerned.
2035(b) takes away/equalizes this if the gift is made during the last three years of the decedent’s
life.—NOTICE HOWEVER: 2035(b) only applies to the last three years of the decedent’s life,
so as long as you do it before the last three years of life, you can obtain the advantage that
making lifetime transfers gives you.” AND: It only applies to gift tax actually paid.
Brown v. United States (9th Cir. 2003)—
Willet Brown created an insurance trust to hold life insurance on his wife Betty’s life so that the
heirs could use the proceeds to pay estate taxes at her death. To fund the trust, Willet gave Betty
a gift of $3,100,000. Betty then wrote a check for $3,100,000 from her account payable to the
trust. The payment of the $3,100,000 to the trust was a taxable gift (a $1,415,732 tax). Willet and
Betty agreed to be jointly libable for gift taxes under § 2513(a) & (d). Under § 2035(b) gift tax
paid in the last three years of life is included in the gross estate. Willet realized that Betty, being
younger than himself, was more likely to outlive the three year period. So, Willet cut Betty a
check for the amount of the gift tax due, from which Betty paid the gift tax to the IRS. It is
admitted that the money was given to Betty with the understanding that she would use it to pay
the gift tax, however, the Estate argued that she was under no legally enforceable obligation to
use the funds to pay the gift tax liability. The Commissioner argued that the “step-transaction”
doctrine should apply and that the amount should be attributed to Willet.
HELD: The gift tax paid is properly attributed to Willet, and because it was paid within 3 yrs. of
his death, it is includable in his gross estate under § 2035(b).
A LITTLE MORE ON STEP-TRANSACTIONS DOCTRINE: Here, the Court views this
looking at it through the step-transaction doctrine. When Willet gave the check for the gift tax,
he intended, and she as well intended, that she would use those funds to pay the gift tax liability.
As such, she was acting as a “mere conduit” for passing the funds between Willet and the
Internal Revenue Service. The only reason for this transaction was avoiding the § 2035(b) claw
back for gift taxes paid, there was no economic substance to the transaction, it was simply a way
to try to lower Willet’s gross estate. Here, substance trumps form.
DIRUSSO ON BROWN: “The economic reality of the situation was that it was his money, his
gift, so the gift tax paid comes into the husbands gross estate under the three year look back for
gift tax paid.”
SECTION 2035(a) includes certain gifts in the gross estate:
§ 2035. Adjustments for certain gifts made within 3 years of decedent’s death.
(a) Inclusion of certain property in gross estate. If—
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(1) the decedent made a transfer (by trust or otherwise) of an interest in any property, or
relinquished a power with respect to any property, during the 3-year period ending on
the date of the decedent’s death, AND
(2) the value of such property (or an interest therein) would have been included in the
decedent’s gross estate under section 2036, 2037, 2038 or 2042 if such transferred
interest or relinquished power had been retained by the decedent on the date of his
death,
the value of the gross estate shall include the value of any property (or interest
therein) which would have been so included.
Example 9-10—Douglas established a revocable trust in 1995. On May 1, 2006, Douglas
releases the right to revoke the trust. He dies on September 15, 2008. Had Douglas not released
the right to revoke, the trust would have been in his gross estate under § 2038(a)(1). Because he
released the right to revoke within the three-year period before his death, the full value of the
trust will be in his gross estate under § 2035(a).
Example 9-11—Daphne establishes an irrevocable trust in 1995 with Friendly National Bank as
Trustee to pay her the income for life and at her death to distribute the property to her niece. On
March 15, 2006, Daphne releases her right to receive trust income, transferring that right to her
sister. She dies on April 10, 2008. Had she not released her right to income, the trust would have
been in Daphne’s gross estate under § 2036(a)(1). Because she made a transfer of her retained
life estate within three years of her death, the full value of the trust will be in her gross estate
under § 2035(a).
Example 9-12—Delores establishes an irrevocable trust in 1995 with Friendly National Bank as
Trustee to pay the income to Ann for life. If Delores is living at Ann’s death, the trust property
will revert to her; otherwise, it will be distributed to Delores’s children. On August 20, 2006,
Delores releases her reversionary interest, thus ensuring that the property will pass to her
children immediately upon Ann’s death. Delores dies on January 9, 2008. Had Delores not
released her reversion, the value of the trust property, less Ann’s outstanding life estate, would
have been in her gross estate under § 2037. Because she transferred her reversion to her children
within three years of her death, the same value will be in her gross estate under § 2035(a).
Example 9-13—Dominic establishes an irrevocable trust in 1995 with Friendly National Bank as
Trustee to pay the income to his children for their lives and, at the death of the last child, to
distribute the trust property to his descendants. Dominic retains the right to add or delete
beneficiaries with respect to both income and corpus. On October 31, 2006, Dominic releases his
power to add or delete beneficiaries. He dies on November 10, 2008. Had Dominic retained this
power, the trust would have been in his gross estate under either § 2036(a)(2) or § 2038(a)(1).
Because he released the power within three years of his death, the value of the trust will be in his
gross estate under § 2035(a).
Under § 2035(a), a decedent who retains an interest in trust or a power over the trust that would
have caused the trust to be included in her gross estate under §§ 2036, 2037, 2038 and then
releases that interest or power within three years of death must include the property in her gross
estate.
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Also, § 2035(a) brings in gifts of life insurance made within three years of death into the gross
estate.
NOTE: § 2035(a) can be avoided by making a bona fide sale for a full and adequate
consideration. If you legitimately sell the asset, you get it out of your gross estate (even if you
get rid of it within three years of death.) Of course, the full and adequate consideration thing
must be seen, i.e. it must be legit. Substance over form, etc.
United States v. Allen (10th Cir. 1961)—
Maria Allen created a trust, in which she reserved 3/5ths of the income for herself, the remainder
to pass to her two children. When she was 78, an estate planner advised her that her retention of
the right to income would cause the property to be included in her gross estate. So, she began to
find a way to rid herself of the interest. She discovered that her son Wharton, was considering
buying the interest. Wharton decided to purchase the interest. The actuarial tables indicated that
the value of the life estate was $135,000 and the attributable share of the corpus was $900,000.
Wharton agreed to pay $140,000 (5,000 over the value), believing that his mother’s life span was
long enough to allow him to recoup his investment. Shortly after the transaction, it was
discovered that Maria had an incurable disease, soon after she died. Due to Maria’s premature
death, Wharton suffered a considerable loss on his investment. The Commissioner, being a jerk,
asserted that the value of Maria’s life estate should be included in her gross estate under §
2035(a). The Commissioner asserted that in order to avoid the application of 2035(a), it would
have been necessary for Maria to sell the value of the interest attributable to corpus. The estate
on the other hand, argued that she sold her interest in a bona fide, arm’s length transaction for a
full and adequate consideration in money or money’s worth, causing 2035(a) to be inapplicable.
HELD: Included in Maria’s gross estate under § 2035(a), minus the purchase price paid by the
son. She would have needed to sell at the corpus value, not the value of the life estate under the
actuarial tables.
WHY? Why can’t you just sell the value of the life interest and avoid § 2035(a)? The position of
the IRS and this court was that if you could do that, it would be too easy to avoid 2035 by selling
your lifetime interest at the actuarial table value right before your death. The IRS requires that
you sell it for value of corpus attributable to your interest (which, in reality you can’t sell a life
estate for that much).
DIRUSSO: This rule minimizes your ability to take advantage of § 2035(d) in the context of
purging your retained life interest. BUT NOTICE: If she had survived three years and a day
after this transaction, she would have been fine, no gross estate inclusion.
Estate of D’Ambrosio v. Comm’r (3rd Cir. 1996)—
Vita D. owned ½ of the preferred stock of Vaparo, Inc. Those shares had a value of $2,350,000.
In 1987, Vita D. transferred her remainder interest in her shares to Vaparo, Inc. for an annuity,
while retaining her income interest in the shares. Decedent died in 1990, having only received
$592,078 in annuity payments and $23,500 in dividends. The Commissioner argued that the full
value of the shares must be included in her gross estate because of her retention of an income
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interest and the fact that she only sold her remainder interest for the actuarial value, not its full
value attributable in corpus. The Decedent’s Estate, obligatorily took the opposite position.
ISSUE: Does the sale of a remainder interest for its FMV constitute full and adequate
consideration?
HELD: Yes, indeed it does. This case limits the rule in the Allen case to selling retained life
interests. Under D’Ambrosio you can sell the remainder for its actuarial value and purge it from
your estate.
Page 328 Problem 1: Dale gives his son, Michael, gifts equal to the amount of the gift tax
annual exclusion each year.
(a). Dale dies on February 1, 2012. Are any of the annual exclusion gifts included in his gross
estate? Explain.
(b). In addition to the annual exclusion gifts, Dave gives Michael $1 million on December 5,
2011. Dale dies on February 1, 2012. Is the $1 million gift included in his gross estate? Explain.
(a). No. This would not be brought back in under 2035(a) because there was no retained
interest transferred. This would not be brought back in under 2035(b) because there was no gift
tax paid because of the gift tax annual exclusion.
(b). No. 2035(a) is inapplicable because there has been no transfer of a retained interest.
2035(b) would only be applicable if there was actually gift tax paid (here we are assuming that
this is just cutting into the 5 million dollar lifetime credit).
Page 328 Problem 2: Dee owns a life insurance policy with a face amount of $3,000,000.
(a). What are the estate tax consequences if Dee owns the policy at her death and the proceeds
are payable to her son, Carl?
(b). Instead, assume that Dee gives the policy to her son, Carl. What are the gift tax
consequences?
(c). Same as 2.b., and Dee dies two years after the gift. What are the estate tax consequences?
(d). Same as 2.b., except that Dee dies five years after the gift. What are the estate tax
consequences?
(a). Includable in gross estate (Generally, insurance policies allow you to pick the beneficiary,
so included in the gross estate).
(b). Completed gift = Dee pays gift tax on the gift based on FMV of policy. This does qualify
as a present interest in property, so the gift tax annual exclusion can be used. So, she would only
pay gift tax to the extent that the amount of the gift exceeds the gift tax annual exclusion and
unified lifetime credit.
(c). Under 2035(a) the value of the death benefit proceeds are brought back into the gross
estate.
(d). None. 2035(a) is a three-year look-back rule. If you outlive the three-year period, then you
get the interest out of your estate.
CHAPTER 10: ANNUITIES AND EMPLOYEE
DEATH BENEFITS
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Section 2039 brings into the gross estate the value of annuities and similar payments receivable
by a beneficiary who survived the decedent.
§ 2039. Annuities.
(a) General. The gross estate shall include the value of an annuity or other payment
receivable by any beneficiary by reason of surviving the decedent under any form of
contract or agreement entered into after March 3, 1931 (other than as insurance under
policies on the life of the decedent), IF, under such contract or agreement, an annuity or
other payment was payable to the decedent, or to the decedent possessed the right to
receive such annuity or payment, either alone or in conjunction with another for his life
or for any period not ascertainable without reference to his death or for any period which
does not in fact end before his death.
(b) Amount includable. Subsection (a) shall apply to only such part of the value of the
annuity or other payment receivable under such contract or agreement as is proportionate
to that part of the purchase price therefor contributed by the decedent. For purposes of
this section, any contribution by the decedent’s employer or former employer to the
purchase price of such contract or agreement (whether or not to an employee’s trust or
fund forming part of a pension, annuity, retirement, bonus or profit sharing plan) shall be
considered to be contributed by the decedent if made by reason of his employment.
Textbook explanation of when 2039 applies:
(1) There must be a contract or agreement entered into after March 3, 1931, that is not life
insurance;
(2) There must be a beneficiary who will receive an annuity or other payment by reason of
surviving the decedent;
AND
(3) The decedent must either be receiving annuity or other payments at the time of her death
or have an enforceable right to such payments.
PLUS:
(4) The payments to the decedent must arise from the same contract or agreement as the
beneficiary’s payments:
AND
(5) The Payments must continue:
(a) For the decedent’s life;
(b) For a period not ascertainable without reference to the decedent’s death;
(c) For a period that did not in fact end before the decedent’s death.
LETS LOOK AT 5 DIFFERENT ANNUITY ARRANGEMENTS AND LOOK AT THE TAX
CONSEQUENCES:
1. Annuity pays Adam a specified amount each month for the remainder of his life.
a. TAX? No. Nobody else gets anything in this arrangement, the payments end at
the end of Adam’s life.
2. Annuity pays Adam a specified amount each month for a designated number of years.
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a. TAX? No. Nobody else gets anything in this arrangement, the payments end at
the end of the specified term, and his estate takes nothing if he dies prematurely.
3. Annuity pays Adam a specified amount each month for the remainder of his life. If the
sum of those payments does not equal a certain amount, the company will pay the
difference to Adam’s estate.
a. TAX? Yes. But, not under § 2039. This comes in under § 2033.
4. Annuity pays Adam a specified amount each month for the remainder of his life and then
to pay Beth the sum for her life.
a. TAX? Yes. Beth gets the benefit on account of Adam’s death. This is included
under § 2039.
5. Annuity pays Adam and Beth a specified amount each month for their joint lives.
a. TAX? Yes. Under § 2039.
Example 10-1—Fidelity agrees to pay Dan an annuity of $2,000 per month from age 70 until his
death. Dan dies at age 72. Nothing is in his gross estate because all payments cease at his death.
The same result occurs if Dan dies at age 64 before he begins receiving payments.
. . . Assume that instead, Dan contracts with Fidelity to pay a lump sum to his estate if he dies
before receiving a certain number of payments. Assume that the annuity requires Fidelity to pay
Dan’s estate $100,000 less the sum of all payments received by Dan before his death. Dan dies
after receiving $60,000, and Fidelity pays his estate $40,000. Section 2039 does not apply to the
$40,000, because no “annuity or payment” is received by “any beneficiary by reason of surviving
the decedent.” Section 2033, however, brings the $40,000 into Dan’s gross estate because he
had an interest in that amount at the time of his death, and that amount passes form Dan to
his beneficiaries or heirs either through his will or by intestacy.
Example 10-2—Fidelity agreed to pay Debra an annuity of $1,000 per month for her life and the
same amount to her sister, Susan, for her life. When Debra dies, the value of the annuity to be
paid to Susan will be in her gross estate under § 2039. There is a contract between Debra and
Fidelity; there are payments to a surviving beneficiary, Susan, under the same contract.
WHAT IS INCLUDED IN THE GROSS ESTATE UNDER § 2039(b)?
The portion of the annuity attributable to the decedent’s contribution to the annuity. If the
decedent paid the full purchase price, then the full value of the annuity payments will be in her
gross estate.
EMPLOYER CONTRIBUTIONS: Amounts paid by the decedent’s employer are considered
as contributions by the decedent if the contributions were made by reason of the decedent’s
employment.
Example 10-3—Debra and her sister, Susan, each contributed equally to the purchase of a joint
and survivor annuity. Debra dies, survived by Susan. The value of the annuity at Debra’s death is
$50,000. Because Debra and Susan contributed half of the purchase price, only $25,000 is in
Debra’s gross estate under § 2039.
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RETIREMENT ANNUITIES PROVIDED BY EMPLOYERS
Section 2039 applies not only to annuities purchased directly by the decedent, but also to
retirement annuities provided through employment.
Retirement annuities paid, or payable, to the decedent and then to a designated beneficiary are
included in the decedent’s gross estate whether paid through a qualified plan or a nonqualified
plan.
Where the beneficiary is the decedent’s spouse, the value of the annuity will usually qualify
for the marital deduction.
Example 10-4—Dan retires and is collecting benefits from his § 401(k) plan at the time of his
death. His wife, Wanda, continues to receive benefits from the plan as his designated beneficiary.
The present value of the benefits to Wanda will be included in Dan’s gross estate under § 2039,
but they will qualify for the marital deduction under § 2056.
Example 10-5—Debra is collecting benefits from her IRA account at the time of death. After her
death, her sister, Susan, collects benefits as Debra’s surviving beneficiary. The present value of
the payments to Susan will be in Debra’s gross estate under § 2039.
Page 335 Problem 1: David purchases an annuity from Fidelity.
(a). What are the estate tax consequences if David is to receive the greater of $1,500 per month
for his life or $100,000 and David dies after receiving payments totaling $125,000? What if
David has only received $75,000?
(b). What are the estate tax consequences if David is to receive $1,500 per month for his life an
after his death his nephew, Ned, is to receive $1,500 per month for his life? David predeceases
Ned.
(a). If he had already received $125,000—nothing is included in his gross estate, because
nobody gets anything after he dies.
If he had only received $75,000—$25,000 would be due to his estate, and this $25,000 would be
included in the gross estate under § 2033 (but not under § 2039).
(b). § 2039 kicks in, the death value to Ned included in David’s gross estate.
Page 355 Problem 2: Harold retired and received Social Security benefits of $1,000 per month.
After his death, his spouse, Wendy, began receiving Social Security benefits of $1,000 because
she was Harold’s surviving spouse. Is the value of the Social Security benefits payable to Wendy
in Harold’s gross estate under § 2039?
No, not included in the gross estate. There was no contract or agreement for Social Security
benefits—in order for § 2039 to come into play, you must have a contract or an agreement.
Page 355 Problem 3: Diane was employed by XYZ, Inc., which provided a retirement benefit
plan. Under the plan, Diane was entitled to an annuity based on her salary and years of service at
retirement or permanent disability. If Diane was married, the annuity would be paid to her
surviving spouse after her death. If Diane was not married, she could designate another
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beneficiary if she died before she began receiving payments. Assume the plan is a qualified
retirement plan.
(a). What are the estate tax consequences if Diane dies while receiving benefits and her surviving
spouse, Steve, continues to receive an annuity?
(b). What if Diane is not married and the annuity payments cease at her death?
(c). What if Diane dies before retirement and her daughter, Nancy, receives a lump sum
payment?
(d). Would the result be different if this was a nonqualifed plan?
(a). Included under § 2039, this fits all the requirements of the statute.
(b). Not included under § 2039, no other beneficiary receives payments.
(c). Included under § 2039. One lump sum payment to a beneficiary is enough, it doesn’t have
to be a series of payments.
(d). No, no different treatment between a qualified and nonqualified plan.
PRIVATE ANNUITIES AND SELF-CANCELING
INSTALLMENT NOTES
A private annuity is an annuity agreement between private individuals (rather than having a
commercial enterprise involved).
When do you see private annuities?
Often, you see them in the context of sale of property by the decedent to family members.
§§ 2033 and 2039 apply to private annuities.
Example 10-6—Drew transfers Blackacre to his daughter, Lisa, in exchange for her promise to
pay him $1,200 per month until his death. Drew dies seven years after the transfer. Nothing is in
his gross estate because the payments cease at his death. If the value of the annuity is not equal to
the fair market value of Blackacre on the date of transfer, the transaction will be characterized as
a part-sale/part-gift.
WHAT IF INSTEAD—Drew’s agreement with his daughter requires her to pay the greater of
$,1200 per month for his life or $250,000. Any amount not paid to Drew before death is to be
paid to his estate. Drew dies after Lisa has made payments totaling $150,000. The $100,000 due
on his death is in Drew’s gross estate pursuant to § 2033.
WHAT IF EVEN INSTEAD—the agreement requires Lisa to pay Drew $1,200 per month until
his death and then to pay that sum to Drew’s spouse, Sarah. At Drew’s death, the value of the
annuity payments to Sarah will be in Drew’s gross estate under § 2039(a).
SCIN—Self Cancelling Installment Notes—under a SCIN, if you survive the lender the rest if
forgiven. You have to pay extra consideration for this feature, but it can be nice.
There are 3 possible ways that a Self-Cancelling Installment Note can be characterized—
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1. Installment Sale
2. Annuity (maybe includable under § 2039).
3. Transfer with a retained life estate (Included under § 2036).
Estate of Moss v. Comm’r (1980)—
Moss sold his stock in his company to the company in exchange for a note. The note had a selfcancelling feature, such that when Moss died, the company would cease to be liable on the note,
they would not have to make any payment to his estate. The Commissioner argued that the value
of the note should be included in his gross estate.
ISSUE: Included in gross estate?
HELD: No.
REASONING: Here, we see a sale for full and adequate consideration. The self-cancelling
feature was just part of the consideration.
DIRUSSO ON SELF-CANCELLING INSTALLMENT NOTES: “If as part of the
consideration you include the self-cancelling feature, you don’t include it in the gross estate. The
downside is that it costs more. Full and adequate consideration for a self-cancelling feature costs
more.”
VALUATION POINT—although the estate tax consequences of annuities and installment sales
with cancellation provisions are similar, the valuation for gift tax purposes is different.
 An annuity will be valued on the basis of the seller’s actuarial life expectancy.
 The valuation of the self-cancelling installment note is more subjective, looking at all the
facts and circumstances to determine the FMV.
In some cases, a private annuity will be treated as a transfer with a retained life interest under §
2036(a)(1). When this occurs, the full date-of-death value of the transferred property is included
in the decedent’s gross estate. –An issue of substance over form—
Estate of Bergen v. Comm’r (Tax Court 1943)—
Here we have three sisters (Margaret, Sarah, and Kate). Kate died intestate, all her property
passing to Margaret and Sarah. Sarah approached Margaret with a proposition. Margaret would
take all of Kate’s estate except for $50,000 in bonds that were to be transferred to Sarah, in
return for the estate property Margaret was to pay all the living expenses of Sarah for her life.
The Commissioner argued that this amounted to Sarah transferring the property and retaining a
life estate in the property. The estate argued that this was simply a transfer of the property for
full and adequate consideration (Margaret got the property, Margaret had to provide support for
Sarah, so long as Sarah lived).
HELD: Not included in gross estate.
REASONING: She transferred the property in consideration for support payments for the rest of
her life. We have a § 2039 question. Nobody receives any payments after her death, so no
inclusion in the gross estate.
DIRUSSO: “How you structure and document your transaction is important—be meticulous in
your documentation, make them sign an annuity contract. Make sure you dot your I’s and cross
your T’s. Do it the right way, don’t cut any corners.”
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Estate of Fabric v. Comm’r (Tax Court 1984)—
Mollie Fabric executed an agreement, which included an annuity agreement, a few days before
undergoing major surgery. The Commissioner argued that she did not make a true annuity
agreement, that in substance she retained a life estate. In the alternative, the Commissioner
argued that even if there was an annuity, Fabric was not entitled to use the actuarial tables due to
her illness.
HELD: Not includable, this was a legit annuity plus the taxpayer was entitled to use the actuarial
tables.
SECTION 7520 VALUATION:
Section 7520 prescribes the valuation tables and principles to determine the valuation of
annuities, life estates, terms of years, and remainders.
--Valuation of annuities factors in two components:
 Interest Rate Component
AND
 Mortality Component
In most circumstances the taxpayer is entitled to use the actuarial tables:
 If the individual who serves as the measuring life is terminally ill on the valuation date
then the tables cannot be used. Terminally ill means that there is at least a 50 percent
probability that the individual will die within one year.
P. 346-347 Problem 2: Derek owned a printing company and sold it to Peter, a longtime
employee of the company.
(a). Peter agreed to pay Derek $10,000 per month until Derek died or until he had made
payments totaling $5,000,000, whichever occurred first. What are the estate tax consequences if
Derek dies after receiving payments totaling $1,500,000?
(b). Instead, Peter agreed to pay Derek 15 percent of the net profits of the printing business each
year until Derek died or Peter had made payments totaling $5,000,000 whichever occurred first.
If Peter sold the printing business before Derek died or before making payments of $5,000,000,
he would owe Derek the difference between $5,000,000 and the amount of payments made. If 15
percent of the net profits were below a specified amount for three years in a row, the property
would revert to Derek. Derek dies eight years later. What are the estate tax consequences?
(a). This looks more like an installment sale, as long as it is reasonable based on his life
expectancy that he will live long enough to collect.
--If this is an installment sale, no inclusion in the gross estate so long as full and adequate
consideration was paid (if not full and adequate, maybe a gift tax problem).
--If this is an annuity, no inclusion, the right to payment ceases at his death.
(b). This could be an installment sale or this could be a transfer with a retained life interest.
But, this is probably a transfer with a retained life interest—the right to income here is tied to the
property—so the 15% interest will probably be included in the gross estate.
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P. 347 Problem 3: Donna establishes an irrevocable trust for the benefit of her children and
grandchildren with FNB as Trustee. Six months after creating the trust, Donna transferred stock
valued at $8,000,000 to the trust in exchange for a payment of $450,000 each year for 20 years.
Donna died 12 years after creating the trust. What are the estate tax consequences?
This could be an annuity or this could be a transfer with a retained life interest.
 If the trustee has the obligation to pay regardless of the performance of the stock, then it
is an annuity.
 If the rights are tied to performance of the stock = then it is a transfer with a retained life
estate.
EMPLOYEE DEATH BENEFITS
Employers provide a wide array of retirement benefits to employees. Often, employers also
provide a survivor’s benefit to an employee’s spouse, dependent child, or other specified
dependent if the employee dies during the term of employment.
The estate tax consequences depend on the terms and conditions of the benefit and analysis
under §§ 2033, 2036, 2038, and 2039.
And make sure to remember—contributions made by the employer are considered contributions
by the employee.
Estate of Barr v. Comm’r (Tax Court 1963)—
Barr worked for Eastman-Kodak. Eastman-Kodak provided a death benefit to the surviving
spouse of an employee. However, there was no guarantee that the surviving spouse would
receive the benefit, it was given in the discretion of the corporate directors, so there was no right
to receive the death benefit.
INCLUDED? No. this is not included in the gross estate of the decedent. § 2033 and § 2039
both require the right to payments. There was no right to payments here, this was a discretionary
payment. The estate has no right to it, the decedent has no right to it. The estate tax is an excise
tax upon the privilege of transferring property upon death. But here, Barr didn’t have any
property in this to transfer.
DIRUSSO: The point—how the employer structures their benefit has tax consequences.
Estate of Tully (Court of Claims 1976)—
Tully was a 50% shareholder in T & D, Inc. Tully and his partner made a contract with the
company their company T &D to pay their surviving spouses a death benefit upon their demise.
The company was to directly pay the benefit to the surviving spouse. The Commissioner argued
that this should be included in the Decedent’s gross estate because Tully retained the power to
alter, revoke, or terminate the arrangement. Of course, the Estate argued that Tully had indeed
not reserved such powers.
ISSUE: Did Tulley have the power to alter, revoke, or terminate?
HELD: NO.
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ANALYSIS: First, the Commissioner pointed out that Tully was a shareholder so he had control
over the company, such that he could have the arrangement revoked. But, the Court rejected this.
Tully was only a 50% shareholder in the corporation. For him to be able to do this, he would
have had to convince the other shareholder to do it, which his ability to do so was speculative at
best. Then, the Commissioner argued that Tully could have revoked the arrangement by
divorcing his wife, because is she was not married to him she could not get the death benefit as a
surviving spouse. Technically this was true, but the Court did not buy this argument, it was
speculative at best. So, the Court completely rejected the Comm’r argument in regards to any
2038 power. The Court also rejected the argument that this should be included under § 2033.
Tully did not own the right to the property at the time of his death, so § 2033 just couldn’t come
into play here. The Comm’r finally got his comeuppance and lost big in this case.
While the Commissioner has been relatively unsuccessful in arguing that employer survivor
benefits should be included under § 2033 and § 2038, he has been somewhat more successful
including survivor’s benefits under § 2039.
Survivor’s Benefits Analysis under § 2039: Whether the decedent was receiving payments at
the time of his death or had an enforceable right to payments pursuant to the same contract or
agreement that provided the payment to the survivor.
The Treasury Regulations have interpreted the “contract or agreement” requirement broadly—
including “any arrangement, understanding, or plan or any combinations of arrangements,
understandings, or plans arising by reason of the decedent’s employment.”
SO—the right to receive a pension or a retirement benefit can be combined with the survivor
benefit to find a “contract or agreement.”
BUT—receipt of salary can’t be combined with the survivorship benefit—can’t do that
Commissioner.
Estate of Siegel v. Comm’r (Tax Court 1980)—
Siegel worked for Vornado, Inc. as CEO. Siegel’s employment agreement provided that in the
case of his disability, he would still render services to the extent possible. Another provision in
the agreement gave a survivorship benefit to his children after his death. He and the company
mutually agreed to reserve the right to alter or amend the employment agreement.
The Commissioner argued that this agreement should be included in the gross estate under either
§ 2038 or § 2039.
SECTION 2039 ANALYSIS: NOT INCLUDED. WHY?
The Commissioner argued that the decedent’s rights to payments during disability should be
combined with the children’s survivorship benefits to find a “contract or agreement” under
which the decedent had a right to receive payments at his death and which provided a benefit to a
survivor. However, the Court rejected this argument. The decedent was bound to preform
services for the company, even while disabled, so this was salary. Salary can’t be combined with
a survivorship benefit to find a “contract or agreement.” BAD COMMISSIONER, you made as
stupid argument.
SECTION 2038 ANALYSIS: INCLUDED. WHY?
The Commissioner argued that the decedent retained the right to revoke, alter, or amend the
agreement, so it should be included in his gross estate under § 2038. If you look at the
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agreement, the company and the decedent expressly reserved the right to modify the agreement
and alter the rights of the beneficiaries. Well, the Commissioner may actually have a point on
this one. The decedent kept enough “strings” to justify inclusion under § 2038(a)(1). They had
the right to alter, revoke, or modify the agreement, so it will be included in the decedent’s gross
estate.
P. 363 Problem 1: Abby was employed by Smallco, Inc. ,which had negotiated an agreement
with Abby to pay her five times her annual salary if she worked for Smallco, Inc. for at least ten
years and agreed not to compete with Smallco, Inc. for two years after leaving Smallco, Inc. The
agreement applied if Abby left Smallco, Inc. voluntarily, if she was terminated, if she retired, if
she died while employed by Smallco, Inc. or if she became disabled. If Abby died before
receiving payment, the payment would be made to her estate. Abby died after working 15 years
for Smallco, Inc. and the company paid her estate $750,000 pursuant to the agreement. What are
the estate tax consequences, if any?
This is included in her gross estate. This is included under § 2033 because the decedent had an
interest at her death and her estate got it after her death. Through her will, she could direct what
happened to it, so this is a § 2033 inclusion issue.
P. 363 Problem 3: Chris was employed by MNO, Inc., which had adopted a plan to pay any
beneficiary designated by the employee an amount equal to three times his or her annual salary if
the employee died while working for MNO, Inc. Employees could change the beneficiary
designation at any time, but employees had no right to payments themselves. MNO, Inc. also
provides all employees with group term life insurance, medical and dental insurance, and shortand long-term disability insurance. Chris died while employed by MNO, Inc. and the company
paid his surviving spouse, Lynn, $630,000.
(a). What are the estate tax consequences if any?
(b). What if Chris was one of three equal owners of MNO, Inc.?
(a). Under § 2033—not included, he doesn’t have an interest in the payments to pass at death.
Under § 2039—we need more facts—is there a right to payments in the decedent during life
under the disability policy—might could combine that with the survivorship benefit to find a
“contract or agreement.”
Under § 2038—included—he can control who gets it. He retained the right to alter or amend.
Under § 2036(a)(2)—included—he retained the right to alter the beneficial enjoyment.
(b). Ownership doesn’t change anything. It does make it easier to find that a transfer occurred,
but overall this is not very significant.
CHAPTER 11: POWERS OF APPOINTMENT
WHAT IS A POWER OF APPOINTMENT?
-A power of appointment is the right to designate who will enjoy property.
--The right to appoint property, demand property, designate beneficiaries, withdraw property, or
consume property are powers of appointment.
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But—the right to invest or manages property (which does not affect beneficial enjoyment) is not
a power of appoint.
POWERS OF APPOINTMENT COME IN TWO FLAVORS—General and Limited.
a. General Power of Appointment—the power to appoint to yourself, your estate, or
your creditors, or the creditors of your estate (or anybody else for that matter).
b. Limited Powers of Appointment—all other powers of appointment (so long as
they don’t include the power to appoint to yourself, your estate, or your creditors,
or the creditors of your estate).
A power of appointment is generally created by someone else, who gives you the power.
SECTION 2041 includes in the gross estate property over which the decedent has a general
power of appointment at the time of death.
SECTION 2041 includes property over which the decedent has released or exercised a general
power of appointment under conditions which, if the decedent had been the owner of the
property, would have included that property in the decedent’s gross estate pursuant to §§ 20352038.
§ 2041. Powers of Appointment. (ESTATE TAX)
(a) In general. The value of the gross estate shall include the value of all property—
(1) . . .
(2) Powers created after October 21, 1942. To the extent of any property with respect
to which the decedent has at the time his death a general power of appointment
created after October 21, 1942, or with respect to which the decedent has at any
time exercised or released such a power of appointment by a disposition which is
of such nature that if it were a transfer of property owned by the decedent, such
property would be includible in the decedent’s gross estate under sections 2035 to
2038, inclusive. For purposes of this paragraph (2), the power of appointment shall
be considered to exist on the date of the decedent’s death even though the exercise
of the power is subject to a precedent giving of notice or even though the exercise
of the power takes effect only on the expiration of a stated period after its exercise,
whether or not on or before the date of the decedent’s death notice has been given
or the power has been exercised.
(b) Definitions. For purposes of subsection (a)—
(1) General Power of Appointment. The term “general power of appointment” means
a power which is exercisable in favor of the decedent, his estate, his creditors, or
the creditors of his estate; except that—
(A) A power to consume, invade, or appropriate property for the benefit of the
decedent which is limited by an ascertainable standard relating to health,
education, support, or maintenance of the decedent shall not be deemed a
general power of appointment.
(B) A power of appointment created on or before October, 21, 1942, which is
exercisable by the decedent only in conjunction with another person shall not
be deemed a general power of appointment.
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(C) In the case of a power of appointment created after October 21, 1942, which
is exercisable by the decedent only in conjunction with another person—
(i)
If the power is not exercisable by the decedent except in
conjunction with the creator of the power—such power shall not
be deemed a general power of appointment.
(ii)
If the power is not exercisable by the decedent except in
conjunction with a person having a substantial interest in the
property, subject to the power, which is adverse to the exercise of
the power in favor of the decedent—such power shall not be
deemed a general power of appointment . . .
(2) Lapse of power. The lapse of a power of appointment created after October 21,
1942, during the life of the individual possessing such power. The preceding
sentence shall apply with respect to the lapse of powers during any calendar year
only to the extent that the property, which could have been appointed by exercise
of such lapsed powers, exceeded in value, at the time of such lapse, the greater of
the following amounts:
(A) $5,000
OR
(B) 5 percent of the aggregate value, at the time of such lapse, of the assets out
of which, or the proceeds of which, the exercise of the lapsed powers could
have been satisfied.
§ 2514. Powers of Appointment. (GIFT TAX)
(a) . . .
(b) Powers created after October 21, 1942. The exercise or release of a general power of
appointment created after October 21, 1942, shall be deemed a transfer of the property by
the individual possessing such power.
(c) Definition of general power of appointment. For purposes of this section, the term
“general power of appointment” means a power which is exercisable in favor of the
individual possessing the power . . . , his estate, his creditors, or the creditors of his
estate; except that—
(1) A power to consume, invade, or appropriate property for the benefit of the
possessor which is limited by an ascertainable standard relating to the health,
education, support, or maintenance of the possessor shall not be deemed a
general power of appointment . . .
(d) . . .
(e) Lapse of power. The lapse of a power of appointment created after October 21, 1942,
during the life of the individual possessing the power shall be considered a release of
such power . . . [to the extent that the lapse] exceeds in value the greater of the following
amounts:
(1) $5,000
OR
(2) 5 percent of the aggregate value of the assets out of which, or the proceeds of
which, the exercise of the lapsed powers could be satisfied.
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LETS BREAK DOWN § 2041 PART BY PART
§ 2041 brings into the gross estate property over which the decedent has a general powers of
appointment:
a) At death.
b) Which the decedent exercised or released that would qualify under §§ 2035-2038.
§ 2041(b) defines a general power of appointment.
§ 2041(b)(1)(A) provides an ascertainable standard exception whereby a power that is limited by
a ascertainable standard relating to the health, education, support, or maintenance of the decedent
is not considered a general power of appointment.
§ 2041(c) provides rules for jointly held powers. In two cases a co-holder of the power can make
it not a general power of appointment:
i) If the power is exercisable only in conjunction with the creator of the power.
ii) If the power is exercisable only in conjunction with someone with a substantial
adverse interest.
§ 2041(e) provides the rules for when a lapse of a power will be treated as if it was a release—
this is the 5 or 5 rule—to the extent the lapse is under this amount, then you are ok. The general
rule is that if you have the power and you allow it to lapse, you are treated as transferring the
property (i.e. making a gift) except the 5 or 5 rule gives you a safeharbor whereby you will not
be treated as the transferor (i.e. not treated as making a gift).
Example 11-2—Dan creates an irrevocable trust with FNB as Trustee to pay the income to Amy
for her life and to distribute the trust property to Amy’s children in equal shares at her death. The
trust also gives Amy the right to withdraw trust property at any time for any purpose. Because
Amy can withdraw trust property for her own benefit or to pay her creditors, Amy has a general
power of appointment.
Example 11-3—Dan creates an irrevocable trust with FNB as Trustee to accumulate trust
income or to distribute it to Bruno as, and when, he requests it. At Bruno’s death, the Trustee is
to distribute the trust property to Bruno’s children in equal shares. Because Bruno can withdraw
trust income for his own benefit or to pay his creditors, he has a general power of appointment.
Example 11-4—Dan creates an irrevocable trust with FNB as Trustee to pay the income to Celia
for her life and to distribute the trust property to those of Celia’s children as she designates in her
will. Because Celia can only appoint the trust property among her children, she does not have a
general power of appointment.
What about when the trust says that the property may be appointed to “such person or persons as
[the person] designates in his/her will.”? It is a matter of state law. Generally, most states
would view this as a allowing the decedent to appoint the property to her estate or creditors, thus
making it a general power of appointment. However, at least one state (Maryland) has found that
this language precludes appointment to the estate or creditors. So at least in Maryland, this is not
a general power of appointment.
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BIG POINT: Whether the decedent has a general power of appointment is a question of state
law. The taxation of property subject to a power of appointment is a question of federal law.
Keeter v. United States (5th Cir. 1972)—
Keeter’s husband died in 1930. He owned a life insurance policy. The policy provided that
Keeter would receive income for life and that the principal and accrued interest would be paid to
“the executor or administrator” of Keeter’s estate. Keeter left a will, giving any property she had
a power of appointment over to her three daughters in equal shares. The Commissioner argued
that the property was subject to a general power of appointment and must be included in the
decedent’s gross estate.
HELD: Included in the gross estate as property over which the decedent had a general power of
appointment.
INTERACTION BETWEEN FEDERAL AND STATE LAW UNDER 2041: The Courts
look to state law to determine whether the substance of the property interest created fits within
the federal tax law definition of a power of appointment. But, it is the substance of the state law
that is relevant, not the labels that state law attaches.
REASONING: Under 2041, a general power of appointment is defined as “a power which is
exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate.” The
language here is disjunctive, so ability to appoint to any of the listed group is enough to trigger
gross estate inclusion. Here, the insurance policy put the funds into hands of the estate of Keeter.
This allowed Keeter the power to direct the disposition of the property through her will. There
were no restrictions on who Keeter could appoint the property to. Here, she exercised a general
power of appointment, so it ends up in her gross estate.
Jenkins v. United States (5th Cir. 1970)—
Martha and Ada were sisters. Martha died, leaving in her will a life estate for Ada, the will also
provided that Ada had the absolute right to dispose of the property however she liked. Seventeen
days after Martha died, and before Ada could do anything with the property, Ada died. Ada
never exercised her power of appointment because of the short-time period, and because she
lived in a frugal manner, her estate argued that she never would have exercised the power. The
Commissioner however argued that all of this was irrelevant, he maintained that a general power
of appointment existed, and therefore that the property must be included in the decedent’s gross
estate.
HELD: Included in the gross estate.
REASONING: The fact that she really didn’t have an opportunity to exercise the power of
appointment didn’t matter for purposes of § 2041. What matters is that the power exists, not
whether you actually used it or planned to use it.
DIRUSSO: “Notice also that both inter vivos and testamentary powers of appointment are
brought into the gross estate. Makes no difference.”
****--A decedent is considered to have a power of appointment even if they have no knowledge
of the power. So, there could be a power of appointment with your name on it floating around
out there you don’t even know about, and if you were to die, it would be included in your gross
estate, despite the fact that you didn’t even know it existed.
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***Furthermore, if the decedent is unable to exercise the power because of incompetency the
property is still included in the decedent’s gross estate—remember it is the existence of the
power, not the exercise of it that causes gross estate inclusion.
P. 375 Problem 1: Peter establishes an irrevocable trust with FNB as Trustee. The Trustee is to
distribute income to Ann for her life and, at her death, to distribute the trust property to Ann’s
issue.
(a). Ann has the right to ask the Trustee to distribute corpus to her or to her issue at any time and
for any purpose. Ann dies without exercising the power. What are the estate tax consequences?
(b). Instead, Ann can appoint the trust property in her will “to any person.” What are the estate
tax consequences?
(c). Instead, Ann can appoint the trust property in her will but only among her issue. What are
the estate tax consequences?
(d). Same as 1.c., except that Ann had borrowed money from her daughter, Ellen.
(e). Same as 1.c., except that if Ann did not appoint the trust property, it passed to her executor.
What are the estate tax consequences?
(a). Included under § 2041—a general power of appointment—both the income and the corpus
are brought in to the gross estate.
(b). Depends on what “any person” means.” A matter of state law, if state law says this means
you can appoint to yourself, you estate, your creditors, or the creditors of your estate, then it is a
general power of appointment and it is included in your gross estate. If, like Maryland, the
language is read as not allowing you to appoint to yourself or your creditors, then it is not a
general power of appointment and therefore not included in your gross estate.
(c). This is not included in the gross estate. This is a limited power of appointment, § 2041
only snags general powers of appointment.
(d). Not included. We don’t analyze every individual to which the power extends to see if they
are a creditor, so long as it does not extend to creditors as a class. Here, this is a limited power of
appointment, so this would not be included in her gross estate.
(e). Included in her gross estate under § 2041. By not acting on the power, the property goes to
the estate. Thus, it is a general power of appointment.
P. 375 Problem 3: Sally establishes an irrevocable trust with Tom as Trustee. The Trustee is to
use the income and corpus of the trust for the benefit of Sally’s grandson, Larry, until he is 21.
When Larry is 21, the Trustee is to distribute the trust property and accumulated income to
Larry. If Larry dies before 21, the trust property is to be distributed to whomever Larry appoints
in his will. In the absence of an appointment by Larry, the trust property is to be distributed to his
surviving siblings.
(a). What are the gift tax consequences to Sally on creation of the trust?
(b). What are the estate tax consequences to Larry if he dies at age 17?
(c). What are the estate tax consequences to Tom if he dies when Larry is 15? Assume that Tom
is Larry’s parent.
(a). Completed gift. It is a present interest, so it qualifies for the annual exclusion up to the
limit.
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(b). Goes into his gross estate as a general power of appointment (this will be true in the case
of any 2503(c) trust, in all 2503(c) trusts the child must have a general power of appointment to
work).
(c). This would be included in his gross estate because he could tap into the trust for his
support obligation—so it is included in the gross estate. DiRusso: “Here, you could have just
given the power to a grandparent or a sibling, so long as the person involved did not have a
support obligation towards the beneficiary you would have been fine.”
POWERS SUBJECT TO AN ASCERTAINABLE
STANDARD
§ 2041. General powers of appointment.
a) . . .
b) Definitions. For purposes of subsection (a)—
(1) General power of appointment. The term “general power of appointment” means
a power which is exercisable in favor of the decedent, his estate, his creditors, or
the creditors of his estate; except that—
(A) A power to consume, invade, or appropriate property for the benefit of the
decedent which is limited by an ascertainable standard relating to the
health, education, support, or maintenance of the decedent shall not be
deemed a general power of appointment.
DIRUSSO: If the property can be consumed, invaded, or appropriated for the decedent’s benefit
only in connection with an ascertainable standard relating to the health, education, support, or
maintenance of a decedent, then it is not considered a general power of appointment—it is
deemed not to be a general power of appointment.
Estate of Vissering v. Comm’n (10th Cir. 1993)—
The Commissioner asserted that a certain Mr. Norman H. Vissering held a power of appointment
over property at his death, which must be included in his gross estate under § 2041. The
provisions of the trust allowed the trustees to invade the funds “required for the continued
comfort, support, maintenance, or education of said beneficiary.” The estate argued that this
provided an ascertainable standard such that the property should not be included in the gross
estate. The Commissioner argued that the word comfort kept this from being an ascertainable
standard—because the code language regarding ascertainable standards consistently refer to
ascertainable standards relating to health, education, support or maintenance.
HELD: This is an ascertainable standard, so not a general power of appointment, so not included
in his gross estate.
REASONING: We look to the substance of state law to determine whether language creates an
ascertainable standard. The Court was convinced that if all the document said was “comfort,” the
Florida Supreme Court would have determined that it was not an ascertainable standard.
However, there were limiting words that modified the word comfort. The Court found that the
words “required for the continued comfort” was limiting enough to create an ascertainable
standard.
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Hyde v. United States (D.N.H. 1996)—
Dorothy Hyde died in 1992. Her son filed her estate tax return, he included in her gross estate the
value of a trust left for Dorothy’s benefit by her mother. The trust provided that Dorothy with a
life estate in the trust assets and empowered Dorothy “to use the income and so much of the
principal as in her sole discretion shall be necessary and desirable.” Her son included this in her
gross estate as property subject to a general power of appointment. However, her estate later
attempted to argue that the necessary and desirable language created an ascertainable standard,
such that the property should not be deemed a general power of appointment and should not be
included in her gross estate. Her estate sought a refund. The Commissioner par usual, denied the
refund. He argues that necessary and desirable in the sole discretion of the beneficiary is not an
ascertainable standard.
HELD: Not an ascertainable standard, so it is a general power of appointment and is included in
her gross estate.
REASONING: To qualify for the 2041(b)(1)(A) exception the power of appointment must 1) be
limited by an ascertainable standard and 2) the limiting standard must relate to his own health,
education, and/or support or maintenance. An ascertainable standard is a standard that a court
could objectively set a value for, i.e. the beneficiary could go into court and demand the trustee
to make a distribution and the court could determine an amount to compel the trustee to
distribute. That is not the case with a standard that is linked to what the beneficiary in her sole
discretion regards as necessary and desirable. This is clearly a GPOA and must be included in
the decedent’s gross estate under § 2041.
P. 381 Problem 1: Gloria’s will provided “All the rest and residue of my property, of whatever
kind and wherever situated, I leave to my son, Adam, for his life, to use in any manner that he
deems proper. Any property remaining at the death of Adam is to be distributed to his surviving
issue.” Adam invested the property he acquired from Gloria and maintained it in an investment
account separate from his other property. Is this property included in Adam’s gross estate?
Yes. This will be included in Adam’s gross estate. “To use in any manner he deems proper” is
likely not an ascertainable standard, so this is a general power of appointment and will be
included in the gross estate under § 2041.
P. 382 Problem 2: George established an irrevocable trust with Friendly National Bank as
Trustee for the benefit of his daughter, Beth. Is the trust in Beth’s gross estate under the
following circumstances?
a. The trust provided that the Trustee was to distribute income or principal to Beth as she
requests for her support and maintenance.
b. The trust provided that the Trustee was to distribute income and principal to Beth, if she
deemed it necessary and desirable.
c. The trust provided that Beth could withdraw trust principal if needed in an emergency.
a. No, not included, “support and maintenance” is an ascertainable standard.
b. Yes, this is included in her gross estate, “necessary and desirable” is not an ascertainable
standard, so this is a general power of appointment.
c. No, not included in the gross estate, this is not deemed to be a general power of appointment
because “emergency” is an ascertainable standard.
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JOINT AND CONDITIONAL POWERS
§ 2041. General power of appointment.
(a) . . .
(b) . . .
(c) In the case of a power of appointment created after October 21, 1942, which is
exercisable by the decedent only in conjunction with another person—
(i) If the power is not exercisable by the decedent except in conjunction with the
creator of the power—such power shall not be deemed a general power of
appointment.
(ii) If the power is not exercisable by the decedent except in conjunction with a person
having a substantial interest in the property, subject to the power, which is adverse
to exercise of the power in favor of the decedent—such power shall not be deemed
a general power of appointment . . .
Under 2041(c) a power of appointment is not a general power for purposes of § 2041 if it can
only be exercised by the decedent in conjunction with either: the creator of the power or an
individual having a substantial adverse interest in the property subject to the power.
DIRUSSO: We have two exception here were having a co-holder of a power will make it not a
general power:
(1) Co-holder is the donor.
(2) Co-holder has substantial adverse interest.
CO-HOLDER IS DONOR—under § 2041(c)(i) if the beneficiary can only exercise the power in
conjunction with the donor, then it is not a general power of appointment and not included in the
beneficiary decedent’s gross estate.
CO-HOLDER HAS A SUBSTANTIAL ADVERSE INTEREST—under § 2041(c)(ii) if the
beneficiary can only exercise the power in conjunction with someone who holds a substantial
adverse interest in the property subject to the power.
WHO HAS AN ADVERSE INTEREST? An individual has an adverse interest only if she has
“a present or future chance to obtain a personal benefit from the property itself.”
HOW SUBSTANTIAL IS SUBSTANTIAL? An adverse interest is substantial “if its value in
relation to the total value of the property subject to the power is not insignificant.”
CAN A TRUSTEE HAVE A SUBSTANTIAL ADVERSE INTEREST? A trustee does not
have a substantial adverse interest in trust property unless the trustee has a beneficial interest in
the trust.
TAKERS IN DEFAULT AND ADVERSE INTERESTS—A taker in default has an adverse
interest.
But, a co-holder of the power does not have an adverse interest merely because he is a coholder of the power or even if he is a permissible appointee.
§ 2041. General power of appointment.
(a) In general. The value of the gross estate shall include the value of all property—a
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(1) . . .
(2) Powers created after October 21, 1942. To the extent of any property with respect to
which the decedent has at the time of his death a general power of appointment . . . . .
. . . . . . . . . . . . . . . the power of appointment shall be considered to exist on the date
of the decedent’s death even though the exercise of the power is subject to a
precedent giving notice or even though the exercise of the power takes effect only on
the expiration of a stated period after its exercise, whether or not on or before the date
of the decedent’s death notice has been given or the power has been exercised.
Under § 2041(a)(2) a general power of appointment exists on the date of the decedent’s death
unless it is subject to a condition or event that has not occurred on or before that date.
The condition must not be illusory and must have some significant nontax consequence
independent of the decedent’s ability to exercise the power.
DIRUSSO ON CONDITIONAL POWERS: The general power of appointment is only
included in the decedent’s gross estate if the power existed on the date of the decedent’s death.
But, fluffy conditions don’t work here. However, if there is a real condition that makes it such
that the power does not exist on the date of the decedent’s death, then it will not be in the gross
estate.
P. 383 Problem 1: Henry left his residuary estate to his wife, Wanda, and his son, Mark, as
Trustees, to pay the income to Wanda for her life and, at her death, to distribute the trust property
to Sam. During her life, Wanda has the power to invade corpus for her own benefit but only with
the consent of Sam. Is the trust property in Wanda’s gross estate at her death? Does it matter
whether Wanda has ever exercised her power to invade trust corpus?
This is not included in Wanda’s gross estate, Sam has a substantial adverse interest. Therefore
under § 2041(c)(ii) this is not a general power of appointment and not included in the decedent’s
gross estate.
P. 383 Problem 2: Mary created an irrevocable trust with FNB as Trustee to pay the income to
her daughter, Nancy, during her life. At Nancy’s death, the trust property was to be distributed to
Nancy’s surviving issue. The trust also provided that Nancy could terminate the trust and receive
the trust principal but only after she had graduated from law school and had been admitted to the
bar. Nancy dies without having attended law school. Is the trust property in her gross estate?
This property is not included in Nancy’s gross estate. This is a real condition. She never met
the condition, so she never gained the right to exercise the power. She never triggered the ability
to access the property. Because the condition was not met, the general power of appointment did
not exist on the date of the decedent’s death—so it is not included in her gross estate.
P. 383 Problem 3: Wendy left her residuary estate to FNB as Trustee. The Trustee had absolute
discretion to accumulate income or to distribute it to, or for the benefit of, Wendy’s spouse,
Hugh. At Hugh’s death, the Trustee is to distribute the trust principal to Wendy’s surviving issue.
Hugh has the right to replace the Trustee at any time for any reason. Hugh dies without
exercising his right to replace the Trustee. What are the estate tax consequences?
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The property is included in Hugh’s gross estate. Hugh could have made himself trustee, so the
trustees powers are imputed to him.
EXERCISE, RELEASE, AND LAPSE
§ 2041. General power of appointment.
(a) . . .
(b) . . .
(1) . . ..
(2) Lapse of power. The lapse of a power of appointment created after October 21, 1942,
during the life of the individual possessing the power shall be considered a release of
such power. The preceding sentence shall apply with respect to the lapse of powers
during any calendar year only to the extent that the property, which could have been
appointed by exercise of such lapsed powers, exceeded in value, at the time of such
lapse, the greater of the following amounts:
(A) $5,000, or
(B) 5 percent of the aggregate value, at the time of such lapse, of the assets out of
which, or the proceeds of which, the exercise of the lapsed powers could have
been satisfied.
Section 2041 also includes in the gross estate property over which the decedent had a general
power of appointment but the decedent released or exercised that power in a transfer that, had the
decedent owned the property outright, would have been included in her gross estate under §§
2035-2038. In addition, § 2514(b) treats the exercise or release of a general power as a
transfer of property by the power holder (donee). As a result, the exercise or release of a
general power of appointment will usually be taxed either as a gift or in the donee’s gross estate.
Example 11-5—Robert leaves the residue of his estate to FNB as Trustee, to pay the income to
his daughter, Diane, for her life and, at her death, to distribute the trust principal to Diane’s
surviving issue. Robert gives Diane the power to invade trust corpus at any time for any purpose.
If Diane instructs the Trustee to distribute $25,000 to her son, John, Diane will have made a gift
of $25,000 to John. The exercise of her power is a transfer of property for gift tax purposes. Part
of the gift will qualify for the gift tax annual exclusion. If Diane instructs the Trustee to
distribute the $25,000 to her, there is no gift because the “transfer” has been from Diane, the
power holder, to herself.
CHANGE THE FACTS: Instead, assume that Diane releases her power to invade the trust
corpus. Her release is a transfer to the trust of the full value of the trust corpus. It is as if Diane
had withdrawn the entire trust corpus and created a new trust, income to herself (Diane) for life,
remainder to her surviving issue. As a result, Diane has made a taxable gift of the remainder
interest to her issue. Because this is a future interest, it does not qualify for the gift tax annual
exclusion. Had Diane created the trust herself, it would have been in her gross estate under §
2036(a)(1). As a result, when Diane dies, the full value of the trust will be in her gross estate
under § 2041.
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Example 11-6—Rebecca establishes an irrevocable trust with FNB as Trustee, to pay the income
to her son, Stephen, for life and, at Stephen’s death, to distribute the trust property to Stephen’s
surviving issue. Rebecca also gives Stephen the power to terminate the trust at any time by
requesting the Trustee to distribute the trust property to him or to another trust. After Rebecca’s
death, Stephen directs FNB to distribute the trust property to a new trust that provides for the
payment of income to his children in equal shares and the distribution of the trust property to his
descendants at the death of his last child. Stephen reserves the right to alter this trust by adding
or deleting beneficiaries. Stephen dies without altering or amending the trust.
Stephen’s exercise of the power is a transfer under § 2514. It is not a completed gift, however,
because Stephen has retained the right to alter or amend the trust. If Stephen had been the
original owner of the trust property, the second (revocable) trust would have been in his gross
estate under § 2036(a)(2) and § 2038 because of his right to alter or amend the trust. As a result,
his exercise of the power brings the trust property into his gross estate under § 2041.
Estate of Rolin v. Comm’r (2d Cir. 1978)—
Daniel Rolin established a trust in 1958. He retained an income interest for life, as well as the
power to amend or revoke the trust at any time. At his death, the corpus was to be divided into
two parts: “Trust A” would receive an amount equal to the marital deduction, and “Trust B”
would receive the remainder. His wife Genevieve was to receive the income of both trusts for
life. She was also given the right to invade the corpus of Trust A at any time and for any amount
during her life, and a general testamentary power of appointment over the assets in Trust A. If
she did not exercise her power of appointment over the property in Trust A, Trust A was to
merge into Trust B at her death and the assets distributed to the Rolin’s issue. Daniel died in
1968. Genevieve was sick and the time of Daniel’s death and she died four months after Daniel.
Genevieve did not receive any income form the trusts in those four months, nor did she exercise
her power of appointment. Genevieve’s executor attempted to posthumously renounce her
interest in the trusts to avoid the estate tax consequences.
HELD: The renunciation was effective.
REASONING: Under New York law, an executor may within a reasonable time, disclaim a
legacy to which the testator was entitled. The disclaimer once made, relates back to the date of
the gift, preventing title from ever vesting in the individual being disclaimed for. Here, the
disclaimer was effective, so the general power of appointment is not included in the decedent’s
gross estate.
LAPSE: Lapse occurs when the done has a limited amount of time to exercise a power of
appointment and fails to do so.
Example 11-7—Richard creates an irrevocable trust with FNB as Trustee. The Trustee has
discretion to accumulate income or to distribute it to Richard’s son, Simon. At Simon’s death,
the trust property is to be distributed to his issue. Simon has the right to demand $13,000 or the
amount contributed to the trust. Richard transfers $13,000 to the trust on January 15. If Simon
does not demand the money within the 60 days, the power lapses. He cannot exercise it. Simon’s
power in this situation is often referred to as a “Crummey power” and is used to qualify transfers
to the trust for the gift tax annual exclusion.
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LAPSE AS RELEASE: The lapse of a power is considered to be a release of that power and,
therefore, a transfer of property by the donee, but only to the extent that property could have
been appointed exceeds the greater of $5,000 or 5 percent of the trust assets out of which the
exercise of the power could have been satisfied.
********Example 11-7 Continued: Because Simon, in Example 11-7, did not exercise the
power, it lapsed. He is, therefore, treated as making a transfer to the trust and a gift to his issue,
the remainderman. The amount of the gift depends on the value of the trust property out of which
the demand could have been satisfied. Assume that the total trust assets are available to satisfy
the demand.
If the trust corpus is $13,000, then Simon is deemed to have made a transfer of $8,000 because
this is the amount that exceeds $5,000.
If the trust corpus is $140,000, then Simon is deemed to have made a transfer of $6,000. Five
percent of the trust corpus is $7,000, and this amount is deemed not to be a transfer by § 2514(e).
If the trust corpus is $260,000, then Simon has not made a transfer because 5 percent of the
trust corpus is $13,000, which is the amount of the property subject to the power that lapsed.
When the donee of a lapsed power dies, the value of the trust property attributable to the
transfers that resulted from the lapse will be in the donee’s gross estate. This happens only if the
donee has an interest in the trust, such as the right to income, or a right, such as the right to
terminate the trust. The interests and rights must be the type that would have brought the
property into the donee’s gross estate under §§ 2035–2038 had the donee been the original
owner of the property.
Example 11-8—Rachel creates a trust with FNB as Trustee, to pay the income to her daughter,
Debra, for life. Debra has the right to withdraw $75,000 of trust income each year for her own
use. This right is not cumulative. That is, Debra can only withdraw $75,000 in any year whether
or not she has withdrawn money in a prior year. Debra dies 11 years after the trust is created
without ever having exercised the right to withdraw. Assume that the trust corpus has remained
at $1,000,000 for the entire term of the trust.
Debra’s gross estate will include $325,000 of the trust property. First, $75,000 in her gross
estate because she has a general power of appointment over that amount at the time of her death.
The right to withdraw for that year has not yet lapsed. Second, an additional $250,000 will be in
her gross estate because there was a lapse in each of the prior ten years. Each lapse is treated as a
transfer by Debra to the trust, but only to the extent that it exceeds the greater of $5,000 or 5
percent of the trust corpus. Since 5 percent of $1,000,000 is $50,000, each lapse is treated as a
transfer of only $25,000, the amount in excess of 5 percent. In each year the transfer of $25,000
equals 2.5 percent of the trust assets. The percentage for each year is added together and the
aggregate percentage, in this case 25 percent, of the trust assets is included in the decedent’s
gross estate.
WHEN CAN A LIMITED POWER BE TURNED INTO A GENERAL POWER?
Under § 2041(a)(3) a limited power of appointment is turned into a taxable power if the donee
can create another power of appointment which under the applicable local law can be validly
exercised so as to postpone the vesting of any estate or interest in such property, or suspend the
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absolute ownership or power of alienation of such property, for a person ascertainable without
regard to the date of the creation of the first power.
SO: If the donee exercises a limited power of appointment to create a new trust with a general
power of appointment in another, it will be taxable to the donee if the RAP period is measured
from the donee’s exercise rather than the creation of the donee’s power.
P. 388 Problem 1: Peter establishes an irrevocable trust with FNB as Trustee. The Trustee is to
distribute income to Ann for her life and, at her death, to distribute the trust property to Ann’s
issue. Ann has the right to invade the trust principal at any time and for any purpose.
a. What are the gift and estate tax consequences if Ann has the Trustee distribute $50,000 to her?
b. What are the gift and estate tax consequences if Ann has the Trustee send $35,000 to Law
School to pay her tuition? What if it is for her daughter’s tuition?
c. What are the gift and estate tax consequences if Ann has the Trustee distribute an amount
equal to the gift tax annual exclusion to each of her three children and ten grandchildren?
a. There is no gift tax, because Ann is giving this to herself—can’t make a gift to yourself. So,
no gift tax. But, this will be included in her gross estate because it is a general power of
appointment.
b. Ann’s Tuition: No gift tax consequences because it is a “gift” to herself. But, this is a
General Power of Appointment, so it will be included in her gross estate under § 2041.
Daughter’s Tuition: The portion of the property used to pay the daughter’s tuition will qualify for
the tuition exclusion under the gift tax, but the rest of the property will be included in her gross
estate as a general power of appointment.
c. These are completed gifts which will qualify for the gift tax annual exclusion. So, there is
no estate tax except to the extent that there is property left in the trust after the gifts are
distributed—whatever is left will be included in her gross estate as a general power of
appointment.
P. 389 Problem 3: Gordon establishes an irrevocable trust with FNB as Trustee to pay the
income to Archie for life and the remainder to Beatrice.
a. Gordon gives Archie the noncumulative right to withdraw an amount equal to the amount of
the gift tax annual exclusion in any year that Gordon makes a contribution to the trust.
(1) What are the gift tax consequences to Gordon when he makes a contribution to the trust
equal to the amount of the gift tax annual exclusion?
(2) Are there any gift tax consequences to Archie if he does not withdraw the amount
contributed to the trust?
(3) What are the gift tax consequences to Gordon if he contributes $50,000 to the trust?
Does it matter if Archie withdraws that amount or not?
(4) What are the estate tax consequences to Archie in situation (1) if he dies in year 6 and
Gordon has contributed an amount equal to the gift tax annual exclusion each year?
a.(1). Gordon makes a gift of income interest to Archie (qualifies for the gift tax annual
exclusion). Gordon also makes a gift of the remainder to Beatrice (this is not a present interest in
property, so it does not qualify for the gift tax annual exclusion).
a.(2). Archie’s failure to withdraw could be a lapse, which means he is treated as making a gift
to the trust. So, the 5 or 5 rules comes into play. DiRusso Analysis: If it lapses in your own favor
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then no problem, but here, there is a remainderman. So—to the extent attributable to the
remainder, the lapse is a gift from Archie to Beatrice.
a.(3). The balance of the property is a taxable gift (obviously some of it will qualify for the gift
tax annual exclusion).
a.(4). Archie’s lapses cause him to be treated as transferor. He is treated as making a gift, with
a retained interest (because he has the life income interest). Also, the amount of the outstanding
withdrawal right for that year is included under § 2041(a).
DiRusso’s explanation/calculation for a.(4).: When Archie dies, the amount of trust property
that is subjected to the general power of appointment, i.e., $13,000, is in her gross estate under §
2041(a).
DiRusso’s lapse calculation: In addition, the percentage of the trust corpus attributable to
Archie’s prior lapses are also in his gross estate under § 2041(b)(2). The percentages of each
year are added together to determine what percentage of the trust property is attributable to the
imputed transfers by Archie under Treas. Reg. § 20.2041-3(d)(4). As a result, the entire trust is
in Archie’s gross estate:
Year 1 – $8,000/$13,000 = 61 percent
Year 2 – $8,000/$26,000 = 31 percent
Year 3 – $8,000/$39,000 = 21 percent
Year 4 – $8,000/$52,000 = 15 percent
Year 5 – $8,000/$65,000 = 12 percent
Total
= 140 percent
3b. Gordon gave Archie the noncumulative right to withdraw annually the lesser of (1) the
amount of the gift tax annual exclusion, (2) the amount transferred to the trust, or (3) the greater
of $5,000 or 5 percent of the trust corpus. Gordon transfers an amount equal to the gift tax annual
exclusion each year and Archie never exercises the right of withdrawal.
(1) What are the gift tax consequences to Gordon?
(2) What are the gift tax consequences to Archie?
(3) What are the estate tax consequences to Archie if Archie dies without ever exercising the
power? Assume he dies in year 6 and that Gordon has contributed an amount equal to the
gift tax annual exclusion each year.
b.(1). Gordon makes a gift to the trust to Archie (that gift qualifies for the gift tax annual
exclusion). Gordon also makes a gift to the trust remainder, which belongs to Beatrice, that is not
a gift of a present interest in property, so it does not qualify for the gift tax annual exclusion.
b.(2). There are no gift tax consequences to Archie because the withdrawal right is capped at 5
or 5.
b.(3). § 2041(a) brings into the gross estate the current years withdrawal right. None of the
past withdrawal rights will be brought into the gross estate because nothing exceeding 5 or 5 has
lapsed.
CHAPTER 12: LIFE INSURANCE
§ 2042. Proceeds of life insurance.
The value of the gross estate shall include the value of all property—
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(1) Receivable by the executor. To the extent of the amount receivable by the executor as
insurance under policies on the life of the decedent.
(2) Receivable by the beneficiary. To the extent of the amount receivable by all other
beneficiaries as insurance under policies on the life of the decedent with respect to which
the decedent possessed at his death any of the incidents of ownership, exercisable either
alone or in conjunction with any other person . . .
DIRUSSO EXPLANATION OF § 2042:
 Section (1) would include any life insurance policies payable to the decedent’s estate.
 Section (2) would include any life insurance policies payable to any other beneficiaries
IF the decedent has ‘incidents of ownership’ at the time of death—then the proceeds are
includable in the gross estate.
LIFE INSURANCE IN GENERAL
Life insurance is a commonly held asset.
TERMS:
Insured—the insured is the person whose life is covered by the policy. The insured may or may
not be the purchaser or the owner of the policy.
Owner—the owner is the person who has all the rights associated with the policy, including the
right to name the beneficiary, determine the payment option, and borrow against the policy. The
rights may be transferred, thereby making a new owner, but if all the rights are transferred, the
insured may still be considered the owner of the policy for purposes of federal estate tax.
Insurer—the insurer is the company issuing the policy. The insurer will only sell a life insurance
policy to someone with a insurable interest.
Beneficiary—the beneficiary is the person, persons, or entity designated in the policy to receive
the proceeds of the life insurance policy at the death of the insured. Donor may designate both
primary beneficiaries and contingent beneficiaries in case the primary beneficiaries are not
around.
Premium—the premium is the cost of the life insurance policy. Premiums may be paid in one
lump sum or at more frequent intervals, i.e. annually, semiannually, or quarterly. Premiums may
be paid by the insured, the owner, an employer, a business association, or anyone.
Premiums Paid by Non-Owners—Premiums paid by someone who is not the owner of the
policy will be considered gifts from the payor to the owner to the extent that the owner does not
transfer adequate and full consideration in money or money’s worth to the payor.
INSURANCE CONTRACTS:
Insurance is a contract. The owner pays a specified amount (the premium), and the insurer agrees
to pay a sum of money if a certain even happens.
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TWO BASIC TYPES OF INSURANCE:
1) TERM INSURANCE—The insurer agrees to pay a set amount if the insured dies. If the
insured dies within the term, the insurer pays. If the insured survives the term, the insurer
keeps the premium. At the end of the term, the insurer and the policy owner may, or may
not, contract for another term.
2) CASH VALUE/WHOLE LIFE INSURANCE—This is term insurance plus an
investment, or savings, component. It has higher premiums than term insurance. It will
generate dividends and interest on the investment component of the policy. At some point
in the insured’s life the total cost of the insurance will be paid and no further premiums
will be due. Whole life insurance has a cash surrender value—the amount the insurer will
pay if the owner cancels the policy. Because of the investment component, the owner can
also borrow from the insurer or use the policy as collateral for a loan.
SECTION 7702 defines “life insurance contract” for all purposes of the Internal Revenue Code.
DEFINITION:
1. The contract must be considered life insurance under the applicable law (usually state
law). [This restricts life insurance to death benefits.]
2. In addition the contract must meet either:
a. the statutory cash value accumulation test; or
b. the guideline premium requirement requirements and fall within the cash value
corridor, both defined in the statue
DiRusso: “In reality you ask the Insurance provider for a letter stating whether or not the tests
are satisfied. That is how this works in real life.”
PROCEEDS PAYABLE TO THE INSURED’S ESTATE
Section 2042(1) includes in the decedent’s gross estate all proceeds of a life insurance policy that
are receivable by the executor.
 The proceeds are considered receivable by the executor even if the estate is not named as
the beneficiary if the insurance proceeds are subject to a legally binding obligation to pay
taxes, debts, or other expenses of, or claims against, the estate.
Example 12-2—Diane purchased a life insurance policy on her own life and transfers it to an
irrevocable life insurance trust that allows, but does not require, the Trustee to use the proceeds
to pay death taxes and expenses. In this situation only the amount of proceeds actually expended
for death taxes and expenses will be included in Diane’s gross estate. Assume the life insurance
proceeds amounted to $250,000, death taxes were $100,000, and expenses were $50,000. Only
$150,000 would be included in Diane’s gross estate by § 2042(1) because this was the amount
actually expended for obligations of the estate.
BUT: TO avoid § 2041(1), the decedent could give the trustee the power to loan the life
insurance proceeds to the decedent’s estate or the power to purchase assets of the estate. The
loan or the sale provides liquidity for the decedent’s estate, but it does not increase the assets
available to the decedent’s executor for payment of expenses and distribution to will
beneficiaries. As a result, it will not subject the life insurance proceeds to the federal estate tax.
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Section 2042(1) also encompasses life insurance payable to another that serves as collateral
security for a debt. The insurance will be deemed payable to the estate to the extent of the loan
outstanding on the date of death because it was the decedent’s, and therefore his estate’s,
obligation to repay it.
Under Section 2042(1) life insurance proceeds are payable to the estate when the primary
beneficiary dies before the insured and the insured has not designated any contingent
beneficiaries.
P. 394 Problem 1: Doris purchased a cash value policy with a face amount of $500,000, naming
her executor as the beneficiary. Doris paid the annual premiums of $750 for five years.
a. At Doris’s death what, if anything, is included in her gross estate?
b. Same facts except that Doris names Ann as the beneficiary of the life insurance policy and
Ann predeceases Doris. Doris has not named a contingent beneficiary.
c. Same as 1.b., except that Doris and Ann die as the result of the same car accident, and the
order of deaths cannot be determined.
a. Everything. (the entire death benefit value is included in her gross estate = $500,000).
b. Everything. (it comes back to Doris’s estate = $500,000 included).
c. Everything. (it comes back to Doris’s estate = $500,000 included). –Really, the answer is
everything probably—it depends on the state law survivorship requirement and the terms of the
life insurance policy.
P. 394-395 Problem 2: Debra creates an irrevocable trust with FNB as the Trustee. During
Debra’s life, the Trustee has discretion to accumulate income or distribute it to Sam, Debra’s
spouse. After Debra’s death, the Trustee must distribute all the income to Sam and has discretion
to distribute corpus if it is necessary for Sam’s support and maintenance. At Sam’s death, the
Trustee is to distribute the trust property to Debra’s issue. Debra funds the trust with two life
insurance policies, with a total face amount of $500,000, as well as cash and stocks.
a. What are the estate tax consequences if the Trustee must transfer to the executor of Debra’s
estate sufficient assets to pay the state and federal estate tax, the funeral expenses, the expenses
of administration, debts, and claims before paying income to Sam?
b. What are the estate tax consequences if the Trustee has discretion, but is not required, to make
the transfers specified in 2.a.? Assume that the Trustee exercises this discretion and transfers
$450,000 to the executor.
a. If you are using it to satisfy your debts & obligations & it is subject to a binding obligation
(to the extent of such) it is included in the gross estate.
b. If it is actually used to pay debts and expenses that portion is included under § 2042(1). So,
if is only the $450,000 that is actually used for this purpose, then only the $450,000 will be
brought in under § 2042(1).
INCIDENTS OF OWNERSHIP
Section 2042(2) includes in the decedent’s gross estate the amount received by a beneficiary
other than the decedent’s estate only if the decedent possessed an incident of ownership in the
life insurance policy at the moment of her death.
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INCIDENT OF OWNERSHIP—is defined broadly in the regs. to include any right of the
insured or her estate to the economic benefits of the policy. The rights to name or alter the
beneficiary, to cancel or surrender the policy for cash, to assign or transfer the policy, to
pledge the policy as collateral for a loan, and to borrow against the policy are typical
incidents of ownership.
Any incident of ownership (even just one) is sufficient to bring the policy into the gross estate.
THE RIGHT TO DESIGNATE BENEFICIARIES:
Perhaps, the most important incident of ownership is the right to designate beneficiaries.
If you have this incident of ownership, § 2042(2) will draw the policy into your gross estate.
However—the right must be real, and not illusory.
Example 12-3—Wife purchases a life insurance policy on Husband’s life and owns all the
incidents of ownership. To ensure a coordinated estate plan, Wife designates the Trustee of
Husband’s revocable trust as the beneficiary of the policy. Husband can alter, amend, or revoke
his trust at any time. By doing so, he can effectively change the beneficiary of the life insurance
policy. Wife, however, still owns the life insurance policy, and she can change the beneficiary
designation at any time and, thus, thwart Husband’s attempt to direct the flow of the life
insurance proceeds. The policy proceeds are not in Husband’s gross estate, because Wife’s
power to change the beneficiary trumps the Husband’s power to change the trust.
Instead—Wife makes an irrevocable assignment of the life insurance policy to the trust. Because
she has given up the right to change the beneficiary, the insurance proceeds will be distributed to
the trust. Now Husband does have the ability to control where those proceeds will go through his
power to alter or revoke the trust. As a result, the insurance proceeds will be in his gross estate
because his ability to amend the trust will be considered an incident of ownership.
WHAT ABOUT CO-HOLDERS IN THE RIGHT TO DESIGNATE THE
BENEFICIARIES: The power to designate the beneficiary in conjunction with any other person
is also an incident of ownership. SO—Co-holders don’t solve the problem.
THE RIGHT TO BORROW AGAINST THE POLICY:
Another important incident of ownership is the right to borrow against the policy.
Example 12-4—Decedent purchases a cash value life insurance policy and transfers it to an
irrevocable, funded life insurance trust. FNB is the Trustee. Decedent retains the right to borrow
against the policy up to the amount of the cash surrender value, but all other rights are held by
the Trustee as owner of the policy. The retention of the ability to borrow against the policy right
is sufficient to bring the policy proceeds into Decedent’s gross estate as Decedent can receive the
economic benefit of the policy merely by borrowing against it.
REVERSIONARY INTERESTS AS INCIDENTS OF OWNERSHIP: “Incidents of
ownership” includes a reversionary interest in a life insurance policy, but only to the extent that
the decedent’s reversionary interest exceeds 5 percent of the value of the policy.
BUT NOTE: If a decedent transfers a life insurance policy to his Wife, there is always the
possibility the wife predeceases the decedent such that the life insurance policy reverts to the
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decedent by will, inheritance, or by exercise of statutory marital rights. These are not
reversionary interest or incidents of ownership per the regulations.
Example 12-5—Decedent and Spouse divorce. The divorce decree requires Decedent to
maintain a life insurance policy on his own life payable to his Ex-Spouse. Under the terms of the
divorce decree, the policy reverts to Decedent if his Ex-Spouse. Dies or remarries. When
Decedent dies, his Ex-Spouse is alive and has not remarried. At the moment before his death,
Decedent has a reversion in the life insurance policy. If that reversion exceeds 5 percent of the
value of the life insurance policy, the proceeds will be in the Decedent’s gross estate even though
they are payable to the Ex-Spouse.
EXISTENCE OF INCIDENTS OF OWNERSHIP DETERMINED AT TIME OF DEATH:
Whether or not the decedent has an incident of ownership is determined at the time of death.
POLICY FACTS vs. INTENT FACTS
Courts will carefully scrutinize all the facts and circumstances to determine whether a decedent
has an incident of ownership. While courts will focus primarily on the economic substance of the
arrangement, they will not ignore the decedent’s legal rights even if the decedent had no practical
method of exercising those rights.
United States v. Rhode Island Hospital Trust Company (1st Cir. 1966)—
Charles A. Horton purchased a life insurance policy on the life of each of his two sons—Holton
(the decedent) and Trowbridge (the decedent’s brother). The policies were identical, the proceeds
of both being payable to Charles and his wife Louise, equally, or to the survivor of them. In
purchasing the policy Charles intended to make sure that funds were available for his wife
Louise, should anything happen to either of the boys. Charles kept the policies in his safe deposit
box and paid the premiums. However, under the policies, the right to change beneficiaries
belonged only to the sons. In January 1952, Louise died. Charles told the boys to go get the
beneficiary changed to make Charles the primary beneficiary, and making their wives, brother ,
and executors or administrator of the last survivor the successive beneficiaries. After the
amendment, the boys retained the right to change the beneficiaries under the terms of the policy,
but never did. Decedent (Holton) died on April 1, 1958. Charles died on October 2, 1961.
Throughout his life, Charles regarded the policies as his, going as far as to tell the boys that it
would be “out of the question” for the sons to claim them as their own.
The Commissioner claimed that the insurance policy should be included in the decedent’s gross
estate because he retained an incident of ownership—i.e. the right to change the beneficiary
designation. The decedent’s estate argued that the policies should be included not in the
decedent’s gross estate, but rather in Charles’s gross estate, as Charles was the true owner in
substance.
ISSUE: Should the insurance policy be included in the Decedent’s gross estate or his father’s
gross estate?
HELD: The decedent’s gross estate.
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REASONING: The Court looked at two types of facts. Intent facts—what the parties intended
and Policy facts—what the policy actually says the party’s rights are. It was clear that the father
had control over the boys in regards to their changing of beneficiaries—i.e. the intent facts would
lead you to say that it was the father’s policy. However, in reality, the policy said that the boys
had sole discretion as to changing the beneficiary designation. The policy facts—i.e. the legal
rights actually controlled here, so the policy has to be included in the decedent’s gross estate.
DIRUSSO: “Look at the rights (legal ability) under the policy. That is what controls. You intent
doesn’t matter, what the policy says is what mattered here.”
Morton v. United States (4th Cir. 1972)—
Decedent took out a life insurance policy in 1932 at the behest of his father-in-law, who wanted
to provide financial security for the decedent’s wife. The decedent never paid any payments and
did not consider himself as the “owner” of the policy. In 1938, the decedent executed an
endorsement of the policy effecting an irrevocable designation of beneficiaries and mode of
settlement.
ISSUE: Did the decedent have incidents of ownership such that the policy should be included in
his gross estate?
HELD: No.
REASONING: When you looked at the irrevocable designation of beneficiaries and mode of
settlement plus the fact that somebody else was paying the premiums, it was legally impossible
for the decedent to exercise any powers he purportedly held under the policy, in any way that any
economic benefits could accrue to him or his estate.
DIRUSSO: “Not included here. We analyze the rights under the agreements, he didn’t hold the
powers, no incidents of ownership. Somebody else held all the incidents of ownership, so it
didn’t have to be included in the decedent’s gross estate, because the decedent didn’t really have
anything.”
INCIDENTS HELD IN A FIDUCIARY CAPACITY
What if the decedent sets up a trust and has a life insurance policy on his own life as one of the
assets in the trust, and the decedent serves as trustee (i.e. in a fiduciary role).
Are powers held in a fiduciary capacity treated as incidents of ownership?
Treas. Reg. § 20.2042-1(c)(4) specifies that a decedent is considered to have an ‘incident of
ownership’ in an insurance policy on his life held in trust if, under the terms of the policy the
decedent . . . has a power (as trustee or otherwise) to change the beneficial ownership in the
policy or its proceeds . . . even though the decedent has no beneficial interest in the trust.
REVENUE RULING 84-179:
 A decedent will not be deemed to have incidents of ownership over an insurance policy
on the decedent’s life where the decedent’s powers are held in a fiduciary capacity, and
are not exercisable for decedent’s personal benefit, where the decedent did not
transfer the policy or any of the consideration for purchasing or maintaining the policy
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
to the trust from personal assets, and the devolution of the powers on the decedent was
not part of a prearranged plan involving the participation of the decedent.
The decedent will be deemed to have incidents of ownership over an insurance policy on
the decedent’s life where the decedent’s has transferred the policy or any of the
consideration for purchasing and maintaining the policy to the trust. Also, where the
decedent’s powers could have been exercised for the decedent’s benefit, they will
constitute incidents of ownership in the policy, without regard to how those powers
were acquired and without consideration of whether the decedent transferred
property to the trust.
EMPLOYER-PROVIDED LIFE INSURANCE
Employers often provide group term life insurance to their employees as a fringe benefit.
 If the employee designates her executor or estate as beneficiary, the proceeds are
included in the employee’s gross estate under 2042(1).
 If the employee designates someone else, the proceeds are included in the employee’s
gross estate under § 2042(2) as long as she retains an incident of ownership.
The right to cancel an insurance policy is an incident of ownership.
 However, the fact that the employee can cancel the policy by terminating employment is
not enough.
o Only powers that affect the insurance policy will be considered incidents of
ownership.
 Powers that affect the insurance policy only collaterally (such as quitting
and thereby canceling the policy) are not.
Whether the right to select settlement options that affect the time or manner of enjoyment
constitute incidents of ownership has created substantial controversy:
Estate of Lumpkin v. Comm’r (5th Cir. 1973)—
At the time of his death the decedent was employed by Humble Oil Co. and was covered by
Humble’s non-contributory group term life insurance. Two benefits were available to the
survivors of the decedent under the policy. One such benefit was the “Contingent Survivors
Group Life Insurance Coverage.” The beneficiaries of these rights were irrevocably set by the
policy. However, the decedent got to make an election as to the mode of settlement. One option
for settlement provided that the payments that were to be made to the survivor would be cut in
half, and the half not paid out to the survivor would be accumulated and paid to the survivor for
an extended period, or if the survivor died before they were paid, to the survivor’s estate. This
allowed the insured to extend the period over which the funds were to be enjoyed.
ISSUE: Does the ability to alter the time of enjoyment through the settlement option constitute
an incident of ownership such that the policy should be included in the decedent’s gross estate?
HELD: Yes.
REASONING: The settlement option was an incident of ownership. It allowed the decedent the
right to decide the time of enjoyment. The Court viewed a right to control the time or manner of
enjoyment as an incident of ownership.
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CIRCUIT SPLIT: However, there is a circuit split on this issue—the third circuit has held that
such a right would not constitute an incident of ownership because it does not give the decedent
any right to any economic benefit.
POLICIES OWNED BY A CORPORATION CONTROLLED BY
THE INSURED
Treas. Reg. § 20.2042-1(c)(6) provides that incidents of ownership held by a corporation will not
be attributable to a controlling, or even the sole, shareholder when the insurance proceeds are
payable directly to the corporation.
Any proceeds payable to a third party for a valid business reason are also not attributed to the
shareholder.
If the insurance proceeds are payable to another beneficiary, such as the decedent’s spouse or
child, any incidents of ownership held by the corporation will be attributed to the shareholder if
the decedent is the sole or controlling shareholder.
WHAT IS A “CONTROLLING” SHAREHOLDER?
A “controlling” shareholder is a shareholder who has 50 percent or more of the voting power.
Estate of Levy v. Comm’r (Tax Court 1978)—
At the time of his death, Mr. Levy owned 80.4 percent of the voting stock in in Levy Bros. and
100 percent of the non-voting stock. Levy Bros. held two life-insurance policies on the life of
Levy. The corporation has all the typical incidents of ownership (i.e. right to change
beneficiaries, right of assignment, right to borrow against the policy). Levy had no incidents of
ownership in the policy at the time of his death, except for the fact that he was a shareholder in
Levy Bros.
ISSUE: Should an 80 percent stockholder be treated the same as a 100 percent stockholder for
purposes of attribution of incidents of ownership held by the corporation?
HELD: Yes, the Court says no distinction should be made between a 80 percent stockholder and
a 100 percent stockholder. Therefore, the incidents of ownership are attributed to Levy and the
polices are included in his gross estate.
REASONING: You have to look at the reality here. In reality, he controlled the corporation,
therefore he had enough power to justify including the policy in his gross estate. He had the
voting power to elect directors who would be amendable to his wishes as to the exercise of the
incidents of ownership held by the corporation.
P. 414 Problem 1: Dwight purchases a life insurance policy from Metropolitan Life Insurance
Co., naming his spouse, Sarah, as primary beneficiary and his children as contingent
beneficiaries.
a. What are the estate tax consequences when Dwight dies and Sarah receives $500,000 from
Metropolitan Life Insurance Co.?
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b. What are the estate tax consequences if Dwight purchases the policy and then transfers it to
Sarah? Assume that Dwight paid all of the premiums even after the transfer and that Sarah’s will
leaves all of her property outright to Dwight. Dwight dies five years after the transfer to Sarah.
c. Same as 1.b., except that Dwight reserved the right to borrow against the policy. He assigned
all other rights to Sarah.
d. Same as 1.b., except that Dwight must consent to any change of beneficiary.
a. This will be included in Dwight’s gross estate under § 2042(2) because Dwight retained
incidents of ownership (DiRusso says that we generally assume there are incidents of
ownership).
b. This will not be included in Dwight’s gross estate. He transferred everything and got out (he
survived the 3 yr. look-back for transfers like this). Paying premiums is not an incident of
ownership. The fact that it could have come back to him under his wife’s will does not matter.
c. This will be included in Dwight’s gross estate under § 2042(2). Dwight retained the right to
borrow against the policy. The right to borrow against the policy is an incident of ownership.
Even one incident of ownership is sufficient to bring the policy into the gross estate under §
2042(2).
d. This is included in Dwight’s gross estate under § 2042(2). Dwight retained the right to
change the beneficiary designation. (Actually, he retained a veto over any changes to the
beneficiary designation). The fact that there is a co-holder of this power does not change it, it is
brought into the gross estate as an incident of ownership under § 2042(2).
P.414 Problem 5: Delwin purchases a $400,000 life insurance policy on his own life and
transfers it to his spouse, Sally. Sally dies five years later. Her will leaves all of her property,
including the life insurance policy, to Delwin. Two years later Delwin dies.
a. Is anything in Delwin’s gross estate? Why?
b. Would it make any difference if Sally had been the original purchaser of the policy and if
Delwin never owned any incidents of ownership until Sally’s death?
a. Yes. Because he has the right at the time of his death, so it is included in his gross estate
under § 2042(1).
b. No, it wouldn’t make any difference. Because he has the right at the time of his death, it will
be included in his gross estate under § 2042(1).
LIFE INSURANCE ON THE LIFE OF ANOTHER
Life insurance may be included in the decedent’s gross estate by a section other than § 2042 if
the owner is not the insured.
Example 12-6—Husband purchases a life insurance policy on his own life and irrevocably
assigns the rights in the policy to his Wife. Five years later, Wife dies. The insurance policy is
property that she owned at death, and its value will be in her gross estate § 2033. The amount
that is included in her gross estate is the fair market value of the life insurance policy on
her date of death, not the face amount or the proceeds that would have been received on that
date if Husband had died.
Example 12-7—Wife purchases a life insurance policy on her Husband’s life and owns all the
incident of ownership in the policy. She selects the settlement option that leave the insurance
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proceeds with the insurance company and pays her only interest and dividends for life. At her
death, the policy proceeds will be paid to her children. This settlement option becomes
irrevocable at Husband’s death. Husband dies, and Wife begins receiving interest and dividends
on the insurance policy. Five years later, Wife dies. The life insurance proceeds are brought into
Wife’s gross estate by § 2036(a)(1), because she made a lifetime transfer and retained the right to
income.
GIFTS OF LIFE INSURANCE
Many owners give life insurance policies to other family members or to a trust to avoid inclusion
in their gross estate under § 2042. If you do it right, you can accomplish this goal. But, when
making a gift of life insurance, the insured must transfer all incidents of ownership to the new
owner, or it will still be in their gross estate under § 2042.
The value of the life insurance policy depends on the type of policy:
 The value of a single-premium whole life policy is the cost, not the cash surrender
value.
 The value of term insurance is also the cost.
o If the insured makes the gift in the beginning of the term, the value of the gift is
the premium paid.
o If the insured makes the gift in the middle of the term, the value is simply the
prorated premium for the remainder of the term.
 Valuation of cash policies is more complicated because the policies include both
insurance and investment elements.
o The value of the insurance element is the prorated premium for the remainder of
the term.
o The value of the investment element is the interpolated terminal reserve—an
amount which is roughly equivalent to the cash surrender value.
Gift Tax Annual Exclusion and Gifts of Life Insurance:
 An outright gift of a life insurance policy qualifies for the gift tax annual exclusion
because the new owner has the right to immediate use, possession, or enjoyment of the
policy. (It is a present interest in property).
 A gift of life insurance to a trust will not qualify as a present interest unless the trust
beneficiaries have the right to demand payment (exp. Crummey power).
Example 12-8–Insured purchases $500,000 of term life insurance by paying the premium due of
$500 and names his spouse as the beneficiary. Two weeks later, Insured dies in an automobile
accident. The value of the insurance policy immediately before Insured’s death was the $500
premium paid. Spouse, however, receives $500,000. Section 2042 recognizes this discrepancy
between value and amount received and includes in the gross estate the amount receivable, not
the value.
Section 2035 includes gifts of life insurance made within three years of death in the gross
estate of the decedent. WHY is this necessary? Because the gift value will often be much less
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than the amount receivable under the policy—if there was not a rule like this, a decedent could
keep a policy until right before they die and dodge a significant amount of tax.
Avoiding 2035 and 2042: Both 2035 and 2042 can be avoided in the insured never owns the
policy. A spouse, child, or trustee can purchase the policy directly from the life insurance
company. Because the decedent would have never had any incidents of ownership and never
made a transfer of the policy—neither 2035 nor 2042 would bring the policy into the decedent’s
gross estate.
P. 418 Problem 1: Daniel purchases a cash value life insurance policy with a face amount of $2
million. He gives the policy to his spouse, Wendy, assigning all his rights in the policy to her.
Daniel continues to pay the premiums.
a. What are the gift tax consequences? What if the policy were a term policy rather than cash
value?
b. Wendy dies five years after the policy is transferred to her. What are the estate tax
consequences?
c. Instead of b., Daniel dies. What are the estate tax consequences if he dies two years after
transferring the policy? What if it is four years later?
a. The transfer of the policy is a completed gift of a present interest in property. Each premium
payment is also a gift. If the policy was a term policy rather than a cash value policy—a term
policy is valued at cost. However, the unlimited marital deduction should apply here.
b. The policy will be included in Wendy’s gross estate at the current value of the policy (FMV
on the date of her death). It is included at the Fair Market Value on the date of Wendy’s death,
and not the face value of the policy.
c. 2 yrs.—If he dies only 2 years after transferring the policy, the two year look-back applies
and it is included in Daniel’s gross estate.
4 yrs.—He survived the 3 yr. look-back period, so the policy is not included in his gross estate.
CHAPTER 14: TRANSFERS TO CHARITY
Section 2055 allows the decedent’s estate to deduct the value of certain transfers to charity.
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§ 2055. Transfers for public, charitable, and religious uses.
(a) In general. For purposes of the tax imposed by section 2001, the value of the taxable
estate shall be determined by deducting from the value of the gross estate the amount of
all bequests, legacies, devises, or transfers—
(1) to or for the use of the United States, any State, any political subdivision thereof, or
the District of Columbia, for exclusively public purposes;
(2) to or for the use of any corporation organized and operated exclusively for
religious, charitable, scientific, literary, or educational purposes, including the
encouragement of art, or to foster national or international amateur sports
competition (but only if no part of its activities involve the provision of athletic
facilities or equipment), and the prevention of cruelty to children or animals . . . no
part of the net earnings of which inures to the benefit of any private
stockholder or individual, which is not disqualified for tax exemption under
section 501(c)(3) by reason of attempting to influence legislation, and which does
not participate in, or intervene in (including the publishing or distribution of
statements), and political campaign on behalf of (or in opposition to) any candidate
for public office;
(3) to a trustee or trustees, or a fraternal society, order, or association operating under
the lodge system, but only if such contributions or gifts are to be used by such
trustee or trustees, or by such fraternal society, order, or association, exclusively for
religious, charitable, scientific, literary, or educational purposes . . .
(4) to or for the use of any veteran’s organization . . .
(5) to an employee stock ownership plan . . .
(b) . . .
(c) . . .
(d) . . .
(e) Disallowance of deductions in certain cases.
(1) . . .
(2) Where an interest in property . . . passes or has passed from the decedent to a
person, or for a use, described in subsection (a), and an interest (other than an
interest which is extinguished upon the decedent’s death) in the same property
passes or has passed (for less than an adequate and full consideration in money or
money’s worth) from the decedent to a person, or for a use, not described in
subsection (a), no deduction shall be allowed under this section for the interest
which passes or has passed to the person, or for the use, described in subsection (a)
unless—
(A) in the case of a remainder interest, such interest is in a trust which is a
charitable remainder annuity trust or a charitable remainder unitrust
(described in section 664) or a pooled income fund (described in section
642(c)(5)), or
(B) in the case of any other interest, such interest is in the form of a guaranteed
annuity or is a fixed percentage distributed yearly of the fair market value of
the property (to be determined yearly).
A QUICK BREAK DOWN OF THE COMPONENTS OF § 2055:
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2055 provides a deduction for all bequests, legacies, devises, or transfers TO:
(1) U.S. or state or local government for exclusively public purposes.
(2) Religious, charitable, scientific, literary, or educational purposes (i.e. 501(c)(3)
organizations). Restrictions: (1) not if it attempts to influence legislation; (2) not if it is
involved in political campaigns.
(3) Lodges—if used for religious, charitable, scientific, literary, or educational purposes.
(4) Veteran’s organization.
(5) Employee stock ownership plan.
DIRUSSO: Out right gifts will always be fine as long as they fit the requirements of 2055(a).
DIRUSSO ON SPLIT GIFTS: However, split gifts—gifts to an organization or person that
does not qualify under 2055(a) and to an organization that does qualify under 2055(a)—might
not qualify, unless they fit within § 2055(e)(2)—
SECTION 2055(e)(2): A split gift will not qualify unless:
(A) Remainder interest—(1) remainder annuity trust; (2) remainder unitrust; (3) pooled
income fund.
(B) Guaranteed annuity of fixed percentage.
You can pick whether you want the charity to have the front end or the back end.
Can’t use an income interest to split it—have to use an annuity or a unitrust.
Section 2055(a) gives a charitable deduction for the value of certain transfers to charity.
The 2055 charitable deduction is similar to the § 170 income tax charitable deduction, but there
are some notable differences.
► Perhaps the most prominent difference is that there are no monetary or percentage limits
on the estate tax or gift tax charitable deduction—except that the deduction cannot
exceed the value of the transferred property.
► Another difference is that the income tax charitable deduction allows for the deduction
for contributions to cemetery associations, no such deduction exists in the gift and estate
tax charitable deduction.
QUALIFYING ORGANIZATION/STATUTORILY LISTED PURPOSE: For an estate to
obtain a charitable deduction, the decedent must designate a qualifying organization. Only
donations to the organizations enumerated in § 2055(a) will qualify and then only if the
donation is for the purposes specified in the statute.
GOVERNMENT AND PUBLIC PURPOSE: Under § 2055(a)(1) bequests to the United
States, any State, or political subdivision are deductible so long as the property must be used
exclusively for public purposes.
DIRUSSO’S THOUGHT: “Section 2055(a)(1) gives the decedent the ability to shift their tax
payment from the federal government to the state government.”
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WHAT QUALIFIES AS A CONTRIBUTION UNDER 2055(a)(1)? Property that escheats to
the state when the decedent dies intestate does not qualify—because the decedent did not transfer
the property to the state; it passed by operation of law.
WHAT ABOUT FOREIGN GOVERNMENTS: A bequest to a foreign government is not
deductible under § 2055(a)(1). However, it may be deductible under (a)(2) or (a)(3) if the
property must be used for charitable purposes only.
SECTION 2055(a)(2) & (a)(3): Section 2055(a)(2) allows a deduction for bequests to
corporations that are organized and operated exclusively for religious, scientific, literary,
educational, or charitable purposes. Section 2055(a)(3) allows a deduction for bequests to trust or
fraternal associations if the gift is to be used exclusively for religious, scientific, literary,
educational, or charitable purposes.
No deduction is allowed to an organization that is disqualified from tax-exempt status because
of lobbying or participating in political campaigns.
SECTION 2055(a)(4) & (a)(5): Section 2055(a)(4) allows a deduction for certain transfers to
veterans organizations. Section 2055(a)(5) allows a deduction for certain transfers to employee
stock ownership plans.
Revenue Ruling 77-232—
Charitable donations, in order to qualify for the gift & estate tax charitable deduction, must be
voluntarily made by the donor and must be made to a qualifying organization.
In this revenue ruling, the service held that a donation to the State Bar Association did not
qualify for the estate and gift tax charitable deduction under 2055(a)(1), because the funds were
for both public and private use.—(state bar served a partially charitable purpose, but it also
served the business purposes of its members by monitoring the unauthorized practice of the law).
So, no deduction was allowed.
If funds may be used for anything other than public purposes (i.e. a private purpose) there may
be no deduction under 2055(a)(1).
DECEDENT MUST PROVIDE FOR CHARITABLE
CONTRIBUTION
The decedent himself/herself must specifically provide for the charitable contribution in her will.
Neither the executor nor the beneficiaries can create a charitable deduction in the absence of a
clear indication from the decedent.
Estate of Pickard v. Comm’r (Tax Court 1973)—
Claire Pickard established a revocable trust in 1954. The trust instrument provided for payment
of income and principal to decedent upon request during her life. After her death, an annuity of
$3,000 was to be paid to her mother, Etta Mae, during her life and, upon the mother’s death “the
Trustees shall transfer, assign and convey the entire Trust Estate then remaining” to Claire’s
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step-father Herbert. Claire died in December 1967. Her mother Etta Mae survived her. However,
Herbert died about 2 months before Claire, in October 1967. His will bequeathed his residuary
estate to a revocable trust—which named Etta Mae as life beneficiary and provided that the
residue would pass ½ to First English Lutheran Church and ½ to the Columbus Foundation. A
probate matter was opened to determine who should get the assets, due to Claire and Herbert
dying in such quick succession. The Probate Court determined that Etta Mae would get the life
benefit and then at her death, the property would pass to the charitable organizations under
Herbert’s trust document. The executor of Claire’s estate sought to take a 2055 charitable
deduction because her property was to pass to charitable organizations.
HELD: No charitable deduction for Claire’s estate.
REASONING: The transfer to the charitable organization must be provided for in the
decedent’s testamentary instrument. Here, the charities received the property because of Claire’s
testamentary disposition to Herbert, not because she made a testamentary disposition to the
charities. It is not the result of the charities receiving the money that matters, it is how the
charities receive the money—and here, Claire didn’t provide for the charities to receive anything
in her testamentary instrument. The Court noted that “[t]here must be something more, namely,
the testamentary facts as gleaned from the decedent’s own disposition must manifest the transfer
to charity.”
DIRUSSO: The decedent must be responsible for making the transfer to the charity. Here, her
trust document didn’t initiate the charitable gift, so she couldn’t take the deduction.
THE ROLE OF STATE LAW
Buder v. United States (8th Cir. 1993)—THE KILL ALL THE COMMUNISTS CASE
Mr. Buder died in 1984, leaving a self-drafted will and a substantial estate. One of the bequests
under the will was to organizations to promote the cause of patriotism and constitutional
government. The estate took a charitable deduction for the bequest under 2055. However, the
Commissioner (likely a Communist sympathizer as this was during the Clinton Administration
after all) challenged the deduction, claiming that bequest shouldn’t qualify for the deduction
because the bequest gives the trustee discretion to dispense funds to organizations that engage in
non-charitable lobbying and campaigning.
HELD: Charitable deduction is allowed for this bequest.
REASONING: To be deductible, the bequest must be used exclusively for religious, charitable,
scientific, literary, or educational purposes, or for the prevention of cruelty to children or
animals. No deduction is available if the organizations donated to are disqualified under
501(c)(3) because they attempt to influence legislation or participate in campaigning. The Court
looked to state law to determine the meaning of the decedent’s bequest. Under the applicable
state law, the intent of the settlor controls the interpretation of the bequest and the intent must be
ascertained by looking at the document as a whole and not just the individual parts. Looking at
the document in its entirety, the court determined that Mr. Buder intended this bequest to be
made only to charitable organizations. Therefore, the executor/trustees discretion was limited to
only giving to charitable organizations, thus it qualifies for the charitable deduction.
DIRUSSO’S TAKE: “He came out OK here. But he got lucky. Draft better than this—plug in
the code language that says exclusively for religious, charitable, scientific purposes, etc. Drafting
a bequest that has such a big consequence, such as a large deduction, is no place for inventive
drafting, just track the code language.”
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To be deductible, state law must:
(1) Uphold the validity of the charitable donation; AND
(2) Restrict the distribution of property to organizations that are charitable within the
meaning of § 2055.
POSTMORTEM EVENTS AND THE CHARITABLE DEDUCTION
Postmortem events can affect the deductibility of a charitable bequest.
For instance: if a beneficiary makes a qualified disclaimer under § 2518, that beneficiary is
treated as predeceasing the decedent. This may qualify a bequest that would otherwise fail to
meet the requirements of § 2055.
Example 14-1–David bequeathed $50,000 to his sister, Sarah, if she survived him, otherwise to
University Law School. Sarah survived David, but she disclaimed her interest in the $50,000 in a
manner that met the requirements of § 2518. As a result, the executor distributed the $50,000 to
University Law School. David will be treated as the transferor, and his estate will be entitled to a
charitable deduction.


The complete termination of a power to consume, invade, or appropriate property made
before the date of filing the estate tax return is deemed to be a qualified disclaimer.
But, the death of the life tenant within this prescribed period, however, does not qualify
as a disclaimer of that interest in order to create or increase the amount of a charitable
contribution.
WILL CONTEST SETTLEMENTS: The estate can take a charitable deduction for payments
to a charitable organization in settlement of will contest, but only if it is a bona fide contest
and not a collusive suit to reform a bequest that does not otherwise qualify under §
2055(e)(2).
Section 2055(e)(3) provides rules for reforming charitable bequests to comply with the split
interest provisions of subsection (e)(2). Modifications or reformations based on nontax
considerations will be given effect even though they do not satisfy the requirements of
subsection (e)(3), but not otherwise.
CONDITIONAL BEQUESTS TO CHARITY
A deduction will be allowed for a conditional bequest, but only if the possibility that the
charitable transfer will not become effective is so remote as to be negligible. In other words, it
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has to be an almost certainty that the bequest will end up going to the charity, despite the
condition.
Example 14-2–Debra’s will provides “if my spouse, Sam, does not survive me by 90 days, I
leave $250,000 to his brother, Carl, but if Sam does survive me, this sum will become part of my
residuary estate.” The residue of Debra’s estate was left to a trust that qualified under §
2055(e)(2), giving Sam an interest for life and the remainder to College. At Debra’s death, Sam
was 75 years old, and he did in fact survive her by 90 days. If the likelihood that a 75-year-old
male would die within 90 days, measured on the day of Debra’s death, is less than 5 percent,
Debra’s estate will receive a charitable deduction for the transfer to the trust.
P. 448 Problem 1: Duane bequeathed $100,000 to each of his three children, Mary, Nancy, and
Oscar. At the time that Duane drafted his will, Nancy belonged to an order of Catholic nuns and
had taken a vow of poverty. Pursuant to that vow, any property that Nancy acquired became the
property of the Catholic Church. Duane’s executor distributed the property as directed in his will,
and Nancy paid over her $100,000 to the Catholic Church. What are the estate tax consequences
to Duane’s estate?
The estate doesn’t get a charitable deduction. It wasn’t voluntarily paid to the church. To get
the deduction, the decedent must have voluntarily directed the assets toward the charity. Here,
that is not the case, so no tax break.
P. 448 Problem 3: What are the estate tax consequences in the following situations?
a. Dierdre sends a $100,000 check to Law School on December 26. She dies on January 2 before
Law School deposits the check. Law School deposits the check on January 3 unaware of her
death. Dierdre’s bank pays the check in the normal course of business
b. Dierdre had agreed to give $100,000 to Law School’s capital campaign, payable over four
years. She died after making the first payment. Her estate pays the remaining $75,000.
c. Dierdre was interested in endowing a tax professorship at Law School. Although she had
extensive discussions with her family and the Dean of the Law School, she had made no
provisions for a contribution before her death. Her will leaves her property to her son, Silas, who
is also her executor. Silas decides to honor Dierdre’s wishes and he sends $2,000,000 from the
estate to Law School to endow a tax professorship.
a. The relation back doctrine should work here. So, there should be a charitable deduction
allowed for the gift.
b. This is OK. A deduction will be allowed. If you make a charitable pledge, it is enforceable
under state law (even in the absence of consideration). Therefore, this is a debt of the estate that
the organization can collect. So, this is deductible as a debt of the estate under § 2053, but not
under § 2055 as a charitable deduction.
c. Dierdre did not direct the payment—so, this doesn’t qualify for the 2055 charitable
deduction. For it to qualify, she must have directed the funds to the law school under the will or
trust. However, son will get a charitable income tax deduction if he does this (but remember,
there are caps and limitations on income tax charitable deduction, unlike the unlimited charitable
deduction provided for in the gift and estate tax).
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P. 449 Problem 4: Douglas leaves the residue of his estate in trust to pay the income to Alex for
life and, at Alex’s death, to distribute the trust property to whomever Alex designates in his will.
In default of appointment by Alex, the property is to be distributed to Church.
a. What are the estate tax consequences to Douglas?
b. What are the estate tax consequences to Alex if he does not appoint the trust property, and it
goes to Church?
c. What are the estate tax consequences to Douglas if Douglas’s will had left the residue of his
estate to “whatever charitable organization my son, Alex, designates,” and Alex designates the
local homeless shelter, which is a § 501(c)(3) organization?
d. Assume that Douglas’s will had left the residue of his estate in trust to pay the income to Alex
for his life, and at Alex’s death, the trust property was to be distributed to “whatever charitable
organization my son, Alex, designates in his will.” Alex designates a child care center that is a §
501(c)(3) organization. What are the estate tax consequences to Douglas? To Alex?
a. No deduction for Douglas. Douglas has given 100% of his property to Alex in substance.
b. The property is included in Alex’s gross estate as a general power of appointment.
However, Alex will get the benefit of the charitable deduction because—the general power of
appointment causes him to be treated as the owner of the property—and by not exercising his
power, he transferred the property to the church.
c. Douglas will get the charitable deduction here. It was Douglas that was responsible for
directing the property to a § 501(c)(3) organization. He gave his son Alex a limited power of
appointment to pick which 501(c)(3) would get the property, but because it was a limited power
of appointment, Douglas is still considered to be the owner, so it is treated as a transfer from
Douglas to the charity directly.
d. Douglas Estate Tax Consequences—This is a split interest income trust. This will not
qualify Douglas for the estate tax charitable deduction because it is a split interest income trust.
Under 2055(e) to qualify for the deduction the split interest must be either an annuity or unitrust
interest, thus an income interest will not qualify.
Alex’s Estate Tax Consequences—Alex does not get a charitable deduction either. He only had a
limited power of appointment—so the property was not included in his gross estate. You never
see a deduction when the property wasn’t included in the gross estate in the first place.
TRANSFERS IN TRUST
There are very specific rules for gifts of split interests in property—where the decedent gives
interests in the same property to both a charitable and a noncharitable beneficiary—to ensure that
the amount of the charitable deduction matches the value of what the charity actually receives.
§ 2055(e). Disallowance of deductions in certain cases.
(1) . . .
(2) Where an interest in property . . . passes or has passed from the decedent to a person, or
for a use, described in subsection (a), and an interest (other than an interest which is
extinguished upon the decedent’s death) in the same property passes or has passed (for
less than an adequate and full consideration in money or money’s worth) from the
decedent to a person, or for a use, not described in subsection (a), no deduction shall be
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allowed under this section for the interest which passes or has passed to the person, or for
the use, described in subsection (a) unless—
(A) in the case of a remainder interest, such interest is in a trust which is a charitable
remainder annuity trust or a charitable remainder unitrust (described in section
664) or a pooled income fund (described in section 642(c)(5)), or
(B) in the case of any other interest, such interest is in the form of a guaranteed
annuity or is a fixed percentage distributed yearly of the fair market value of the
property (to be determined yearly).
2055(e)(2) allows an estate tax deduction for split interest gifts only if the interest given to
charity is one of the following:
(1) a charitable remainder annuity trust,
(2) a charitable remainder unitrust,
(3) a pooled income fund,
(4) a guaranteed annuity or unitrust interest,
(5) a remainder interest in a personal residence or farm,
(6) an undivided portion of the taxpayer’s entire interest in the property,
(7) a qualified conservation contribution.
THE CRAT (CHARITABLE REMAINDER ANNUITY TRUST)
§ 664. Charitable remainder trusts.
(a) . . .
(b) . . .
(c) . . .
(d) Definitions.
(1) Charitable remainder annuity trust. For purposes of this section, a charitable
remainder annuity trust is a trust—
(A) from which a sum certain (which is not less than 5 percent nor more than 50
percent of the initial net fair market value of all property placed in trust) is to be
paid, not less often than annually, to one or more persons . . . for a term of years
(not in excess of 20 years) or for the life or lives of such individual or
individuals,
(B) from which no amount other than the payments described in subparagraph (A)
and other than qualified gratuitous transfers described in subparagraph (C) may
be paid to or for the use of any person . . .
(C) following the termination of the payments described in subparagraph (A), the
remainder interest in the trust is to be transferred to, or for the use of, an
organization described in section 170(c) . . . and
(D) the value (determined under section 7520) of such remainder interest is at least
10 percent of the initial fair market value of all property placed in the trust.
A charitable remainder annuity trust (CRAT) is an irrevocable trust where an income interest is
paid to one or more beneficiaries, at least one of whom is not a charitable organization. The
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income interest may be paid for one life, for two or more lives, or for a term of years that
does not exceed 20 years.
If the interest is to be paid to an individual, the person must be living at the date of the creation
of the CRAT.
The income interest must be a specified sum that is at least 5 percent of the initial fair market
value of the property placed in trust and not more than 50 percent of that value.
 The sum certain can be expressed as a dollar amount or as a fraction or percentage
amount of the initial fair market value of the property placed in trust.
 The income interest must be distributed at least annually, and the value of the remainder
interest must be at least 10 percent of the initial fair market value of all the property
placed in trust.
Example 14-3–Duncan transfers $750,000 to FNB as Trustee to pay $25,000 each year to his
mother, Martha, for her life and, at her death, to distribute the trust property to College. If the
remainder interest has a value of at least $75,000, this trust meets the requirements of §
664(d)(1), and Duncan will be allowed a gift tax deduction for the value of the remainder
interest.
Example 14-4–Donna bequeaths $900,000 to FNB as Trustee to pay her son, Sam, an amount
equal to 7 percent of the FMV of the trust, determined as of the date her estate tax return is due,
each year for 15 years. After 15 years, the trust property is to be distributed to Church. If the
remainder interest has a value of at least $90,000, this trust meets the requirements of §
664(d)(1), and Donna will be allowed an estate tax deduction for the value of the remainder
interest.
THE CRUT (Charitable Remainder Unitrust)
§ 664. Charitable remainder trusts.
(a) . . .
(b) . . .
(c) . . .
(d) Definitions.
(1) . . .
(2) Charitable remainder unitrust. For purposes of this section, a charitable remainder
unitrust is a trust—
(A) from which a fixed percentage (which is not less than 5 percent nor more than
50 percent) of the net fair market value of its assets, valued annually, is to be
paid, not less often than annually, to one or more persons . . . for a term of years
(not in excess of 20 years) or for the life or lives of such individual or
individuals,
(B) from which no amount other than the payments described in subparagraph (A)
and other than qualified gratuitous transfers described in subparagraph (C) may
be paid to or for the use of any person other than an organization described in
section 170(c),
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(C) following the termination of the payments described in subparagraph (A), the
remainder interest in the trust is to be transferred to, or for the use of, an
organization described in section 170(c) . . .
(D) with respect to each contribution of property to the trust, the value (determined
under section 7520) of such remainder interest in such property is at least 10
percent of the net fair market value of such property as of the date such property
is contributed to the trust.
A CRUT must meet the same requirements as a CRAT, except that the income interest must
be a fixed percentage of the net fair market value of the trust assets, valued annually.
 That percentage must be not less than 5 percent or more than 50 percent of the net fair
market value determined annually.
 The income interest in a CRUT must be stated as a fixed percentage.
o Thus, the amount of income distributed from a CRUT will change each year as
the value of the trust assets increases or decreases.
Example 14-5–Daniel bequeaths $800,000 to FNB as Trustee to pay his spouse, Sarah, 6 percent
of the net FMV of the trust assets, valued annually, in quarterly installments. At Sarah’s death,
the Trustee is to transfer the trust property to the American Red Cross. If the remainder interest
has a value of at least $80,000, this trust meets the requirements of § 664(d)(2), and Daniel will
be allowed an estate tax deduction for the value of the remainder interest.
POOLED INCOME FUND
A donor or decedent will also receive a charitable deduction for the value of a remainder interest
donated to a pooled income fund for a public charity, as defined in § 170(b)(1)(A), other than
charities in clauses (vii) and (viii). The pooled income fund must be a trust maintained by the
charity that is the remainder beneficiary. The income interest must be paid to one or more
beneficiaries who are living at the time of the transfer to the fund for their lives.
LEAD TRUSTS
A decedent’s estate may also receive a charitable deduction for transfers where the charity
receives the front end interest rather than a remainder interest. The charitable organization
must receive either a guaranteed annuity or a fixed percentage of the FMV of the trust
assets determined annually.
UNDIVIDED PORTIONS OF THE ENTIRE ESTATE,
PERSONAL RESIDENCES, FARMS, CONSERVATION
A decedent’s estate may also receive a deduction under § 2055(e)(2) for contributions specified
in § 170(f)(3)(B), i.e., an undivided portion of the decedent’s entire interest in property, a
remainder interest in a personal residence or a farm, or a qualified conservation contribution.
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P. 454 Problem 2: Dennis bequeaths the residue of his estate, $10,000,000, to FNB as Trustee to
pay the income to Charity for 15 years and then to distribute the trust property in equal shares to
his surviving issue.
a. Will Dennis’s estate be entitled to a deduction under § 2055 for this bequest?
b. What if the Trustee is to pay Charity $300,000 per year for 15 years?
c. What if the Trustee is to pay Charity 6 percent of the value of the trust each year?
a. No. Here we have an income interest—you only get the charitable deduction if the interest
is an annuity or unitrust interest.
b. Yes, this would qualify for the charitable deduction so long as the remainder is sufficient—
this is a charitable lead annuity trust. Deduction attributable to the annuity interest.
c. Yes, this is a charitable lead remainder trust—so it qualifies for the charitable deduction.
P. 454 Problem 3: Doris bequeaths $10,000,000 to FNB as Trustee to pay the income to her
child, Chris, for life and at his death to distribute the trust property to Charity.
a. Will Doris’s estate be entitled to a deduction under § 2055 for this bequest?
b. What if the Trustee is to pay Chris $35,000 each year?
c. What if the Trustee is to pay Chris $60,000 each year for 25 years and at the end of the 25
years to distribute the trust property to Charity?
a. No this will not qualify. Again, this is a straight up income interest, it is not a qualifying
interest (it is neither a unitrust interest nor an annuity interest).
b. No deduction. This is an annuity interest, but it has to be at least 5% to qualify, this is only
3.5%, so it is not a qualifying interest.
c. No deduction. This is an annuity interest, but if the annuity interest is for a term of years, it
must be for less than 20 years, so 25 years is too long, so this is not a qualifying interest.
CHAPTER 15: TRANSFERS TO THE SURVIVING
SPOUSE
The gift and estate tax system provides a marital deduction for transfers between spouses. The
marital deduction is an issue of tax deferral, no tax at the time of the gift or upon the death of the
first spouse, but in theory it will be taxed at the death of the surviving spouse.
§ 2056. Bequests, etc., to surviving spouse.
(a) Allowance of marital deduction. For purposes of the tax imposed by section 2001, the
value of the taxable estate shall, except as limited by subsection (b), be determined by
deducting from the value of the gross estate an amount equal to the value of any interest
in property which passes or has passed from the decedent to his surviving spouse, but
only to the extent that such interest is included in determining the value of the gross
estate.
DiRusso: “Note that the property must be included in the decedent’s gross estate in order to
qualify for the estate tax marital deduction. If the property was not included in the decedent’s
gross estate in the first place, they cannot get a deduction. What is an example of a time when the
decedent will transfer property to their surviving spouse without the property having been in the
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decedent’s gross estate in the first place? When the decedent has a limited power of appointment
(not in decedent’s gross estate) and exercises it in favor of the surviving spouse. In this case,
there will be no deduction allowed, because the property subject to the limited power of
appointment was never in the decedent’s gross estate to begin with.”
SIX BASIC REQUIREMENTS:
(1) The marital deduction
is available to any decedent who is
subject to the federal estate tax even if he is not a citizen or
resident of the United States.
a. The marital deduction is only available to a non-citizen or non-resident if the
property is included in his gross estate (i.e. the property is located in the
United States) and otherwise structured properly.
(2)
The property must be given to a spouse.
a. Marital status is determined by state law—however DOMA controls the
federal definition of marriage—2013 saw a major S. Ct. decision regarding
DOMA, expect the service to promulgate regulations on this for guidance.
b. When does marriage end? Only a final divorce decree is sufficient to change
marital status, legal separation or the simple filing for divorce is not enough.
c. Common Law Marriage—common law spouses may qualify for the estate tax
marital deduction if common law is recognized in their state and they satisfy
all the requirements of their states common law marriage rules.
d. Citizenship of Surviving Spouse—the surviving spouse need not be a citizen
or even a resident. However, if the spouse is not a citizen, the property
must be left to a qualified domestic trust as defined in § 2056A.
e. Timing Issues—Here we see a difference between the gift tax marital
deduction and the estate tax marital deduction:
i. Gift Tax—The donor and donee must be married at the time of the
transfer to qualify for the gift tax marital deduction.
ii. Estate Tax—For the estate tax marital deduction, the decedent need
not have been married to the recipient at the time of the transfer as
long as (1) the decedent and recipient are married at the time of the
transferor’s death and (2) the property is included in the decedent’s
gross estate.
1. Consequence of divorce—For the estate tax marital deduction,
if the decedent and recipient were married at the time of the
transfer but subsequently divorced, the property will not
qualify for the marital deduction.
iii. Analysis: The gift tax marital deduction focuses on whether the
individuals were married at the time of the gift. The estate tax marital
deduction focuses on whether the individuals were married at the time
of the transferor’s death.
(3)
The spouse must survive the decedent.
a. Can be for even a millisecond.
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b. What if the order of death can’t be determined? Survivorship may be
determined by state law default rules or by a survivorship provision in your
document. [2056(b)(3) specifically allows a martial deduction bequest to be
made contingent on survival of the spouse for a limited period (not exceeding
6 months)].
i. TWO ISSUES WITH SURVIVORSHIP PROVISIONS:
1. Where a survivorship provision applies only to deaths resulting
from a common disaster—the provision is ineffective for
federal transfer tax purposes if the order of deaths can be
established.
a. THE FIX: draft as follows—“whenever the order of
death cannot be determined.”
2. When you include the exact same survivorship provision in the
will of both spouses—“if my spouse and I die in circumstances
where the order of deaths cannot be determined, my spouse is
deemed to survive me.” This would create the exact same
result as the state law presumption of survivorship. Instead, the
clauses should be drafted such that they specify that one spouse
is deemed the survivor.
ii. Survivorship provisions cannot change the actual order of
deaths—2056(b)(3) allows the bequest to be conditioned on
survivorship for a stated period, not in excess of 6 months. However,
2056(b)(3) does not permit the spouses to alter the actual order of
death for estate tax purposes—
1. EXAMPLE: H and W are married. H’s will provides that W
will only take if W survives H by 6 months. Under 2056(b)(3)
this will qualify for the marital deduction—you CAN do that.
2. BUT: If H has in his document that even if W predeceases him,
she will be deemed to survive him—that you CAN NOT do.
(4)
The property must be in the decedent’s gross estate as
determined by §§ 2033-2044.
a. If the property was not in the decedent’s gross estate, it would allow a double
benefit.
b. WHEN IS THIS RELEVANT? POWERS OF APPOINTMENT:
i. If the first spouse to die has only a limited power of appointment over
the property, then it will not be included in the gross estate of the first
spouse to die—therefore the estate will get no marital deduction.
(5) The property must “pass” from the decedent to the
surviving spouse.
a. This requirement is met when the property is in the decedent’s gross estate
and if the survivor acquires the property as a result of the decedent’s death.
b. Under 2056(c) bequests and devises, inheritances, dower or curtesy interests
or the statutory share, joint tenancy property, life insurance, property subject
to a power of appointment, and property subject to §§ 2035–2038 are
considered as “passing” if the decedent transferred them to the surviving
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c.
d.
e.
f.
g.
(6)
spouse. Additionally, a surviving spouse’s interest in pension plans, employer
death benefits, and similar arrangement are also considered to “pass.”
DISCLAIMER BY SURVIVING SPOUSE: If the surviving spouse
disclaim under § 2518 then the property passes to somebody else, so the
marital deduction does not apply.
DISCLAIMER BY OTHER CAUSING PROPERTY TO PASS TO
SURVIVING SPOUSE: If a decedent left property to a third party and the
third party disclaims the property such that the property will go to the
surviving spouse, then the property IS considered to “pass from the
decedent to the surviving spouse and will therefore qualify for the marital
deduction.
ELECTIVE SHARE AND WILL CONTESTS: The spouse’s exercise of
the elective share will qualify as property which “passes” from the decedent to
the surviving spouse.
WILL CONTESTS: Property that the surviving spouse acquires in a
settlement of a will contest will qualify as long as the settlement represents a
“bona fide recognition of enforceable rights.
NET VALUE RULE: The passing requirement limits the amount of the
marital deduction to the net value of the property received by the surviving
spouse.
i. What is the consequence? Any encumbrances, tax burdens, or
expenses of administration will be taken out—leaving only the net
value benefit to the surviving spouse to qualify for the marital
deduction.
ii. Example 15-3: H and W are married. W owns an apartment building
that has a FMV of $350,000 and a mortgage of $200,000. W devises
this property to H. Her gross estate includes the $350,000 value. Her
estate is entitled to a martial deduction of only $150,000, the net value
of the property passing to H. Her estate will, however, be entitled to a
deduction under § 2053 for the $200,000 mortgage. As a result, the
amount in her taxable estate will be zero.
iii. The Net Value Rule also applies to conditional bequests:
1. For instance in United States v. Stapf (1963): First spouse to
dies will provided that the surviving spouse could make an
election between a widow’s election or another option. She
chose the widow’s election. Under the widow’s election she
received less than she would have under the other option. So,
there was no net benefit, thus no marital deduction was
allowed. From a policy standpoint, this was just a disguised
gift to the children.
The interest must NOT be a nondeductible terminable interest.
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P. 468 Problem 1: Harold and Wanda are married. They own a home (valued at $600,000) as
joint tenants with the right of survivorship. Harold also owns a life insurance policy (face amount
$1,700,000) payable to Wanda and investments (valued at $3,000,000). In addition, Harold’s
mother had established a testamentary trust to pay the income to Harold for life and remainder to
whomever he appoints by will, and in default of appointment by Harold to his children in equal
shares. At the time of Harold’s death, the trust corpus is worth $5,000,000.
a. Harold’s will leaves all of his property to Wanda, his spouse. In addition, Harold exercises his
power of appointment in favor of Wanda. What is the value of Harold’s gross estate? What is the
value of his taxable estate? Why?
a. Overall $10,000,000 will be included in the gross estate. How did we get there?
§ 2040(b) will bring in ½ of the value of the jointly held property = so ½ house is $30,000.
§ 2033 brings in the investment income = $3,000,000.
§ 2041 will bring in the trust corpus because of the GPOA = $5,000,000.
§ 2042 will bring in life insurance if he has incidents of ownership (probably does) = $1,700,000.
All of these assets, which were passed under the will, will be eligible for the marital deduction—
because everything passes outright to the spouse here. So, we take our gross estate of
($10,000,000) minus the deductions of ($10,000,000) which gives us a taxable estate of $0.
b. Harold had consulted an attorney about estate planning, indicating that he wanted to leave
everything to Wanda. Harold, however, dies before he can execute his will or exercise his power
of appointment. Wanda inherits ½ of the investment property under the intestacy laws. Chris,
Harold’s son, inherits the other one-half. The trust property passes under the default clause to
Chris.
b.(1). What is the value of Harold’s taxable estate? Why?
b.(2). Chris disclaims his interest in the investments, and his interest passes to Wanda pursuant to
state law. Assume that Chris’s disclaimer meets the requirements of § 2518. What is the value of
Harold’s taxable estate? Why?
b.(3). Instead of (2), Chris and Wanda engage in lengthy discussions and negotiations. They
finally agree that Chris will transfer the investments and one-half of the value of the trust
property to Wanda. This agreement does not meet state property law requirements as a
disclaimer, nor does it meet the requirements of § 2518. What is the value of Harold’s taxable
estate? Why?
b.(1). Gross Estate is again $10,000,000. But, much less will qualify for the marital deduction
here—Wanda gets ½ of the joint tenancy real estate ($300,000); ½ of the investments
($1,500,000); she gets the life insurance ($1,700,000) = ($3,200,000) qualifies for the marital
deduction. Chris gets the trust corpus ($5,000,000) and ½ of the investments ($1,500,000) =
$6,500,000 passing to Chris. So—we have a $10,000,000 gross estate minus $3,500,000 of
marital deduction, leaving us with a taxable estate of $6,800,000.
b.(2). Gross Estate is $10,000,000. The investment property disclaimed by Chris will be
treated as having ‘passed’ from the decedent to Wanda, so it will qualify for the marital
deduction. So, it is the same as b.(1). except that all of the investments will go to Wanda, and
thus qualify for the marital deduction. So, the only thing going to Chris is the trust property, that
will be $5,000,000. So Harold’s taxable estate will be $5,000,000—because everything else
qualifies for the marital deduction.
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b.(3). So long as this is a valid will contest, which passes all the scrutiny that is usually applied
to family transactions, then this will be ok (i.e. so long as it represents a bona fide recognition of
enforceable rights). So, all of the property will pass to the surviving spouse, and thereby qualify
for the marital deduction, except for the ½ of the trust property that Chris will keep
($2,500,000)—this $2,500,000 will be Harold’s taxable estate.
c. Instead, Harold made the insurance proceeds payable to Chris, left all his other property to
Chris, and appointed the trust property to Chris. (The house is still in joint tenancy with Wanda.)
c.(1). If Wanda elects against the will, will the amount she receives qualify for the marital
deduction? Why?
c.(2). What if, instead, she challenged the will on grounds of mental capacity and undue
influence and won? Assume that there was a prior will leaving everything to Wanda and
exercising the power of appointment in favor of her. The court decree upholds the prior will.
c.(3). Same as (2), except that Wanda and Chris settle before trial. Will the amount that Wanda
receives under the settlement qualify for the marital deduction? Why?
c.(1). Yes, the election against the will qualifies as long as the spouse will receive an
appropriate interest (i.e. an interest in property that qualifies for the marital deduction). [i.e. it
must be not be a nondeductible terminable interest—i.e. if the state elective share statute only
allowed a life estate, then it wouldn’t qualify.]
c.(2). She would get everything that she was entitled to under the prior will—and—as long as
the will contest was bona fide—it meets the passing requirement and qualifies for the marital
deduction.
c.(3). As long as it is a bona fide settlement, the property that passes to her as a result of the
settlement will qualify for the marital deduction.
d. Assume that the trust gave Harold only a special power of appointment to appoint to Wanda or
his lineal descendants. What are the estate tax consequences if Harold leaves his investments to
Chris and appoints the trust property to Wanda? (Assume the insurance proceeds are still payable
to Wanda.)
d. Here, his power of appointment is limited. So, the property subject to the limited power of
appointment will not be included in Harold’s gross estate. Property must be included in the
decedent’s gross estate in order for it to qualify for the marital deduction—so it will neither be
taxed to Harold, nor will Harold’s estate receive a deduction for the property. All other property
passing to Wanda will qualify for a deduction. However, the investments passing to Chris will be
included in the gross estate and will not be subject to a deduction, so their entire value will be
included in the taxable estate.
e. What are the estate tax consequences in problem 1.a. if the house is subject to $300,000
mortgage?
e. As to the mortgage, the net value rule comes into play. One-half the value of the mortgage
($150,000) will be subtracted from the value of the ½ interest in the jointly owned property
($300,000 -$150,000 = $150,000). So, only $150,000 of the jointly owned property will qualify
for the marital deduction.
P. 470 Problem 2: Leslie and Robin have lived together for 25 years and have always identified
themselves as a couple. Leslie’s will provides: “I leave all of my property to my partner, Robin.”
Leslie owned property valued at $12,000,000. What is the value of Leslie’s taxable estate? Why?
Probably $12,000,000. It depends on whether they were legally married under state law. They
don’t appear to be, but if their state recognized common law marriage and they hit all the
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elements, then they would qualify for the marital deduction. But, likely not, so a $12,000,000
taxable estate is the most likely outcome here.
P. 470 Problem 3: Alan and Brenda are married and have two adult children, Ethan and Faith.
Alan owns investments of $7,500,000; Brenda owns investments of $2,000,000. Alan’s will
leaves all his property to Brenda, and if she does not survive him to their children. Brenda’s will
leaves all her property to Alan, and if he does not survive her to their children. Alan shoots
Brenda and then himself. State law provides that a killer is considered to have predeceased the
victim.
a. What is the value of Alan’s gross estate? His taxable estate?
b. What is the value of Brenda’s gross estate? Her taxable estate?
a. Alan’s gross estate is valued at $7,500,000. Brenda didn’t actually survive Alan, so even
though state law treats Brenda as surviving Alan, because she failed to actually survive Alan,
Alan’s estate cannot receive a marital deduction—so his taxable estate is $7,500,000.
b. Brenda’s gross estate is valued at $2,000,000. Under state law, despite the fact that Alan
actually survived Brenda, Alan is treated as dying first, so no marital deduction is allowed—so
her taxable estate is $2,000,000. (Plus, depending on the state law, Alan may not get anything in
the first place because he was Brenda’s slayer).
TRANSFERS TO NON-CITIZEN SPOUSES: QDOTS
§ 2056(d). Disallowance of marital deduction where surviving spouse not United States
citizen.
(1) In general. Except as provided in paragraph (2), if the surviving spouse of the decedent is
not a citizen of the United States—
(A) no deduction shall be allowed under subsection (a), and
(B) section 2040(b) shall not apply.
(2) Marital deduction allowed for certain transfers in trust.
(A) In general. Paragraph (1) shall not apply to any property passing to the surviving
spouse in a qualified domestic trust.
(B) Special Rule. If any property passes from the decedent to the surviving spouse of
the decedent, for purposes of subparagraph (A), such property shall be treated as
passing to such spouse in a qualified domestic trust IF—
(i) such property is transferred to such a trust before the date on which the return of
the tax imposed by this chapter is made, or
(ii) such property is irrevocably assigned to such a trust under an irrevocable
assignment made on or before such date which is enforceable under local law.
The rules of the marital deduction are different when the surviving spouse is not a U.S. citizen.
1. The gift tax marital deduction is not available at all. Instead of the marital deduction, a
larger annual exclusion is allowed--$100,000 indexed for inflation.
2. The § 2040(b) rule in regard to spousal joint tenancies is inapplicable.
3. The estate tax marital deduction is only allowed if the property is left to a QDOT.
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QDOT REQUIREMENTS:
 A QDOT must have a trustee who is either a citizen of the U.S. or a domestic
corporation.
 The trustee must have the right to withhold the estate tax imposed by § 2056A(b) on any
distribution, other than a distribution of income.
 Furthermore, the trust must meet the requirements of one of the following types of trusts:
o A Power of Appointment Trust (§ 2056(b)(5)).
o A QTIP Trust (§ 2056(b)(7)).
o A Charitable Remainder Trust with the Spouse as the only Noncharitable
Beneficiary (§ 2056(b)(8)).
o An Estate Trust (Treas. Reg. § 20.2056(c)-2(b)(1)).
 The executor must make an election.
 The trust must comply with all the requirements designed to ensure collection of the tax.
THE TERMINABLE INTEREST RULE (§ 2056(b))
Section 2056(b) (Section 2523(b) for gift tax purposes) states the terminable interest rule:
§ 2056(b). Limitation in the case of life estate or other terminable interest.
(1) General Rule. Where, on the lapse of time, on the occurrence of an event or
contingency, or on the failure of an event or contingency to occur, an interest passing to
the surviving spouse will terminate or fail, no deduction shall be allowed under this
section with respect to such interest—
(A) if an interest in such property passes or has passed (for less than an adequate and full
consideration in money or money’s worth) from the decedent to any person other than
such surviving spouse (or the estate of such spouse); and
(B) if by reason of such passing such person (or his heirs or assigns) may possess or enjoy
any part of such property after such termination or failure of the interest so passing to
the surviving spouse;
and no deduction shall be allowed with respect to such interest (even if such
deduction is not disallowed under subparagraphs (A) and (B))—
(C) if such interest is to be acquired for the surviving spouse, pursuant to directions of the
decedent, by his executor or by the trustee of a trust.
2 THINGS THAT ARE NOT TERMINABLE INTERESTS:
1. Under 2056(a)(2) “an interest shall not be considered as an interest which will terminate
or fail merely because it is the ownership of a bond, note, or similar contractual
obligation.
This means that nature of the property will not make it a nondeductible terminable interest.
2. Under 2056(a)(3) a survival period of no more than six months is authorized.
This means that the spouse’s receipt of the property can be made contingent on surviving the
other spouse for a period of time (but no more than 6 months).
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GENERAL RULE UNDER TERMINABLE INTEREST RULE: Property left to a surviving
spouse will qualify for the marital deduction only if the spouse’s interest is a ‘nondeductible
terminable interest.’
WHAT IS A TERMINABLE INTEREST?
A terminable interest is an in an interest in property that will terminate or fail on the lapse of
time or the occurrence or nonoccurrence of an event or contingency. Classic Example: A life
estate—because it terminates at the life tenant’s death.
ARE ALL TERMINABLE INTERESTS FATAL TO THE MARITAL DEDUCTION?
NO—only nondeductible terminable interests are fatal to the marital deduction. The code
provides that many terminable interests are deductible and therefore qualify for the marital
deduction.
Example 15-4–Decedent leaves property in trust to pay the income to Spouse for life and the
remainder to her Children. The gift to Spouse is a nondeductible terminable interest. Decedent
transferred an interest to the surviving Spouse that will terminate at his death. Decedent also
transferred an interest to her Children, who will enjoy the property after the spouse’s death. No
marital deduction is allowed for the transfer to the Spouse because it is a nondeductible
terminable interest.
Example 15-5–Decedent leaves a patent to Spouse. The patent will expire in ten years. The
property interest is a terminable interest because of the limited protection granted by statute, but
Decedent has not transferred an interest in the patent to anyone other than Spouse. As a result,
the value of the patent qualifies for the marital deduction.
THE EXCEPTIONS TO THE TERMINABLE INTEREST RULE:
The terminable interest rule is not without exceptions, those exceptions make certain terminable
interests deductible.
 The primary exception are power of appointment trusts and qualified terminable interest
property trusts.
 When a third party pays the decedent adequate and full consideration in money or
money’s worth for an interest—then a terminable interest that will pass to that third party
will qualify.
o Example 15-6–Wife owns Whiteacre and transfers a life estate to Husband. At
the same time, Wife sells the remainder interest in Whiteacre to Children.
Although the life estate is a terminable interest, it will qualify for the marital
deduction because the Children pay adequate and full consideration for their
remainder interest. Because this payment is made directly to the decedent, it will
be in her gross estate pursuant to § 2033.
 Another exception is the “estate trust,” which is a trust that pays the income to the
surviving spouse for life and the remainder to the surviving spouse’s estate. Because the
property passes to the surviving spouse’s estate, the surviving spouse will be able to
transfer the property to anyone by will—so it will be included in the surviving spouse’s
gross estate under § 2033.
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Jackson v. United States (1964)—
George Richards died. The probate court allowed Mrs. Richards to take a $3,000 per month
“widow’s allowance” under the probate code for her support and maintenance during the
administration of the estate. In total $72,000 was paid to Mrs. Richards in this widow’s
allowance. Mrs. Richards was entitled to these payments by the probate code, but if at anytime
Mrs. Richards remarried, she would lose her rights to payments. The estate took a martial
deduction for the entire $72,000 value. The Commissioner denied the deduction.
HELD: No deduction should be allowed, this is a nondeductible terminable interest.
REASONING: For purposes of the marital deduction, you look at the rights the surviving
spouse has at the date of the decedent’s death. Here, the surviving spouse’s interest was
terminable at the date of the decedent’s death. It was terminable because if she remarried, she
lost the right to the funds. Here, the funds were statutorily conditioned on the widow surviving
and remaining unmarried up to the date of the order for allowance of the “widow’s allowance.”
Therefore it was a nondeductible terminable interest and no marital deduction was allowed.
P. 475 Problem 1: John and Nancy are married, and Nancy dies. Her will leaves all her property
($8,000,000) in trust, income to John for life, remainder to their children. (Assume the executor
does not make the election under § 2056(b)(7)).
a. What are the estate tax consequences to Nancy?
b. What are the estate tax consequences if John and the children (who are adults) agree that John
will receive $3,500,000 outright, which is the actuarial value of his life estate, and that the
children will receive the remainder?
c. What are the estate tax consequences if the trust paid the income to John only until his
remarriage? What if it paid the income to him only for ten years?
d. What are the estate tax consequences if the trust had provided income to Nancy’s mother for
life, remainder to John?
a. Nancy would have a gross estate of $8,000,000. Her taxable estate would also be
$8,000,000. No marital deduction would be allowed because this is a nondeductible terminable
interest.
b. The consequences will again be the same as (a). No marital deduction will be allowed
because this is a nondeductible terminable interest. The surviving spouse and the children can’t
rewrite the estate plan to make it qualify for the marital deduction.
c. Neither the payments (1) until remarriage or (2) for ten years; will qualify for the marital
deduction, they are both nondeductible terminable interests.
d. Yes. John’s remainder interest qualifies for the marital deduction. A remainder can qualify
for the marital deduction.
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DEDUCTIBLE TERMINABLE INTERESTS:
EXCEPTIONS TO THE TERMINABLE INTEREST
RULE
There are some exceptions to the terminable interest rule. Essentially, there are some deductible
terminable interests.
SURVIVORSHIP CONDITIONS § 2056(b)(3)
A survivorship condition of up to six months is OK. So, you can condition the spouse’s receipt
of the property on the spouse surviving the decedent by up to six months.
Section 2056(b)(3) provides that a bequest to a spouse conditioned upon survival will qualify for
the marital deduction as long as (1) the survivorship condition is limited to a period not
exceeding six months after the decedent’s death or to death from a common disaster and (2) the
spouse in fact survives.
Example 15-7–H and W are married. W leaves all of her property to H but only if he survives
her by 180 days. W dies on March 1. H dies on December 15 of the same years. H has survived
W by more than 180 days. He will receive the property, and W’s estate will be entitled to the
marital deduction.
BUT: Now assume that W dies on March 1 and that H dies on May 1. Because H did not survive
for the period required by the will, he will not receive the property form W, and her estate will
not be entitled to the marital deduction.
However, survivorship clauses should not refer to surviving specific events. It does not matter if
the event actually occurs within the six-month period. The marital deduction will be denied if
there was the possibility that the event could have occurred beyond that six-month period.
Example 15-8–H and W are married. H leaves his property outright to W “provided that if she
dies before my will is probated, I leave all of my property to my son A.” H’s will is probated
within four months of his death. W survives and receives the property. H’s estate will not be
entitled to the marital deduction because it was possible, viewed at the moment of his death, that
probate might not occur within the six months required by § 2056(b)(3). Because it was not
absolutely certain on the date of his death, his estate will not be able to claim the marital
deduction.
CHARITABLE-MARITAL TRUST (MARITAL CRT)
§ 2056(b)(8). Special rules for charitable remainder trusts.
(A) In general. If the surviving spouse of the decedent is the only beneficiary of a qualified
charitable remainder trust who is not a charitable beneficiary nor an ESOP beneficiary,
paragraph (1) shall not apply to any interest in such trust which passes or has passed form
the decedent to such surviving spouse.
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§ 2056(b)(8) allows you to combine the charitable deduction (CRATS or CRUTS) with the
marital deduction.
Under this approach, you would have no estate tax on the death of either spouse.
Such a trust must comport with § 2056(b)(8) and the rules regarding the charitable deduction.
THE ESTATE TRUST (Treas. Reg. § 20.2056(c)-2(b)(1))
Treas. Reg. § 20.2056(c)-2(b)(1).
(b) Examples. The following illustrates the provisions of paragraph (a) of this section:
(1) A property interest bequeathed in trust by H (the decedent) is considered as having
passed from him to W (his surviving spouse)—
(i) If the trust income is payable to W for life and upon her death the corpus is
distributable to her executors or administrators;
(ii) If W is entitled to the trust income for a terms of years following which the corpus
is to be paid to W or her estate;
(iii) If the trust income is to be accumulated for a term of years or for W’s life and the
augmented fund paid to W or her estate; or
(iv) If the terms of the transfer satisfy the requirements of § 20.2056(b)-5 or §
20.2056(b)-7.
DIRUSSO: An estate trust is simply a trust that distributes to the surviving spouse’s estate at the
death of the surviving spouse after benefiting the surviving spouse during their life. There are
generally three options in structuring them:
 Income to surviving spouse for life, remainder to surviving spouse’s estate.
 Income to spouse for a term of years, remainder to surviving spouse or surviving
spouse’s estate.
 Income accumulated for life or term of years that is paid to the surviving spouse or the
surviving spouse’s estate—this option would allow the decedent to provide no lifetime
interest to the surviving spouse and still qualify the property for the marital deduction.
DiRusso: Estate trusts aren’t particularly common.
THE POWER OF APPOINTMENT TRUST (§ 2056(b)(5) Trust)
§ 2056(b)(5). Life estate with power of appointment in surviving spouse.
In the case of an interest in property passing from the decedent, if the surviving spouse is entitled
for life to all income from the entire interest, or all the income from a specific portion thereof,
payable annually or at more frequent intervals, with power in the surviving spouse to appoint the
entire interest, or such specified portion (exercisable in favor of such surviving spouse, or of the
estate of such surviving spouse, or in favor of either, whether or not in each case the power is
exercisable in favor of others), and with no power in any other person to appoint any part of the
interest, or such specific portion, to any person other than the surviving spouse—
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(A) the interest or such portion thereof so passing shall, for purposes of subsection (a), be
considered as passing to the surviving spouse, and
(B) no part of the interest so passing shall, for purposes of paragraph (1)(A), be considered as
passing to any person other than the surviving spouse.
This paragraph shall apply only if such power in the surviving spouse to appoint the entire
interest . . . is exercisable by such spouse alone and in all events.
WHY DOES THIS WORK? This is allowed because the property will be in the gross estate of
the surviving spouse upon their death because of the general power of appointment.
DIRUSSO SYNOPSIS OF (b)(5) TRUSTS:
The POA trust allows the marital deduction to apply, so long as:
1. the spouse is entitled to all of the income for life
2. the income is payable at least annually
3. the spouse has the power to appoint the property to herself or her estate (alone and in all
events), and
4. no person has the power to appoint to someone other than the surviving spouse.
BREAKING DOWN THE REQUIREMENTS:
THE RIGHT TO INCOME: The first requirement is that the surviving spouse be entitled to the
income for her life, payable annually or at more frequent intervals.
 The trustee cannot have the discretion to accumulate income, the payment of income
must be mandatory.
 The trust property must either produce income or be personal use property, such as a
residence. If the trust property is unproductive, the trustee must have the ability to
convert it to income-producing property.
 Administrative powers of the trustee will not keep it from getting marital deduction so
long as the powers do not deprive the surviving spouse of the beneficial enjoyment of the
trust property or if the remainder beneficiaries are preferred over the surviving spouse.
 The trust income must be paid to the surviving spouse annually or at more frequent
intervals.
Example 15-9–Decedent’s will leaves the residuary of his estate in trust with Friendly National
Bank as Trustee. The Trustee shall pay, in quarterly or more frequent installments, all of the net
income that the trustee determines to be proper for the health, education, or support,
maintenance, comfort, and welfare of Surviving Spouse in accordance with her accustomed
manner of living. Surviving Spouse has a power to appoint the trust property to anyone in her
will. This will not qualify for the marital deduction because the Surviving Spouse is not entitled
to all of the income for life, because of the ascertainable standard.
THE POWER OF APPOINTMENT: The surviving spouse must have the power to appoint the
trust property to herself or to her estate, alone and in all events. The spouse must be treated as
the unqualified owner of the trust property, and there must be no substantial limitations on
her right to appoint the property.
o However, note, that the decedent may provide a taker in default of appointment—that
will not disqualify the property from the marital deduction. (The decedent can give the
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o
o
o
o
o
surviving spouse a GPOA over the property and say that if my spouse fails to appoint
anyone to take the property it passes to somebody else).
The surviving spouse must have the ability to exercise the power without the consent of
anyone else.
The surviving spouse must have the ability to exercise the power in all events. This
means that the power cannot be limited in terms of time or by contingencies.
o BUT—the surviving spouse need not have the ability to exercise the power both
during life and under the terms of their will. The ability to exercise the power
(either during life or at death) is sufficient. The surviving spouse need not have
both.
NOTE ON GENERAL POWER OF APPOINTMENT: Under § 2056(b)(5) the
surviving spouse must have the power to appoint to themselves or their estate. The ability
to appoint to creditors and the creditors of their estate is not sufficient for § 2056(b)(5),
despite the fact that they would be GPOA for purposes of inclusion in the gross estate.
SURVIVING SPOUSE MAY HOLD ADDITIONAL POWERS: Because the property
will be included in the surviving spouses gross estate anyway, you can safely give other
additional powers.
ABILITIES OF OTHER PERSONS: Someone other than the surviving spouse may
also have the power to appoint the trust property as long as this power is not in opposition
to that of the surviving spouse. So, the trustee can have the power to appoint trust corpus
to the surviving spouse. This can be valuable if the surviving spouse becomes
incapacitated, and therefore unable to appoint property to themselves.
Example 15-10–H and W are married. W dies, leaving her property in trust with FNB as Trustee
to pay H all of the income from the trust every quarter. H has the right to demand trust corpus
during his life at any time for any purpose. This trust will qualify for the marital deduction
under § 2056(b)(5) even though H is not able to appoint trust property in his will.
BUT: Same facts, except that H does not have the ability to obtain trust corpus during his life.
Instead, the trust property is to be distributed as H designates in his will. Because H can appoint
the property to his estate, the trust will qualify for the marital deduction under § 2056(b)(5)
even though H has no ability to obtain trust property during his life.
Example 15-11–H and W are married. W dies, leaving her property in trust with FNB as Trustee
to pay H all of the income from the trust every quarter. H has the right to demand trust corpus
during his life at any time for any purpose. H also has the power to appoint the trust corpus
among W’s children at his death. This trust will qualify for the marital deduction even
though H’s power to appoint in his will is limited to W’s children because he also has the
power to appoint to himself during life at any time for any reason.
INSTEAD: Instead, H has the right to demand trust corpus during his life but only for his own
support and maintenance. He also has the power to appoint the trust corpus by will to anyone.
Because H can appoint the property to his estate, the trust will qualify for the marital
deduction even though H’s ability to obtain trust property during his life is limited by the
ascertainable standard of support and maintenance. If H had only the power to demand trust
corpus during his life for his own support and maintenance (and no right to appoint in the will),
the trust would not qualify for the marital deduction because he did not have the right to appoint
trust property “in all events.”
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SPECIFIC PORTION: Section 2056(b)(5) allows a marital deduction if the spouse’s right to
income or power of appointment is limited to a specific portion of the trust. Basically, this means
that it need not be the entire trust, it can be just a portion of the trust—but, if this is the case, only
the fractional portion that belongs to the surviving will qualify for the marital deduction.
 In fact: the surviving spouse’s right to income or her power of appointment or both can
be limited to a specific portion. But, the marital deduction will only be allowed for the
smaller portion.
o Example: Surviving spouse is given the right to ½ of the income from the trust
and the power to appoint the entire trust corpus in her will. Only ½ of the trust
will qualify for the marital deduction
o Similarly: If the surviving spouse is given the right to all income from the trust,
but the right to appoint only 40 percent of the trust corpus. Only 40 percent of the
trust property will qualify for the marital deduction.
QTIP TRUSTS (§ 2056(b)(7) Trust)
QTIP stands for Qualified Terminable Interest Property.
–§ 2056(b)(7) allows a decedent to control the ultimate disposition of the property without
depriving him of the benefits of the marital deduction—so long as the trust is a properly
structured 2056(b)(7) trust. This is useful in dealing with issues that arise in second marriages
and non-traditional families.
§ 2056(b)(7). Election with respect to life estate for surviving spouse.
(A) . . .
(B) Qualified terminable interest property defined. For purposes of this paragraph—
(i) In general. The term “qualified terminable interest property” means property—
(I) which passes from the decedent,
(II) in which the surviving spouse has a qualifying income interest for life, and
(III) to which an election under this paragraph applies.
(ii) Qualifying income interest for life. The surviving spouse has a qualifying income
interest for life if—
(I) the surviving spouse is entitled to all the income from the property, payable
annually or at more frequent intervals, or has a usufruct interest for life in the
property, and
(II) no person has a power to appoint any part of the property to any person other
than the surviving spouse . . .
(iii) . . .
(iv) . . .
(v) Election. An election under this paragraph with respect to any property shall be
made by the executor on the return of tax imposed by section 2001. Such an
election, once made, shall be irrevocable.
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WHY IS THIS ALLOWED? It reflects the reality of mixed/non-traditional families. The
property will be in the second spouse to dies gross estate under § 2044 (an estate tax code section
that brings in property subject to a QTIP election into the decedent’s gross estate).
DIRUSSO’S BREAK DOWN OF QTIPS:
The QTIP trust allows the marital deduction to apply, so long as:
1. the spouse is entitled to all of the income for life;
2. the income is payable at least annually;
3. no person may have the power to appoint trust property to anyone other than the
surviving spouse during the spouse’s life; and
4. the executor elects QTIP treatment.
BREAKING DOWN THE REQUIREMENTS:
THE RIGHT TO INCOME: The first requirement is that the surviving spouse be entitled to the
income for her life, payable annually or at more frequent intervals.
 This requirement is the same as that under § 2056(b)(5) except that stub income need not
be distributed to the surviving spouse nor need it be subject to a power of appointment in
the surviving spouse.
o What is stub income? Stub income is the income earned by the trust between the
last distribution date and the date of the surviving spouse’s death.
o The rule regarding the stub income not having to be distributed to the surviving
spouse was upheld in Estate of Shelfer v. Comm’r (11th Cir. 1996).
NO POWER TO APPOINT TO OTHER THAN THE SURVIVING SPOUSE: To qualify for §
2056(b)(7), no person can have the power to appoint any part of the QTIP property to anyone
other than the surviving spouse during her life. But, someone may have the right to have the
power to appoint to the surviving spouse during the surviving spouse’s life.
o Note: If the surviving spouse has a general power of appointment over the property, then
the general power of appointment may convert the trust from a QTIP trust into a power of
appointment ((b)(5)) trust.
o No one may have an ability to appoint property to anyone other than the surviving spouse
during the surviving spouse’s life—but after the surviving spouse’s death, another person
may have the power to appoint the trust property to somebody else.
o SALE OR GIFT OF SURVIVING SPOUSE’S INCOME INTEREST: The surviving
spouse may give away or sell his/her income interest. If he/she does so, § 2519 treats the
transaction as a transfer of the underlying assets minus his/her income interest.
Example 15-12–Decedent’s will leaves $5,000,000 in trust with FNB as Trustee, to pay the
income quarterly to Spouse. At Spouse’s death, the Trustee is to distribute the trust property to
those of Decedent’s children as Spouse appoints in his will and, in default of appointment, to
Decedent’s children equally. If the executor elects, the trust will qualify under § 2056(b)(7) even
though Spouse has a limited power to appoint among Decedent’s children because that power
does not arise until Spouse’s death. The trust property will be included in Spouse’s gross estate
by § 2044.
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Example 15-13–Decedent’s will leaves $5,000,000 in trust with FNB as Trustee, to pay the
income quarterly to Spouse. After Spouse’s death, the Trustee is to distribute income to
Decedent’s children equally and has discretion to distribute trust property to Decedent’s children
for their health, education, support, or in an emergency. If the executor elects, the trust will
qualify under § 2056(b)(7) because the Trustee’s power does not arise until after Spouse’s death
and the trust property will be in Spouse’s gross estate under § 2044.
Example 15-14–Decedent’s will leaves $1,000,000 in trust with FNB as Trustee, to pay the
income quarterly to Spouse, and at her death, to distribute the trust property to Decedent’s
children equally. When Spouse’s income interest has a value of $400,000, she gives that interest
to the her Daughter. Section 2519 treats this as a gift of $600,000, the value of the trust property
minus the value of Spouse’s income interest. Section 2511 treats the transfer of the $400,00
income interest as a gift. As a result, Spouse has made gifts totaling $1,000,000.
If Spouse had sold her income interest to Daughter for its actuarial value of $400,000, she
would still have made a gift of $600,000, the value of the remainder interest.
Thus, Section 2519 prevents the surviving spouse from avoiding § 2044 through lifetime
transfers.
THE ELECTION: To qualify for § 2056(b)(7), the executor must make the appropriate election
on the decedent’s estate tax return. This is a check-the-box election on the tax return.
The IRS presumes that the executor is making the QTIP election if the estate tax is calculated
as if the marital deduction is in fact claimed or unless the executor affirmatively indicates that he
or she is not making the QTIP election.
Estate of Letts v. Comm’r (11th Cir. 2000)—
The decedent was Mildred Letts. Her husband, who predeceased her, was James Letts. When
James died, his estate took a marital deduction to the extent of the property he passed to his wife.
On James’s estate tax return, his executor checked “no” on the QTIP election. While they did not
make the QTIP election, James’s estate calculated their tax burden as if they had made the QTIP
election. The statute of limitations for estate tax on James return expired on September 8, 1989.
Decedent Mildred died on April 20, 1991. Mildred’s executor did not include the property that
was treated as though it was QTIP property in her gross estate. The Commissioner challenged
this, arguing that since the first spouse’s estate tax burden was calculated as if the QTIP election
had been made, under the duty of consistency the second spouse could not argue that it was not
QTIP property subject to inclusion in her gross estate under § 2044.
HELD: The property will be included in Mildred’s gross estate under § 2044 as property that
was subject to a QTIP election.
REASONING: Under the duty of consistency theory—if the first spouse treats the property as
QTIP property at the date of the 1st spouse’s death—the second spouse can’t change their
position and argue that it was not QTIP property because of the failure to make the QTIP
election.
RULE (DUTY OF CONSISTENCY): The duty of consistency prevents a taxpayer who has
benefitted from a past representation from adopting a position inconsistent with that taken in a
year barred by the statute of limitations; the doctrine prevents a taxpayer from claiming that he or
she should have paid more tax before and so avoid the present tax.
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P. 496 Problem 1: Alice and Bruce are married, and Alice dies. The residuary clause of her will
provides: “All the rest and residue of my property I leave to my spouse, Bruce, if he survives me
by ninety days; if he does not survive me, I leave this property to my children equally, share and
share alike.”
a. What are the estate tax consequences if Bruce survives Alice by five years?
b. What are the estate tax consequences if he dies 30 days after her?
c. Instead, what if the residuary clause required Bruce to survive by eight months and he did, in
fact, survive?
a. This transfer qualifies for the marital deduction (a survivorship requirement is OK, if it is
less than six months).
b. If Bruce fails to survive Alice by 90 days the transfer will not qualify for the marital
deduction. Because Bruce failed to survive Alice by 90 days, he will take nothing under the will,
thus there will be no property that will qualify for the marital deduction.
c. This will not qualify for the marital deduction, despite the fact that Bruce did actually
survive and take property from Alice. The survivorship contingency is capped at 6 months, so an
8 month survivorship contingency will disqualify the transfer of property from qualifying for the
marital deduction.
P. 497 Problem 4: Hugh and Wendy are married, and Hugh dies. Hugh leaves his property to
FNB as Trustee, income to Wendy for life, remainder to their children in equal shares. Analyze
this trust first under § 2056(b)(5) and then under § 2056(b)(7).
a. Does this trust qualify for the marital deduction? Why?
b. What if Wendy has the power to appoint the corpus in her will among Hugh’s children?
c. What if Wendy has the power to appoint the corpus during her life or in her will, but only to
Hugh’s children and her creditors?
d. What if Wendy has the power to appoint the corpus to herself during her life?
e. What if Wendy is the Trustee and has the power to invade the corpus for any purpose?
f. What if the power in 4.e. is limited by an ascertainable standard of Wendy’s health, education,
or welfare?
g. What if the Trustee who is not Wendy has the power to invade corpus for the benefit of
Wendy?
h. What if the Trustee who is not Wendy has the power to invade corpus for the health,
education, or welfare of Wendy?
§ 2056(b)(5) Analysis:
a. No, Wendy must have a general power of appointment (either at death or during her life, or
both) over the trust property in order for the to qualify under § 2056(b)(5). (After all, what good
is a power of appointment trust without a power of appointment?)
b. No, this is a limited power of appointment that limits her to appointing to Hugh’s children.
In order for it to qualify for the marital deduction under § 2056(b)(5) the surviving spouse must
have the power to appoint to herself or her estate.
c. No, this does not qualify for the marital deduction under § 2056(b)(5). The power of
appointment must be the right to appoint to herself or her estate, ability to appoint to one’s
creditors or the creditors of one’s estate is not enough. (DiRusso: But notice that she can appoint
to her creditors here, so § 2041 will bring it into her gross estate as a general power of
appointment, but c not qualify for the marital deduction when it passes from Hugh to Wendy
because it is not set up right for § 2056(b)(5)).
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d. Yes, this will qualify under § 2056(b)(5). This is a general power of appointment under §
2056(b)(5) because she can appoint the trust corpus to herself during her lifetime.
e. Yes, this qualifies for the marital deduction under § 2056(b)(5) because Wendy can appoint
the property to herself.
f. No, if there is an ascertainable standard here it will not qualify under § 2056(b)(5). In order
to qualify under § 2056(b)(5) the power to appoint must be a power to appoint in all events.
g. No, Wendy has to have the power in order for it to qualify under § 2056(b)(5). So, because
Wendy does not have the power, this will not qualify. However, if the Trustee had this power, in
addition to Wendy having the power to appoint to herself or her estate, it would be no problem.
h. No, Wendy does not have the power here, like she must in order to qualify under §
2056(b)(5), therefore this doesn’t qualify. But, if the trustee had this power, in addition to Wendy
having a power to appoint to herself or her estate, it would not be a problem.
§ 2056(b)(7) Analysis:
a. Yes, this trust would qualify for the marital deduction under § 2056(b)(7) as long as the
executor makes a QTIP election.
b. Yes, this qualifies for the marital deduction under § 2056(b)(7). This is a QTIP structure; it
just adds a limited power of appointment. It is OK to add more control to the QTIP, additional
powers in the surviving spouse are OK.
c. No. They can’t have the power to appoint the property to somebody else during their life
under § 2056(b)(7), so this will not qualify.
d. Yes, this is OK. This will qualify for the marital deduction under § 2056(b)(7).
e. Depends on how “for any purpose” would be interpreted. If it is just for her—then it is OK
and would qualify for the marital deduction under § 2056(b)(7). However, if this means that she
can direct the property to anybody then no this would not qualify.
f. Yes, it is ok—so long as it is not directed towards anybody but herself—if it can be directed
to somebody else, then it will not qualify.
g. Yes, this is OK. But, the trustee must only be able to invade corpus for Wendy’s benefit, if
the Trustee can direct corpus to other individuals, then it will not qualify under § 2056(b)(7).
h. Yes, this is OK.
MARITAL DEDUCTION PLANNING
DIRUSSO ON THE GOAL: The goal of tax planning is to pay as little tax as possible.
We don’t need to zero out the gross estate in order to reduce our taxes to zero. We can reduce tax
to zero by reducing the gross estate minus deductions and credits to zero. What we want to do is
to shelter the amount in the Gross Estate with credits and deductions. And, to the extent that we
can’t get rid of all tax liability, we want to delay tax until a later date (i.e. the second spouse’s
death).
WHAT TOOLS DO WE HAVE IN THIS GAME OF REDUCING TAX?
 Lifetime gifts = making use of the gift tax annual exclusion.
 Marital deduction = the marital deduction allows you to shelter property at the death of
the first spouse, delaying tax until the death of the surviving spouse. (DiRusso: Be
careful not to overuse the marital deduction, or you could create tax consequences later).
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
CREDIT SHELTER TRUST—one of the main considerations in estate planning for a
married couple is to ensure that you make maximal usage of the unified transfer tax credit
at the death of both individuals.
o The purpose of the credit shelter trust is to take advantage of the unified transfer
tax credit in the estate of the first spouse to die. This is done by making sure that
the trust does not qualify for the marital deduction (we don’t want the property to
be in the surviving spouse’s gross estate at their death)—so the surviving spouse
cannot have a general power of appointment over the property and the executor
should not make a QTIP election in regards to the property.
o WHAT CAN THE SURVIVING SPOUSE HAVE IN THE TRUST? The
surviving spouse can be given the right to income from the trust and a power to
withdraw trust corpus for health, education, support, and maintenance. An
independent trustee could be given broad powers to distribute trust corpus to the
surviving spouse, so long as the surviving spouse cannot become the trustee.
o The credit shelter trust will be in the decedent’s taxable estate, because it does
not qualify for the marital deduction—but it will be sheltered by the unified
transfer tax credit.
o The typical high net worth estate plan will include two trusts—a credit shelter
trust and a marital deduction trust.
 Strategically, you want to use the marital deduction trust to take care of
the needs of the surviving spouse, because whatever is left in it will end up
in the surviving spouse’s gross estate. If you substantially deplete the
marital deduction trust, there will be much less to be included in the
surviving spouse’s gross estate.
o WHY IS THIS IMPORTANT?
o Example 15-16–H and W are married. H owns $10,000,000 of property and W
owns nothing. H dies in 2011 and leaves all of his property outright to W. H’s
estate will pay no tax because the $10,000,000 will qualify for the marital
deduction. If W dies in 2012, her estate will pay a tax of $1,750,00. If H had left
one-half of his property in a credit shelter trust for the benefit of W, she would
have paid no estate tax on her death because the taxable estate of each would be
only $5,000,000—the amount that is sheltered by the unified credit.

Portability--§ 2010(c)(4) increases a decedent’s applicable exclusion amount by the
unused exclusion amount of his/her deceased spouse.
1. To obtain the benefit, an election must be made on the tax return of the first
spouse to die.
2. However, a decedent is only allowed to use the unused exclusion amount of her
“last deceased spouse.” So, if the surviving spouse remarries, they lose the benefit
of portability of the first spouses unused unified transfer tax credit.
3. DIRUSSO ON PORTABILITY: Be careful. There is lots of fine print with
portability. Making use of the credit shelter trust is the better option. Portability
can be an after the fact fix for those that failed to plan by making use of the credit
shelter trust.
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
Disclaimer—In some cases, disclaimer can be a useful tool in marital estate tax planning.
1. Assume that H and W are married. H has $10,000,000. H leaves all $10,000,000
to W outright. All $10,000,000 qualifies for the marital deduction and therefore is
not taxed at H’s death. But, at W’s death, all $10,000,000 would be in her gross
estate, and only $5,000,000 would be sheltered by the unified transfer tax credit.
It would be better for H to have had $5,000,000 sheltered by the unified transfer
tax credit at his death. If W disclaims the property such that it passes to somebody
else, it will be sheltered by the unified transfer tax credit and it will not be in the
gross estate of the surviving spouse.

Savings Clause—Many estate plans will include a savings clause:
o EXAMPLE: “It is my intent that [Trust A] will qualify for the federal estate tax
marital deduction. The executor [trustee] shall allocate to [Trust A] only property
that will qualify for the marital deduction. Furthermore, all powers and discretions
in the administration of this trust shall be interpreted and exercised in a manner
consistent with the marital deduction.”

Reformation by the probate court—the executor or surviving spouse can petition the
probate court to reform the document to conform with the requirements of § 2056 in
order to qualify for the marital deduction.
o Will it work? MAYBE.
 Only the decision of the state’s highest court is considered controlling, but
the IRS and courts are to apply the state law after giving “proper regard’ to
the court rulings of courts other than the highest court of the state.
ALLOCATION OF TAXES AND EXPENSES
Taxes and administrative expenses that are allocated to property that qualifies for the marital
deduction will reduce the amount of the deduction allowed.
Example 15-20–D and S are married and D dies, owning property valued at $15,000,000. D’s
will leaves one-half of the property to D’s children and one-half of the property to S. Assume
that federal estate taxes, state death taxes, and administrative expenses total $1,500,000. If these
amounts are allocated to the property passing to S, they will reduce the amount of the marital
deduction and thus increase the amount of tax due. This will leave even less property for S.
The decedent’s will should specify how to allocate these expenses—by providing in the will how
the expenses are allocated, you can prevent the taxes and expenses from being allocated to the
marital deduction property.
P. 504 Problem 1: Gorge and Martha are married; they are in their early 70s and retired. They
have two adult children and six grandchildren. They own most of their property as joint tenants
with the right of survivorship although they each own some separate property. They each have a
will leaving their property to the other spouse if that spouse survives, otherwise to their children.
They want to ensure that the survivor is adequately provided for and to minimize any estate tax
burden.
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a. Assume that their combined estates are approximately $4 million. What estate planning advice
would you give them?
b. What estate planning advice would you give them if their combined estate were approximately
$12 million?
c. What if their combined estates were $30 million?
d. Same as 1.c., except that Martha owns the $30 million.
e. Same as 1.d., except that both children are Martha’s from a prior marriage.
a. This amount is within the unified transfer tax credit amount. For smaller, low value estates,
you don’t need planning for estate tax purposes.
b. Set up a credit shelter trust and a marital deduction trust. You may also give lifetime gifts
that qualify for the gift tax annual exclusion. Give some to charity for the charitable deduction.
c. At the death of the first spouse you can use the credit shelter trust and the marital deduction.
-obviously, you can use lifetime gifts (annual exclusion gifts) to minimize the property you hold
at death.
-Charitable Trusts (unlimited charitable deduction)
-Make use of a Family Limited Partnership
-Valuation: Fractional Interest Discounts
-Installment Sales
d. Make use of the credit shelter amounts of both spouses.
-could shift assets to the poorer spouse
-maybe able to use portability as a safety net.
e. DiRusso: The point of this question is to just show you that sometimes tax planning goals
can be in conflict with family goals. Again while saving/minimizing taxes is an important,
worthy goal, it is not the end-all be-all, there are other goals and considerations.
CHAPTER 13: EXPENSES, CLAIMS, DEBTS,
TAXES, AND LOSSES
§ 2053 provides deductions for certain amounts that do not pass gratuitously form the decedent
to others. THEORY: You should be taxed on those funds that you actually pass to others—
but, if the amounts aren’t actually being passed to others, for instance amounts expended in
administering the estate, then there is not particularly fair to impose a tax on those funds.
§ 2053. Expenses, indebtedness, and taxes.
(a) General rule.—for purposes of the tax imposed by section 2001, the value of the taxable
estate shall be determined by deducting from the value of the gross estate such amounts—
(1) for funeral expenses,
(2) for administration expenses,
(3) for claims against the estate, and
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(4) for unpaid mortgages on, or any indebtedness in respect of, property where the value
of the decedent’s interest therein, undiminished by such mortgage or indebtedness, is
included in the value of the gross estate,
as are allowable by the laws of the jurisdiction, whether within or without the United
States, under which the estate is being administered.
(b) Other administration expenses.—Subject to the limitations in paragraph (1) of subsection
(c), there shall be deducted in determining the taxable estate amounts representing
expenses incurred in administering property not subject to claims which is included in the
gross estate to the same extent such amounts would be allowable as a deduction under
subsection (a) if such property were subject to claims, and such amounts are paid before
the expiration of the period of limitation for assessment provided in section 6501.
(c) Limitations.—
(1) Limitations applicable to subsection (a) and (b).—
(A) Consideration for claims.—The deduction allowed by this section in the case of
claims against the estate, unpaid mortgages, or any indebtedness shall, when
founded on a promise or agreement, be limited to the extent that they were
contracted bona fide and for an adequate and full consideration in money or
money’s worth . . .
SO: SECTION 2053 allows a deduction for:
1. FUNERAL EXPENSES
2. ADMINISTRATION EXPENSES
3. CERTAIN TAXES
4. CLAIMS AGAINST THE ESTATE
5. DEBTS
UNDER 2053, there is a TWO PART TEST FOR DEDUCTIBILITY:
1. The expense must be one that is listed in § 2053—federal law dictates what qualifies as a
deductible expense under § 2053.
2. The expense must be allowable under the law of the state (in terms of both character and
amount).
Example 13-1–State has a nonclaim statute that requires all claims against Decedent’s estate to
be presented for payment within six months of Decedent’s death. Decedent owes Debtor $25,000
but fails to present the claim within six months. The claim is unenforceable as a result.
Decedent’s estate cannot deduct the $25,000, even if it pays Debtor, because the claim was not
allowable under state law.
AMOUNTS PAYABLE OUT OF PROPERTY SUBJECT TO PROBATE CLAIMS:
Section 2053 distinguishes between amounts that are payable out of property subject to claims
and amounts incurred in administering nonprobate property that is included in the gross estate.
Section 2053(c)(2) limits the deduction of amounts that are payable out of property subject
to claims to the value of the property subject to claims plus any amount paid within the
time for filing the estate tax return.
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Example 13-2–David’s gross estate includes bank accounts of $60,000, life insurance of
$2,000,000 payable to his daughter, and jointly owned property worth $3,000,000. Funeral
expenses are $10,000, administration expenses are $15,000, and claims against the estate are
$75,000. Only the bank account is probate property. David’s daughter contributes $40,000 of the
life insurance proceeds toward the payment of the claims, and David’s executor uses the $60,000
bank account to pay the remainder of the claims and expenses. If all the claims and expenses
are paid within the time specified for filing the estate tax return, i.e., nine months, then the
full $100,000 will be allowed as a § 2053 deduction.
INSTEAD: Instead, assume that $30,000 of the claims was not paid until six months after the
date for filing the estate tax return. In that case, only $70,000 would be allowed as a § 2053
deduction.
NON-PROBATE PROPERTY: Expenses of nonprobate property are deductible as long as they
are paid before the expiration of the period of limitation for the assessment of the estate tax, i.e.,
usually three years.
EXPENSES
Section 2053 permits the deduction of REASONABLE FUNERAL EXPENSES that are
actually expended. (FUNERAL EXPENSES)
Section 2053 permits the deduction of EXPENSES THAT ARE ACTUALLY AND
NECESSARILY INCURRED IN THE ADMINISTRATION OF THE ESTATE.
(ADMINISTRATION EXPENSES)—notice that to be deductible administrative expenses
must be both actually expended and necessary.
WHAT ARE ADMINISTRATION EXPENSES?
They include:
a. Executors’ commissions
b. Attorneys’ fees
c. Appraisers’ fees
d. Court costs
Hibernia Bank v. United States (9th Cir. 1978)—
In 1965, Celia Clark died testate, leaving an estate worth several million dollars. She had
executed a valid will before her death—her will directed the residue of her estate was to be
divided between four testamentary trusts—income to her children, remainder to her
grandchildren. The residue of her estate consisted of: (1) a mansion on 240 acres in California
and (2) 10,000 shares of common stock in Hibernia Bank. Her will was admitted to probate on
June 2, 1965. By December 1967, all specific bequests and virtually all claims against the estate
had been paid. Hibernia Bank was serving as administrator of the estate. Instead of distributing
the mansion and stock to the testamentary trusts, they decided to sell the mansion. They ran into
trouble in finding a buyer. In fact, it was quite costly to maintain the residence ($60,000/yr).
More money was necessary for the maintenance. The bank had two choices as administrator,
they could either sell the Hibernia stock to provide liquidity or they could take loans. Hibernia
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elected to take out loans for the estate. They took out 4 loans, totaling $775,000. Interest
payments on the loans totaled $196,210. The California Probate Court approved the payments of
the interest as expenses of the estate. In June 1971, Hibernia filed for a refund based on the
interest on the loans as § 2053 expenses of administration. The Commissioner denied the refund.
HELD: No refund (i.e. no deduction under § 2053 for the interest on the loans).
REASONING: In order to get the § 2053 deduction, the expense must be allowable under state
law AND it must be a reasonable administrative expense under § 2053. SO—it must qualify
under BOTH state and federal law. It qualified under state law, per the California probate that
approved the expenses. But, § 2053, the federal law side, is where we run into a problem. Here, it
was not necessary to leave the estate open for as long as Hibernia did. The reason they attempted
to sell the mansion was that the beneficiaries preferred cash in the trusts rather than the mansion.
So, the decision to take out the loans was less about necessity and more about the convenience of
the beneficiaries. Thus, it was not necessary to keep the estate open or to take out the loan. Since
the interest they incurred on the loan was not a necessary expense, it was not deductible under §
2053.
NOTE that deductions for expenses are limited to amounts actually paid.
 Under Treas. Reg. § 20.2053-1, events occurring after the date of the decedent’s death
will determine both:
o IF an expense is deductible.
o The Amount Deductible.
CLAIMING DEDUCTION FOR EXPENSES NOT PAID BY THE TIME ESTATE TAX
RETURN IS FILED:
1. May be claimed on estate tax return only if: (1) ascertainable with reasonable certainty &
(2) it will in fact be paid.
2. For other expenses, the executor must file for a refund after actual payment.
a. The executor may file a protective claim in order to preserve the right to the
refund after the limitations period.
CLAIMS AND DEBTS
Section 2053 provides a deduction for CLAIMS AGAINST THE DECEDENT’S ESTATE as
well as the DECEDENT’S DEBTS.
o Claims that are founded on a promise or agreement must be bona fide and contracted for
adequate consideration in money or money’s worth.
o Only debts that are personal obligations of the decedent may be deducted.
Estate of Flandreau v. Comm’r (2d Cir. 1993)—
Decedent gave gifts to her two children and their wives. In turn, the children and wives
transferred the amounts back to the decedent in exchange for non-interest bearing, unsecured
promissory notes. The notes were payable either in (1) 1995 OR (2) when she died, whichever
was earlier. Decedent died on Feb. 20, 1986, not having repaid any of the notes. The Estate took
a deduction of $102,000 (the full amount of the notes)—the Commissioner denied the deduction,
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arguing that no deduction should be allowed because the debts were not bona fide debts
contracted for adequate and full consideration in money or money’s worth.
HELD: No deduction was allowed.
REASONING: Here, we have a substance vs. form issue. The Estate had the burden of proving
that at the time of the transaction there existed a real expectation of repayment and an intent to
enforce collection. The sons and daughters-in-law never really expected the money would be
repaid. This was really them trying to do an end-around on the estate tax, and the Commissioner
saw right through it and said no dice.
Leopold v. United States (9th Cir. 1975)—
Decedent and Constance were married in 1958. They had a daughter, Beatrice Tina. In 1959,
Constance filed for divorce. The couple entered into a property-settlement agreement, requiring
the decedent to make a will leaving Beatrice Tina $250,000 plus an amount to be determined by
reference to certain trusts. The property agreement was entered as a final judgment by the court.
The decedent did make a bequest to Beatrice Tina, but the amount was indefinite. So, Constance
filed suit on Beatrice Tina’s behalf. An out of court settlement was reached, settling for
$264,000. The Estate claimed a deduction for the fall amount of the settlement as a “claim
against the estate” under § 2053(a)(3). The Commissioner denied the claim, arguing that the
claim was not contracted for an adequate and full consideration in money or money’s worth.
HELD: Deduction is allowed as a claim against the estate under § 2053.
REASONING: The Court found this to be an agreement contracted for in good faith for full and
adequate consideration in money or money’s worth and therefore deductible. Constance settled
the divorce property settlement for less than she could have in return for her husband’s promise
to bequeath more than $250,000 to her daughter, this is consideration—so it qualifies.
CONSIDERATION OF POST-DEATH EVENTS IN DEDUCTING CLAIMS AGAINST
THE ESTATE: The Treasury Regulations state that “[e]vents occurring after the date of the
decedent’s death shall be considered in determining whether and to what extent a deduction is
allowed under section 2053.”
There are 3 exceptions:
1. A deduction is allowed even if the claim has not been paid by the time the estate tax
return is filed if the amount is ascertainable with reasonable certainty and will in fact be
paid.
2. Claims Totaling Not More Than $500,000: This applies if (1) the claim meets the other
requirements of Treas. Reg. § 20.2053-1; (2) the claim is a personal obligation of the
decedent existing at the time of his death; (3) the claim is enforceable against the estate at
the time it is paid; (4) the value of the claim is established by a qualified appraiser; and
(5) the full value of the claim must be deductible under this exception.—The total value
of such claim is limited to $500,000 and is subject to adjustment for post-death events.
3. If the Decedent’s Gross Estate includes Claims or Causes of Actions—Any claim or
counterclaims that are related to those in the gross estate may be deducted before a final
resolution IF: (1) the claim meets the other requirements of Treas. Reg. § 20.2053-1; (2)
the claim is a personal obligation of the decedent existing at the time of death; (3) the
value of the claim is established by a qualified appraiser; and (4) the aggregate value of
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related claims and counterclaims exceeds 10 percent of the value of the decedent’s gross
estate.
TAXES
Taxes are allowed as a deduction under § 2053 only as claims against the estate.
SO: Property taxes that have actually accrued before death and that are enforceable
obligations at the time of death may be deducted.
AND: Tax due on gifts made before death are deductible if they are not paid before death.
PLUS: Income taxes for amounts received before death are deductible.
However, death taxes paid to a state or other jurisdiction ARE NOT deductible under § 2053.
Nevertheless, § 2058 provides a deduction for death taxes.
§ 2058. State death taxes
(a) Allowance of deduction.—For purposes of the tax imposed by section 2001, the value of
the taxable estate shall be determined by deducting from the value of the gross estate the
amount of any estate, inheritance, legacy, or succession taxes actually paid to any State or
the District of Columbia, in respect of any property included in the gross estate (not
including any such taxes paid with respect to the estate of a person other than the
decedent).
LOSSES
§ 2054. Losses
For purposes of the tax imposed by section 2001, the value of the taxable estate shall be
determined by deducting from the value of the gross estate losses incurred during the settlement
of estates arising from fires, storms, shipwrecks, or other casualties, or from theft, when such
losses are not compensated for by insurance or otherwise.
Section 2054 allows a deduction for certain losses that occur during the administration of the
estate. (If the loss happens before the decedent’s death, it can only be deducted from the
decedent’s final income tax return).
WHICH LOSSES:
Losses arising from:
1. Fire
2. Storms
3. Shipwrecks
4. Other Casualties
5. Theft
& ONLY TO THE EXTENT NOT COVERED BY INSURANCE.
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P. 437 Problem 4: David’s estate included a summer home valued at $350,000. Two months
after David’s death, the summer home burned. What are the tax consequences if the insurance
company paid David’s estate $300,000?
The $50,000 balance which was not covered by casualty loss insurance is deductible under §
2054.
P. 437 Problem 6: Fiona had a close relationship with her brother, Doug. When Doug started a
business, Fiona agreed to help him. Doug promised that he would pay Fiona “when the business
became established.” For three years, Fiona worked approximately 20 hours a week. At one
point, Fiona asked Doug about payment, and he again promised to pay her. Doug died without
ever paying Fiona. His will left all his property to her and appointed her as executor. Including
the business, Doug owned approximately $5,000,000 at the time of his death. The reasonable
value of Fiona’s services to Doug’s business was $75,000. The executor’s fee would be $50,000.
Fiona consults you to determine whether she should file a claim against the estate for the value
of her services and whether she should waive the executor’s fee. What advice would you give
her?
This has income tax and estate tax implications. Bequests are income tax free for the recipient.
So, it would be better for Fiona to take everything under the will.
CHAPTER THREE: VALUATION
DiRusso: Once something is in the gross estate, that is not the end of the story. Then, we have to
value the item that is to be included in the gross estate. Some of your best opportunities for tax
planning come in the valuation realm.
Treas. Reg. § 20.2031-1(b):
The value of every item of property includible in a decedent’s gross estate . . . is its fair market
value at the time of the decedent’s death . . . . [i.e.,] the price at which the property would
change hands between a willing buyer and a willing seller, neither being under any compulsion
to buy or to sell and both having reasonable knowledge of relevant facts [and] . . . is not to be
determined by a forced sale price. Nor is the fair market value of an item of property to be
determined by the sale price of the item in a market other than that in which such item is most
commonly sold to the public.
GENERAL RULE: Fair Market Value on the Date of Death/Date of Gift—as determined by
the “Willing Buyer, Willing Seller” Test.
FMV = the amount of money that a willing buyer would pay a willing seller. It is not the
subjective value of the item to a particular individual. Neither is it the intrinsic or inherit/hidden
value of an item. It is the value for which it would exchange between a willing buyer and a
willing seller in the normal course of dealings.
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THREE METHODS OF VALUATION
Value is determined in the market where the item is commonly bought and sold. If the property
is typically sold to the general public, that retail market determines the value. If there is a
specialized market (i.e. art) that market establishes the value.
THERE ARE THREE MAJOR METHODS USED FOR VALUATION:
1) MARKET APPROACH—The market approach uses both actual sales of the particular
piece of property and sales of comparable properties.
Actual sales date are used if the date of the sale is reasonably close to the date of death
or the date of the gift and the sale is an arm’s-length transaction.
Sales after the valuation date may be considered but are of limited value if they are
influenced by events that were not known on the valuation date.
Subsequent events are generally ignored when valuing either property or claims against
the estate.
When comparable sales are used to establish value, there must be a sufficient number to
ensure accuracy; they must be within a reasonable time of the valuation date; and they
must be of similar property.
WHAT TYPE OF ASSETS DO WE USE THE MARKET APPROACH FOR?
Stocks, bonds, and real estate.
2) CAPITALIZATION OF INCOME APPROACH—Assets held for investment or for
use in a trade or business or the business itself may be valued using the capitalization of
income method.
Step One: Determine the income the property will produce over time.
Step Two: Capitalize the income. Capitalization = the application of the anticipated rate
of return to the projected income.
WHAT TYPE OF ASSETS DO WE USE THE CAPITALIZATION OF INCOME
APPROACH FOR? Commercial real estate and closely held business interest.
3) COST APPROACH—The cost approach estimates how much it would take to replace or
reproduce the asset. The cost approach takes into consideration both historical cost and
depreciation.
WHAT TYPE OF ASSETS DO WE USE THE COST APPROACH FOR? The cost
approach is used to value certain business interests and life insurance policies for gift tax
purposes.
VALUATION AS AN ISSUE OF FACT/THE BURDEN
The valuation of a specific item of property is a question of fact.
The donor or the estate has the burden of proving valuation.
If the donor or estate produces sufficient credible evidence, the burden then shifts to the IRS.
Quite often, valuation ends up being a battle of experts.
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VALUATION DATE
For Gift Tax Purposes = Gifts are valued on the date the gift is complete—the date on which
the donor has given up all power to change the beneficial ownership of the property.
For Estate Tax Purposes = Property in the decedent’s estate is valued as of the date of the
decedent’s death—unless the executor elects the alternative valuation date.
For Generation-Skipping Transfer Tax Purpose = The value of property subject to the
generation-skipping transfer tax is determined on the date of the transfer—i.e. the date of the
direct skip, taxable distribution, or the taxable termination.
EVENTS SUBSEQUENT TO DEATH AND VALUATION
GENERAL RULE: The general rule is that events occurring after the date of death are not
considered in assessing valuation.
However, there are exceptions to this rule.
One exception is when the executor elects the alternative valuation date:
THE ALTERNATE VALUATION DATE—In some instances, an executor may elect an
alternative valuation date for estate tax purposes.
§ 2032. Alternate valuation
(a) General. The value of the gross estate may be determined, if the executor so elects, by
valuing all the property included in the gross estate as follows:
(1) In the case of property distributed, sold, exchanged, or otherwise disposed of,
within 6 months after the decedent’s death such property shall be valued as of the
date of the distribution, sale, exchange, or other disposition.
(2) In the case of property not distributed, sold, exchanged, or otherwise disposed of,
within 6 months after the decedent’s death such property shall be valued as of the
date 6 months after the decedent’s death.
(3) Any interest or estate which is affected by mere lapse of time shall be included at
its value as of the time of death (instead of the later date) with adjustment for any
difference in its value as of the later date not due to mere lapse of time.
(b) . . .
(c) Election must decrease gross estate and estate tax. No election may be made under
this section with respect to an estate unless such election will decrease—
(1) the value of the gross estate; and
(2) the sum of the tax imposed by this chapter and the tax imposed by chapter 13 with
respect to property includible in the decedent’s gross estate (reduced by credits
allowable against such taxes).
(d) Election.
(1) In general. The election provided for in this section shall be made by the executor
on the return of the tax imposed by this chapter. Such election, once made, shall be
irrevocable.
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WHEN IS THIS USEFUL: The alternate valuation date is a matter of fairness, it protects
beneficiaries from decreases in value occurring after death. This is useful in a recessionary
period, where date of death values may have been very high, but the values of all the assets by
the time tax payment came due had substantially declined.
REQUIREMENTS:
o An election must be made on the estate tax return.
o The election is irrevocable.
HOW IS THE PROPERTY VALUED:
As a result of the election:
(1) Assets sold, distributed, or otherwise disposed of within six months of decedent’s death
are valued on the date of the sale, distribution, or disposition;
(2) Other assets are valued as of date six months after the decedent’s death;
(3) Interests that are affected only by the mere laps of time are valued without consideration
of that lapse of time.
Example 3-1–Doris died on Feb. 1, owning Blackacre, stock in X, Inc., stock in Y, Inc., stock in
Z, Inc., and a remainder interest in a trust established by her grandfather. On Feb. 1 the value of
the assets were:
Blackacre ($400,000)
Stock in X, Inc. ($1,000,000)
Stock in Y, Inc. ($3,500,000)
Stock in Z, Inc. ($500,000)
Remainder ($250,000)
– On May 5, the executor sold the stock in Z, Inc. for $480,000. On June 15, when the
value of the Stock in Y, Inc. was $3,250,000, the executor distributed it to Beneficiary.
On Aug. 1, the property remaining in the estate had the following values:
Blackacre ($425,000)
Stock in X, Inc. ($900,000)
Stock in Y, Inc. ($3,000,000)
Remainder ($245,000)
–Doris’s executor may elect the alternate valuation date because the value of the assets and any
estate tax liability would decrease between Feb. 1 and Aug. 1. If the executor elects the alternate
valuation date, the assets will be valued on the estate tax return as follows:
Blackacre ($425,000)
Stock in X, Inc. ($900,000)
Stock in Y, Inc. ($3,250,000)
Stock in Z, Inc. ($480,000)
Remainder ($250,000)
P. 59 Problem 1: Peter purchased Whiteacre, commercial real estate, 20 years ago for $30,000.
Three years ago, when the local property tax appraisal on it was $225,000, Peter gave Whiteacre
to his daughter, Deanna. Deanna died this year. Two months before her death, Bert offered to
purchase Whiteacre for $350,000, but Deanna refused to sell. Five months after Deanna’s death,
chemical waste form a manufacturing business that pre-dated Peter’s purchase was discovered on
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the property. Two years after Deanna’s death, Whiteacre was distributed to her sister, Sally, who
sold it for $50,000. What is the value of Whiteacre for gift and estate tax purposese?
For Gift Tax Purposes: For gift tax purposes, the valuation is FMV on the date of the
completion of the gift. The property appraisal is not necessarily FMV, so that will not
conclusively establish the FMV of the property. DiRusso: The answer here is that with the
information we have we don’t know.
For Estate Tax Purposes: For estate tax purposes, valuation is the FMV on the date of the
decedent’s death. WE need more information. The sale 2 years later doesn’t tell us anything. We
need to know what result the willing-buyer/willing-seller test would produce.
–What about the chemical waste? The chemical waste was there before the date of death, but the
discovery didn’t occur until later—but because it was discovered within 6 months, the executor
could elect the alternate valuation date.
DIRUSSO: DiRusso says that problem 1 is deliberately unanswerable.
P. 59 Problem 3: Daniel died on March 15. He owned the following assets, which were valued
on that date and on September 15 as follows:
Asset
March 15 Value
September 15 Value
Stock in A, Inc.
$500,000
$400,000
Stock in B, Inc.
$750,000
$600,000
Stock in C, Inc.
$1,250,000
$1,000,000
Farmacre
$1,000,000
$1,500,000
Greenacre
$1,500,000
$1,000,000
Daniel also owned a life insurance policy that paid $2,000,000 to his estate.
a. What is the value of Daniel’s estate for estate tax purposes?
b. What if the estate had sold Farmacre on June 10 to Daniel’s nephew, Ned, for $750,000 as
they had agreed prior to Daniel’s death?
c. Same as 3.a., except that the estate had distributed Greenacre to Ann on May 10 when it had a
value of $1,800,000.
d. Same as 3.a., except that Daniel did not own any insurance, and on March 15 stock in A, Inc.
had a value of $400,000, stock in B, Inc. had a value of $600,000, and stock in C, Inc. had a
value of $1,000,000, while on September 15 stock in A, Inc. had a value of $500,000, stock in B,
Inc. had a value of $750,000, and stock in C, Inc. had a value of $1,250,000.
a. March 15–$7,000,0000
Sept. 15–$ 6,500,000.
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b. If the agreement was bona fide for fair and adequate consideration in money or money’s
worth, then will establish the FMV of Farmacre.
c. March 15—Wouldn’t change.
September 15–Gross Estate would be $7,300,000.
d. March 15–$4,000,000
September 15–$5,000,000 –the consequence—because the tax wouldn’t go down, you can’t elect
the alternative valuation date.
VALUATION OF SPECIFIC ASSETS
We have our general rule that valuation is the FMV under the willing-buyer/willing-seller test.
With the willing-buyer/willing-seller-test as the base, the Treasury Regulations provide
specific guidance on valuing many different specific assets.
STOCKS AND BONDS—Very detailed regulations, but the general rule is that if stocks and
bonds are sold in an established market—the FMV is the mean between the highest and the
lowest quoted selling price on the valuation date.
REAL ESTATE—Real estate is valued at its highest and best use—unless it qualifies for
special use valuation (some property will be valued as special use property for its actual use, and
not its highest and best use).
HOUSEHOLD & PERSONAL EFFECTS—Items worth less than $100 may be grouped
together. Individual items worth more than $3,000 and collections that have an aggregate value
exceeding $10,000 must be appraised.
PROMISSORY NOTE—the value of a promissory note is presumed to be the unpaid principal
plus the amount of interest accrued to the date of death.
CASH DEPOSITS—value is the amount in the account on the date of death.
LIFE INSURANCE—life insurance is valued differently for estate and gift tax purposes.
 GIFT TAX = for gift tax purposes the value of a life insurance policy is the replacement
cost.
 ESTATE TAX (WHEN POLICY IS ON DECEDENTS LIFE) = the amount
receivable by the estate or the beneficiary is included in the gross estate (i.e. the death
benefit is included).
 ESTATE TAX (WHEN POLICY IS ON LIFE OF ANOTHER) = same as for gift tax
purposes—the replacement cost.
PARTIAL INTERESTS IN PROPERTY (Remainders, Life Estates, etc.)—The regulations
prescribe actuarial factors for valuing life estates, terms of years, annuities, reversions, and
remainders. (you use the tables in the regs. and the § 7520 interest rates).
o Value of a remainder—the value of a remainder based on one person’s life is simply the
value of the property multiplied by the appropriate actuarial factor.
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o Value of life estate—The value of the life estate based on one life is the difference
between the value of the property and the value of the remainder.
ANNUITY—The value of an annuity is calculated by using actuarial tables.
Cook v. Comm’r (5th Cir. 2003)—
Gladys Cook and Myrtle Newby had an informal agreement whereby they would jointly
purchase Texas Lottery tickets and share the winnings. In 1995, Gladys Cook bought a winning
ticket worth $17 million, payable in 20 annual installments. Texas law prohibited assignment of
the rights and the prize could not be paid out as a lump sum. Later in 1995, Cook and Newby
created a Limited Partnership an each assigned their interest in the lotto winnings to the
partnership. Cook died towards the end of 1995. The IRS wanted to value the interest in the
partnership as a private annuity and value it under the actuarial tables.
HELD: This is a private annuity and will be valued under the actuarial tables.
CIRCUIT SPLIT: There is a circuit split on how to value lottery payments paid over a term of
years.
EXCEPTIONS TO USING ACTUARIAL TABLES: The actuarial tables may not be used
to value interests measured by the life of an individual who is terminally ill on the valuation date.
(Terminally ill means that there is at least a 50 percent probability that the individual will die
within 1 year.)
P. 68 Problem 1: Glen established an irrevocable inter vivos trust by transferring $5,000,000 to
FNB as Trustee to pay the income to Ann for her life and then to distribute the trust property to
Beth.
a. What are the values of the life estate and the remainder for gift tax purposes? Assume that Ann
is 60 years old and the applicable interest rate is 4.6 percent.
b. What are the values if the income is to be paid to Ann for 15 years?
c. If Ann dies two months after the trust is created, will that affect the valuation?
a. We must look to Table S in Publication 1457 (actuarial tables) to determine our value. The
appropriate factor for a life estate for a 60 year old at 4.6% interest is .58110 = 58.11%. So, we
take the value of the trust property ($5,000,000) and multiply it by the factor of (.58110) and get
$2,905,500 (the value of the lifetime interest). To calculate the value of the remainder interest,
we take the value of the property ($5,000,000) and subtract the value of the lifetime interest
($2,905,500) = $2,094,500 (value of remainder interest).
b. We look to Table B in Publication 1457 to value interests for terms of years. The factor for
an income interest for a term of years at 4.6% interest is .490640 = 49.0640%. We take the value
of the trust property ($5,000,000) and multiply it by the factor of (.490640) and get $2,453,200
(value of the income interest for the term of 15 years). To calculate the remainder interest, we
take the value of the property ($5,000,000) and subtract the value of the income interest
($2,453,200) and get a value of $ 2,546,800 (value of remainder interest).
c. Her actual death would generally not affect the valuation of the interests for tax purposes.
You use the actuarial tables unless the person is terminally ill.
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VALUING BUSINESS INTERESTS
Interests in closely held businesses are often hard to value.
Revenue Ruling 59-60: This ruling provides a non-exclusive list of relevant factors in valuing
business interests:
(a) The nature of the business and the history of the enterprise from its inception.
(b) The economic outlook in general and the condition and outlook of the specific industry in
particular.
(c) The book value of the stock and the financial condition of the business.
(d) The earning capacity of the company.
(e) The dividend-paying capacity.
(f) Whether or not the enterprise has goodwill or other intangible value.
(g) Sales of the stock and the size of the block of stock to be valued.
(h) The market price of stocks of corporations engaged in the same or a similar line of
business having their stock actively traded in a free and open market, either on an
exchange or over-the-counter.
SECTION 2032A SPECIAL USE VALUATION:
Section 2032A allows the executor to elect “special-use,” rather than fair market, valuation for
real property used in farming or another trade or business.
Requirements of 2032A:
1. Decedent must have been a citizen or resident of the U.S., and the real property must be
located in the U.S.
2. Decedent or a member of decedent’s family must have been using the property for
farming or business on the date of death.
3. Decedent must transfer the property to a qualified heir (a member of decedent’s family).
4. The qualified heir must continue to use the property in farming or business for the next
10 years.
5. At least 50 percent of the gross estate must consist of real and personal property used in
farming or business.
6. At least 25 percent of the gross estate must consist of the real property used in farming or
business.
7. During five of the eight years immediately preceding death, the decedent or a member of
his family must have used the real property for farming or business and materially
participated in the operation of the farm business.
Under 2032A—the estate may only reduce the value of the real property by $750,000
(adjusted for inflation).
If they dispose of the property within 10 years, except to another qualified member of the
family, the tax benefit will be recaptured.
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DISCOUNTS AND PREMIUMS
DIRUSSO: This is where we can really have some fun. Discounts and premiums, how exciting.
You can accomplish major tax planning goals of your clients by using discounts and premiums.
***Factors such as the amount of stock owned by the decedent or the lack of a ready market for
the property can affect valuation of the property.
Estate of O’Keeffe v. Comm’r (Tax Court 1992)—
Famous artist Georgia O’Keefe died in 1986. She died still possessing 1,100-1,200 pieces of
unsold art. The total value of the art was $72 million. However, if all of the art was dumped onto
the market at the same time, the value of the art would be substantially less.
ISSUE: What discount should be applied to the artwork?
HELD: The estate is entitled to a blockage discount.
REASONING: The fact that there is so much art, and that it could not receive full value if it was
all sold at the same time entitled the estate to a blockage discount. The art that was determined to
be salable in a short period of time at normal value was given a 25% blockage discount. The art
that was marketable only over a period of years with substantial effort was given a 75% discount.
DISCOUNTS:
1) BLOCKAGE DISCOUNT—discount reflecting the difficulty of selling a large block of
property at the same time.
2) MARKETABILITY DISCOUNT—discount reflecting the absence of a recognized
market for closely held stock and accounting for the fact that closely held stock is
generally not readily transferable.
3) MINORITY INTEREST DISCOUNT—discount for holding a minority interest in a
business.
PREMIUMS: A premium may be added to the valuation of property which constitutes a
controlling interest.
DIRUSSO ON STRATEGY: Strategically, valuation is important, and there are things you can
do with discounts and premiums to suppress value.
 You want to suppress the value of what you retain. This will suppress the value of what is
included in your gross estate.
 You want to suppress the value of what you give as gifts.
 You don’t want to suppress marital deduction property or credit shelter property.
P. 81 Problem 1: Henry owns 100 percent of the stock in Family Business, Inc.
a. Henry gives 40 percent of the stock outright to his spouse, Wanda. Henry also creates a trust
for Wanda’s benefit that qualifies for the marital deduction as QTIP, and he transfers 40 percent
of the stock to it. Henry also gives 5 percent of the stock to each of his four children. How will
the gifts be valued?
b. Instead, Henry dies owning all the stock. He bequeaths the property as designated in problem
1.a. How will the stock be valued for purposes of his estate?
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c. Same as 1.b., then Wanda dies. How will the stock be valued in her estate? Would it make any
difference if Henry had left the stock to a trust that qualified for the marital deduction by giving
Wanda a testamentary general power of appointment?
d. Same as 1.b., except that Henry gave 60 percent of the stock to Wanda outright and gave each
of his children 10 percent. How will the stock be valued for purposes of Henry’s estate? How
should it be valued for purposes of the marital deduction?
a. The 5% interests to the children will get both minority interest and marketability discounts.
The 80% interest to the wife will get a marketability discount. (DiRusso: Issue—do we add the
two 40% blocks together or not—it is unclear, the IRS has gone both ways). If you do aggregate
the two blocks, then they will also have a control premium applied to them.
b. All of it is valued in his estate without a discount at the date of his death. (DiRusso: This
shows one of the benefits of lifetime gifts—No Sale = No Discount).
c. Again, we come to the issue of whether we aggregate the two 40% blocks of stock. The
answer is unclear. But, with QTIP we probably won’t aggregate. Therefore, the property will be
given a marketability discount. If it is a Power of Appointment Trust, then the property likely
will be aggregated and will receive both a marketability discount and a control premium.
d. Same as b., except that the marital deduction property will be allowed a marketability
discount and a control premium.
CHAPTER 14 RULES
Chapter 14 of the Internal Revenue Code provides special rules for assessing value to certain
interests.
Primarily, Chapter 14 was designed and enacted to suppress certain estate planning
techniques.
SECTION 2071 (Applies to Gift Tax Only)–Section 2701 applies to the transfer of certain
business interests to members of the transferor’s family, but only if the transferor or specified
family members retain an interest in the business.
Section 2071 does not apply to transfers at death if any of the following are true: (1) the
retained interest has a market quotation readily available on an established securities market; (2)
if the retained interest and the transferred interest are of the same class; or (3) if the retained
interest and the transferred interest are proportionally the same.
For 2701 to apply—there must be a transfer to a member of the transferor’s family & the
transferor or an applicable family member must retain an applicable interest.
Example 3-6–Father owns all the common stock in Family, Inc., which has a value of
$5,000,000. He recapitalizes the corporation with common and preferred stock. He transfers the
common stock to Daughter and retains the preferred stock. Section 2071 will apply to this
transfer and will value the common stock at $5,000,000 unless the preferred stock is cumulative
and will pay dividends at a fixed rate on a periodic basis.
If the preferred stock is cumulative and will pay dividends at a fixed rate on a periodic basis,
any liquidation, put, call, or conversion rights will be valued at their lowest possible value. The
common stock will have a minimum value of $500,000.
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WHY HAVE 2071? Section 2071 attempts to prevent transferors from not enforcing their rights
and thereby allowing value to shift to other shareholders.
SECTION 2702 (Applies to Gift Tax Only)–Section 2702 applies to transfers to members of the
transferor’s family where the transferor, or an applicable family member, retains an interest such
as a life estate, a term of years, or a remainder.
2702 does not apply if: (1) the gift is incomplete, (2) the only property is a personal residence,
or (3) the Treasury Regulations exempt the transaction as not inconsistent with the purposes of
2702.
For 2702 to apply, the transferor must transfer an interest to a family member and the
transferor or an applicable family member must retain an interest.
A retained interest will be valued at zero unless it is a qualified interest
►
There are three types of qualified interests:
o A qualified annuity
o A qualified unitrust interest
o A qualified remainder interest
DIRUSSO ON 2702: This is an anti-GRIT provision.
If you have an intra-family transfer & the value the grantor retains is an income stream, we value
the gift as the whole thing. This pushes the value of the gift onto the remainder. This is a noGRIT provision—a grantor retained income trust will cause you to be treated as the transferor of
the whole value. EXCEPTION: You can do a QPRT. A Qualified Personal Residence Trust.
SECTION 2703—Section 2703 provides that any option, agreement, or right to acquire or use
property at a price less than fair market value and any restriction on the right to sell or use
property will be ignored in valuing the property.
2703 applies to valuation for purposes of the gift, estate, and GST taxes.
2703 applies to any arrangement that affects the sue or sale of property and is not limited to
transfers between family members.
DIRUSSO: 2703 disregards certain restrictions on property for valuation purposes.
Estate of Blount v. Comm’r (11th Cir. 2005)—
Blount owned a business, it was a closely-held corporation. He had a buy-sell agreement with the
corporation. He later discovered that the buy-sell agreement was going to hurt the liquidity of the
company. Therefore, he altered the buy-sell agreement. However, at the time of the transaction,
he was the sole-shareholder, so he was engaging in an agreement with himself. So, the restriction
on the property was disregarded for valuation purposes under § 2703.
Estate of Amlie v. Comm’r (Tax Court 2006)—
Decedent had a legitimate arm’s length transaction. Here, because it was legitimate and at arm’s
length, we don’t disregard it for purposes of 2703.
POINT: Section 2703 doesn’t completely take away the buy-sell agreement for valuation
purposes, it is just intended to make sure that the buy-sell agreement is legitimate.
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SECTION 2704—Section 2704 provides that the lapse of certain rights and restrictions will be
treated as a transfer and may, as a result, be subject to gift or estate tax.
2704 applies to the lapse of a voting or liquidation right in a corporation or partnership and
then only if the individual holding the right and her family control the entity. (Control = 50%).
CHAPTER SIXTEEN: CREDITS AND
CALCULATION OF THE GIFT AND ESTATE
TAXES
The gift and estate tax system share a unified rate structure.
ESTATE PLANNING GOAL: Your goal in estate planning is to make efficient use of the
credit shelter.
UNIFIED CREDIT
§ 2010. Unified credit against estate tax.
(a) . . .
(b) . . .
(c) Applicable credit amount.
(1) In general. For purpose of this section, the applicable credit is the amount of the
tentative tax which would be determined under section 2001(c) if the amount with
respect to which such tentative tax is to be computed were equal to the applicable
exclusion amount.
(2) Applicable exclusion amount. For purposes of this subsection, the applicable
exclusion amount is the sum of—
(A) the basic exclusion amount, and
(B) in the case of a surviving spouse, the deceased spousal unused exclusion
amount.
(3) Basic exclusion amount.
(A) In general. For purposes of this subsection, the basic exclusion amount is
$5,000,000 [NOTE: $5.25 million in 2013; $5.34 million in 2014 .]
(B) Inflation adjustment. [The exclusion amount is indexed for inflation.]
§ 2505 states the same rule for the credit against the gift tax—because it is a unified tax credit,
it may be used to shelter $5 million of gifts during life or of amounts in the gross estate at
death—however no double benefit will be allowed, it is one $5 million credit that applies to both
the gift and the estate tax.
DIRUSSO: “§ 2010(c) provides a credit in the amount needed to offset $5 million (or
whatever the amount is indexed for inflation in that particular year, 2013 = $5.25 million).
Notice that it is a credit. A credit is subtracted after the tentative tax is calculated, not before.
166
The estate and gift tax system have a unified transfer tax credit that shelters an amount equal to
the tax imposed on $5 million dollars (indexed for inflation). The credit is $1,730,800 (the tax on
$5,000,000), indexed for inflation.
Notice 2010(c)(2) Portability: 2010(c)(2) provides for portability of any unused portion of the
most recent predeceased spouse’s credit shelter. However, portability is limited by the fact that it
applies only to the most recently deceased spouse—so, if you remarry, you may lose the benefit.
Therefore, it should be a back-up option, not an estate-planning tool in and of itself.
HOW TO CALCULATE/FIND THE CREDIT SHELTER AMOUNT
§ 2001(c) provides the rate structure for estate tax calculations (and since it is a unified transfer
tax system—these will be the same rates as the gift tax). The rates are graduated if you look at
the rate tables, however, because the graduated rates level off at $1 million, and the unified credit
covers up to $5 million, the tax is in effect a 40% flat tax. However, the graduated rates are still
important in calculating the credit shelter amount.
§ 2001(c).
If the amount with respect to which the
tentative tax is computed is:
the tentative tax is:
Not over $10,000 . . . . . . . . . . . . . . . . . . . . . . 18 percent of such amount
Over $10,000 but not over $20,000 . . . . . . . . . $1,800 plus 20 percent of the excess of such
amount over $10,000.
Over $20,000 but not over $40,000 . . . . . . . . . $3,800 plus 22 percent of the excess of such
amount over $20,000.
Over $40,000 but not over $60,000 . . . . . . . . . $8,200 plus 24 percent of the excess of such
amount over $40,000.
Over $60,000 but not over $80,000 . . . . . . . . . $13,000 plus 26 percent of the excess of such
amount over $60,000.
Over $80,000 but not over $100,000 . . . . . . . . $18,200 plus 28 percent of the excess of such
amount over $80,000.
Over $100,000 but not over $150,000 . . . . . . . $23,800 plus 30 percent of the excess of such
amount over $100,000.
Over $150,000 but not over $250,000 . . . . . . $38,800 plus 32 percent of the excess of such
amount over $150,000.
167
Over $250,000 but not over $500,000 . . . . . . $70,800 plus 34 percent of the excess of such
amount over $250,000.
Over $500,000 but not over $750,000 . . . . . . $155,800 plus 37 percent of the excess of such
amount over $500,000.
Over $750,000 but not over $1,000,000 . . . . . $248,300 plus 39 percent of the excess of such
amount over $750,000.
Over $1,000,000 . . . . . . . . . . . . . . . . . . . . . $345,800 plus 40 percent of the excess of such
Amount over $1,000,000.
SO: for $5,250,000 with a top rate of 40%  $345,800 + 40% ($4,250,000) = $345,800 +
$1,700,000 = $2,045,800.—this is the credit shelter amount for 2013.
CREDIT FOR PRIOR TRANSFERS
Section 2013 provides a credit for the federal estate tax that was paid when the decedent acquired
property from an individual (the “transferor”) who died within ten years before or two years after
the decedent.
DiRusso: § 2013(a) provides a lower rate on property when we have taxes actually paid within
10 years.—(so, if it is from a spouse under the marital deduction, no tax was actually paid and
there shall be no credit allowed).
Purpose: To relieve the estate tax burden in successive estates when individuals die within a
relatively short time period of each other.
Example 16-5–Tom bequeaths all his property to his brother, Doug, and Doug dies six months
after Tom, bequeathing all his property to his son, Sam. Assume a flat 50 percent rate of tax, no
unified credit, and no credit for prior transfers. Tom has $10,000,000 of property. After taxes,
Doug receives $5,000,000. Doug has an additional $10,000,000 of his own property. Because of
the two estate taxes imposed, one on Tom’s estate and one on Doug’s estate, Sam receives only
$7,500,000.
Now—assume a credit for prior transfers equal to the amount of tax paid by Tom’s estate. The
tax on Doug’s estate will only be $2,500,000, compared to $7,500,000 without such a credit. As
a result, Sam will receive $12,500,000 of property, not $7,500,000.
TWO LIMITATIONS ON § 2013:
1. The credit cannot exceed the federal estate tax attributable to inclusion of the property in
the transferor’s estate.
2. The credit cannot exceed the federal estate tax attributable to including the property
received from the transferor in the decedent’s estate.
168
CREDIT FOR TAXES
There used to be a credit for state death taxes. The credit for state death taxes no longer exists.
Instead, § 2058 provides a deduction for state death taxes paid.
Section 2012 (§ 2012) allows a credit for federal gift taxes paid on gifts made prior to 1977 if the
value of the property is included in the decedent’s gross estate.
Section 2014 (§ 2014) allows a credit for death taxes paid to a foreign country if property located
in that country is also subject to the federal estate tax. Essentially, § 2014 avoids the harsh result
of double taxation.
CALCULATION OF THE GIFT AND ESTATE TAX
First we calculate the gross estate.
THE GROSS ESTATE:
§ 2033
Property Owned at Death
+§ 2034
Dower or Curtesy
+§ 2035
Certain transfers (LI) within 3 years of death
+§ 2036
Transfers with retained Life Estate or Retained Controls
+§ 2037
Transfers taking effect at death (reversions)
+§ 2038
Revocable Transfers
+§ 2039
Annuities and Death benefits
+§ 2040
Property passing by right of survivorship
+§ 2041
General Powers of Appointment
+§ 2042
Life Insurance
+§ 2043
Transfers for a partial consideration
+§ 2044
Transfers for which a QTIP was allowed
_________ ___________________________________
TOTAL
= GROSS ESTATE
Then:
SUBTRACT DEDUCTIONS to come up with the taxable estate.
Gross Estate
-Deductions
–––––––––––
Taxable Estate = amount of estate subject to tax.
Then: ADD THE TAXABLE ESTATE AND ADJUSTED TAXABLE GIFTS to get the
tentative tax base.
Taxable Estate
+ Adjusted Taxable Gifts
–––––––––––––––––––––––
Tentative Estate Tax Base
169
THEN: MULTIPLY THE ESTATE TAX BASE BY THE TAX RATE to get the tentative
estate tax.
Tentative Estate Tax Base X Tax Rate = Tentative Estate Tax
THEN: SUBTRACT THE UNIFIED TRANSFER TAX CREDIT AND THE CREDIT
FOR GIFT TAX PAID (AND OTHER CREDITS) to get the ESTATE TAX DUE.
Tentative Estate Tax
- Unified Transfer Tax Credit
- Credit for Gift Tax Paid (and other Credits)
–––––––––––––––––––––––––––––––––––––––
ESTATE TAX DUE
TAKING GIFTS INTO ACCOUNT
We consider cumulative lifetime gifts for purposes of calculating the estate tax.
CALCULATING TAX ON GIFTS:
Taxable gifts this year
+ taxable gifts in earlier year
–––––––––––––––––––––––––
Cumulative Taxable Gifts
Tax on Cumulative Taxable Gifts
- Tax on Earlier Taxable Gifts
–––––––––––––––––––––––––––
Tentative Gift Tax
Tentative Gift Tax
- Unified Transfer Tax Credit Used
–––––––––––––––––––––––––––––––
GIFT TAX DUE
170
P. 517 Problem 7: Ellen makes taxable gifts of $3 million in year 1 and dies in year 3 owning
property valued at $4 million. Assume there are no claims, expenses, or other deductions.
Calculate the federal gift and estate tax due.
To solve this, we first need to calculate the gift tax in year 1
Year One Gift Tax:
Current Year Taxable Gift
$3,000,000
+ Prior Year Taxable Gift
$0
––––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gift
$3,000,000
Now—calculate the tentative tax on aggregate taxable gift using the rate tables:
3,000,000
- 500,000
–––––––––
2,500,000
x .35
–––––––––
875,000 + 155,800 = $1,030,800 = tentative tax on aggregate taxable gifts.
Tentative Tax on Aggregate Taxable Gifts
$1,030,800
Minus (-) Tentative Tax on Prior Taxable Gifts
$0
––––––––––––––––––––––––––––––––––––––––––––––––––––––––––
Equals Tentative Tax on Current Taxable Gifts
$1,030,800
Tentative Tax on Current Taxable Gifts
$1,030,800
Minus (-) Unified Transfer Tax Credit
$1,780,800
–––––––––––––––––––––––––––––––––––––––––––––––––––––––––
Equals Estate Tax Due
[-$750,000]So no gift tax due.
Now—in year 3 Ellen dies. Estate Tax:
Gross Estate
$4,000,000
Minus (-) Deductions
(0)
––––––––––––––––––––––––––––––––––––––––
Taxable Estate
$4,000,000
Taxable Estate
$4,000,000
Plus (+) Adjusted Taxable Gifts
$3,000,000
––––––––––––––––––––––––––––––––––––––––
Tentative Estate Tax Base
$7,000,000
171
Tentative Tax =
7,000,000
- 500,000
––––––––
6,500,000
X .35
––––––––
2,275,000 + 155,800 = $2,430,800
Tentative Tax
2,430,800
Minus (-) § 2010 unified credit
(1,730,800)
Minus (-) Gift Tax Paid and other credits
(0)
––––––––––––––––––––––––––––––––––––––––––––––
Estate Tax Due
$700,000
P. 517 Problem 8: Frank makes taxable gifts of $6 million in year 1 and dies in year 3 owning
other property valued at $4 million. Assume there are no claims, expenses, or other deductions.
Calculate the federal gift and estate tax due.
Year One Gift Tax:
Current Year Taxable Gifts
$6,000,000
Plus (+) Prior Year Taxable Gifts
$0
––––––––––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gifts
$6,000,000
Now—calculate the tentative tax on aggregate taxable gifts using the rate tables:
$6,000,000
(-) 500,000
–––––––––––
$5,500,000
X .35
–––––––––––
$1,925,000 + 155,800 = $2,080,800 = tentative tax on aggregate taxable gifts
Tentative tax on aggregate taxable gifts
$2,080,800
Minus tentative tax on prior taxable gifts
(0)
––––––––––––––––––––––––––––––––––––––––––––––––––––
Tentative tax on current taxable gifts
$2,080,800
Tentative tax on current taxable gifts
2,080,800
Minus § 2505 unified credit remaining
-1,730,800
––––––––––––––––––––––––––––––––––––––––––––––––––––
Gift Tax Due
$350,000
172
Now—in year 3 Frank dies. ESTATE TAX:
What is in Frank’s Gross Estate?
Property
§ 2033
$4,000,000
Gift Tax Paid
§ 2035(b)
350,000
––––––––––––––––––––––––––––––––––––––––
Total Gross Estate
$4,350,000
Gross Estate
$4,350,000
Minus (-) Deductions
(0)
–––––––––––––––––––––––––––––––––
Equals Taxable Estate
$4,350,000
Taxable Estate
$4,350,000
Plus (+) Adjusted Taxable Gifts
$6,000,000
––––––––––––––––––––––––––––––––––––––––
Equals Tax Base
$10,350,000
Tentative Tax =
$10,350,000
- $500,000
––––––––––
9,850,000
x .35
–––––––––––
3,447,500 + 155,800 = $3,603,300
Tentative Tax on Base
$3,603,300
Minus § 2010 Unified Credit
-1,730,800
Less Gift Tax Paid and Other Credits
-350,000
––––––––––––––––––––––––––––––––––––––––––––
Estate tax due
1,522,500
NOTE: the tax due on $5 million at 35 percent is $1,750,000. The tax on the gift tax, $350,000 at
35 percent is $122,500. So total tax due is $1,872,500. Debra “prepaid” the tax of $350,000. So
the tax due at death is $1,522,500.
173
P. 517 Problem 9: In year 1, David purchased Skyacre, taking title with Paul as joint tenants
with the right of survivorship. Assume either can sever the joint tenancy unilaterally. The
purchase price was $4 million and David paid the entire amount in year 1. In year 2, David gave
Paul $1 million cash. In year 3, David gave Paul a life insurance policy on David’s life. David
transferred all the incidents of ownership to Paul. The fair market value at the time of the gift
was $1 million. In year 4, David gave Paul $2 million cash. In Year 5, David died. The FMV of
Skyacre was $4 million. The amount receivable under the life insurance policy $1 million. David
owned other property with a fair market value of $3 million. Assume there are no claims,
expenses, or other deductions. Calculate the federal gift and estate tax due.
Year One Gift Tax:
In Year one there is a taxable gift of $2 million for a ½ interest in Skyacre.
Current Year Taxable Gift
$2,000,000
Plus Prior Year Taxable Gift
$0
––––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gifts
$2,000,000
Tentative Tax on Aggregate Taxable Gifts =
$2,000,000
- 500,000
––––––––––
1,500,000
x .35
–––––––––
525,000 + 155,800 = $680,800 = tentative tax on aggregate taxable gifts
Tentative tax on aggregate taxable gifts
$680,800
Minus tentative tax on prior taxable gifts
(0)
–––––––––––––––––––––––––––––––––––––––––––––––––
Tentative Tax on Current Taxable Gifts
680,800
Tentative Tax on Current Taxable Gifts
680,800
Minus § 2505 Unified Credit remaining
-(1,730,800)
–––––––––––––––––––––––––––––––––––––––––––––––––––––
Gift Tax Due
[-1,050,000] = 0 Gift Tax Due
Year Two Gift Tax:
In Year Two there is a taxable gift of $1 million of cash.
Current Year Taxable Gift
$1,000,000
Plus Prior Year Taxable Gift
$2,000,000
–––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gifts
$3,000,000
174
Tentative Tax on Aggregate Taxable Gifts =
$3,000,000
- 500,000
––––––––––
2,500,000
x .35
–––––––––
875,000 + 155,800 = 1,030,800 = Tentative Tax on Aggregate Taxable Gifts
Tentative Tax on Aggregate Taxable Gifts
$1,030,800
Less Tentative Tax on Prior Taxable Gifts
-680,800
–––––––––––––––––––––––––––––––––––––––––––––––––
Tentative Tax on Current Taxable Gifts
$350,000
Tentative Tax on Current Taxable Gifts
$350,000
Minus § 2505 unified credit remaining
-1,050,000*
––––––––––––––––––––––––––––––––––––––––––––––––––––
Gift Tax Due
[-700,000] = 0 Gift Tax Due
*($1,730,800 – 680,800, which was used last year = 1,050,000).
Year 3 Gift Tax:
In Year 3 there is a taxable gift of a life insurance policy.
Current Year Taxable Gift
$1,000,000
Plus Prior Year Taxable Gift
3,000,000
––––––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gifts
$4,000,000
Tentative Tax on Aggregate Taxable Gifts =
4,000,000
- 500,000
–––––––––
3,500,000
x .35
––––––––––
1,225,000 + 155,800 = 1,380,800 = aggregate taxable gifts
Tentative Tax on Aggregate Taxable Gifts
$1,380,800
Less Tentative Tax on Prior Taxable Gifts
-1,030,800
–––––––––––––––––––––––––––––––––––––––––––––––––––––
Tentative Tax on Current Taxable Gifts
350,000
175
Tentative Tax on Current Taxable Gifts
$350,000
Minus § 2505 unified credit remaining
-700,000
–––––––––––––––––––––––––––––––––––––––––––––––––
Gift Tax Due
[-350,000] = 0 Tax Due
* ($1,730,800 – 1,030,800, which was used in earlier years = 700,000).
Year 4 Gift Tax:
In Year 4 there is a taxable gift of $2 million of cash.
Current Year Taxable Gift
$4,000,000
Plus Prior Year Taxable Gifts
2,000,000
–––––––––––––––––––––––––––––––––––––––
Aggregate Taxable Gifts
6,000,000
Tentative Tax on Aggregate Taxable Gifts =
6,000,000
- 500,000
–––––––––
5,500,000
x .35
––––––––––
1,925,000 + 155,800 = $2,080,800 = Tentative Tax on Aggregate Taxable Gifts
Tentative Tax on Aggregate Taxable Gifts
2,080,800
Less Tentative Tax on Prior Taxable Gifts
-1,380,800
–––––––––––––––––––––––––––––––––––––––––––––––––––
Tentative tax on current taxable gift
700,000
Tentative Tax on Current Taxable Gifts
700,000
Minus § 2505 unified credit remaining
-350,000
––––––––––––––––––––––––––––––––––––––––––––––––––
Gift Tax Due
350,000
* (1,730,800 – 1,380,800, which was used in earlier years, = 350,000
176
Now—in year 5, David dies. ESTATE TAX:
What is in David’s Gross Estate?
Property Owned at Death
§ 2033
3,000,000
Joint Tenancy Property
§ 2040(a)
4,000,000
Life Insurance
§ 2042(2)
1,000,000
Gift Tax Paid
§ 2035(b)
350,000
–––––––––––––––––––––––––––––––––––––––––––––
Total Gross Estate
$8,350,000
Gross Estate
$8,350,000
Minus Deductions
(0)
––––––––––––––––––––––––––––––––––––––––
Equals Taxable Estate
8,350,000
Taxable Estate
8,350,000
Plus Adjusted Taxable Gifts
3,000,000
–––––––––––––––––––––––––––––––––––––––––
Equals Tax Base
11,350,000
Tentative Tax on Tax Base =
11,350,000
- 500,000
––––––––––
10,850,000
x .35
–––––––––––
3,797,500 + 155,800 = $3,953,300 = Tentative Tax on Tax Base
Tentative Tax on Tax Base
3,953,300
Minus § 2010 unified credit
-1,730,800
Minus Gift Tax Paid and other credits
-350,000
–––––––––––––––––––––––––––––––––––––––––––––
Equals Estate Tax Due
$1,872,500
177
CHAPTER SEVENTEEN: THE GENERATIONSKIPPING TRANSFER TAX
The generation-skipping transfer tax is based on the policy that the transfer of property should be
taxed at least once at each generation.
Trust created before 1986 may be grandfathered out of the system.
The GST piggybacks on the estate and gift tax rules—it has the same rates & exemptions as the
estate and gift tax system.
Policy: The generation-skipping transfer tax ensure that tax is paid on the transfer of property to
each generation as well as on transfers that skip generations.
Tax Rate: 40%.
§ 2601. Tax imposed.
A tax is hereby imposed on every generation-skipping transfer (within the meaning of subchapter
B).
§ 2602. Amount of tax.
The amount of tax imposed by section 2601 is—
(1) the taxable amount (determined under subchapter C), multiplied by
(2) the applicable rate (determined under subchapter E).
§ 2641. Applicable rate.
(a) General rule. For purposes of this chapter, the term ‘applicable rate’ means, with respect
to any generation-skipping transfer, the product of—
(1) the maximum Federal estate tax rate, and
(2) the inclusion ratio with respect to the transfer.
(b) Maximum Federal estate tax rate. For purposes of subsection (a), the term ‘maximum
Federal Estate tax rate’ means the maximum rate imposed by section 2001 on the estates
of decedents dying at the time of the taxable distribution, taxable termination, or direct
skip, as the case may be.
THE TERMINOLOGY
The generation-skipping transfer (GST) tax is imposed on direct skips, taxable terminations, and
taxable distributions.
178
TRANSFEROR—Section 2652(a) defines a transferor as the donor, if the property is subject to
gift tax, or the decedent if the property is subject to the estate tax.
The donor or the decedent is the transferor even if no gift or estate tax is actually paid because
of applicable exclusions, exemptions, deductions, or credits.
Example 17-3–Pam gives her granddaughter, Gail, $1,000,000 but does not pay any gift tax
because of the applicable credit amount in § 2505. Pam is considered the donor for purposes of
the gift tax and is, therefore, the transferor for purposes of the generation-skipping transfer tax.
Similarly: If Pam left the property to her granddaughter, Gail, in her will, the result would be the
same. Pam is the decedent for purposes of the estate tax even if no estate tax is due because of
the applicable credit amount in § 2010. She is still the transferor for purposes of the generationskipping transfer tax.
If an individual and her spouse elect to split gifts under § 2513, then each is treated as the
transferor with respect to one-half of the gift.
Effect of GPOA or Lapse on Who Qualifies as Transferor—The holder of a power of
appointment may or may not be a transferor for purposes of the generation-skipping transfer tax.
Example 17-4–David leaves his residuary estate in trust to pay the income to his son, Peter, for
his life. At Peter’s death, the Trustee is to distribute the trust property to whomever Peter
appoints in his will. Because Peter can appoint to anyone, including his creditors, the creditors of
his estate, or his estate, the power is a general power of appointment, and the trust property will
be in Peter’s gross estate pursuant to § 2041. As a result, Peter will be considered the
transferor of the trust property after his death whether or not he actually exercises the
power and appoints the property. Still, there may or may not be a generation-skipping
transfer.
IF Peter appoints the property to his grandchildren, there will be a generation-skipping
transfer because Peter is the transferor and his grandchildren are two generations below
him.
IF instead, Peter fails to appoint the trust property, it passes to his children as takers in default.
This is not a generation-skipping transfer because while Peter is still the transferor, his children
are only one generation below him even though they are two generations below David, the settlor
of the trust.
Example 17-5–Instead, David leaves his residuary estate in trust to pay income to his son, Peter,
for life. At Peter’s death, the Trustee is to distribute the trust property to those of Peter’s children
as Peter appoints in his will. If Peter does not appoint the trust property, it will be distributed
equally to those children. This is not a general power of appointment because Peter cannot
appoint to himself, his estate, his creditors, or the creditors of his estate, and the trust property
will not be in Peter’s gross estate. As a result, David remains the transferor and there will
be a generation-skipping transfer when Peter dies, whether or not he exercises his power of
appointment, because the property goes from David to his grandchildren.
179
LAPSES AND THE TRANSFEROR: If the power holder has a lapsing power, such as a
Crummey power, the power holder will be considered the transferor if the power lapses, but only
to the extent that the lapse exceeds the greater of $5,000 or 5% of the trust property.
MARITAL DEDUCTION AND THE TRANSFEROR: The identity of the transferor may
also shift in a marital deduction trust.
When you have a QTIP—the transferor for GST Tax purposes is the person who receives the
property (i.e. the surviving spouse)—but § 2652(a)(3), allows the Decedent’s (first spouse to
die) estate to make a reverse Q-Tip election, meaning that the Q-Tip election qualifies the
property for the marital deduction, but the reverse election causes the QTIP election to be
ignored for purposes of the GST Tax—meaning that the decedent (first spouse to die) is treated
as the transferor for GST Tax purposes.
INTEREST—The GST Tax will only be imposed if there is an outright transfer to a skip person
or if there is a taxable event transferring property to a recipient who has an interest as defined by
§ 2652(c) and who is a skip person.
Section 2652(c) provides that a person has an interest in property held in trust if that person
either has the present right to receive income or corpus or is a permissible current
recipient of income or corpus and is not a charity.
Example 17-9–Dwight establishes an irrevocable trust to pay the income to his daughter, Ann,
for life and at her death to distribute the trust property to Ann’s daughter, Beth. Ann has an
interest in the trust because she has the present right to receive income. Beth does not have an
interest in the trust for purposes of the generation-skipping transfer tax because her vested
remainder is a future interest.
Example 17-10–Dwight establishes an irrevocable trust with FNB as Trustee. The Trustee has
discretion to distribute corpus to any of Dwight’s three children. The Trustee also has discretion
to distribute corpus to any of Dwight’s four grandchildren. All three children and all four
grandchildren have interests because they are current permissible recipients of income or corpus.
CERTAIN INTERESTS DISREGARDED:
 Interests designed to postpone or avoid the generation-skipping transfer tax will be
disregarded.
 The fact that income or corpus from a trust may be used to satisfy a legal obligation of
support will be disregarded in determining whether a person has an interest in a trust as
long as the use of trust funds is either discretionary or pursuant to state law such as the
Uniform Transfers to Minors Act.
180
SKIP PERSONS
The generation-skipping transfers are defined in terms of transfers to skip persons.
SKIP-PERSON: A skip person is a natural person assigned to a generation that is two or more
generations below that of the transferor.
A trust can be a skip person if either:
(1) all the interests in the trust are held by skip persons
(2) no person holds an interest in the trust and there cannot be a distribution to a nonskip
person.
EXAMPLES: The transferor’s grandchild and great-grandchild are skip persons, grandnieces
and grandnephews are also skip persons. The transferor’s children, nieces, and nephews are not
skip persons.
Example 17-11–Dian establishes an irrevocable trust with FNB as Trustee. The Trustee has
discretion to distribute income among Diane’s grand-children during their lives. At the death of
her last grandchild, the trust property is to be distributed to the grandchild’s issue. Diane’s
grandchildren all have interest in this trust because the Trustee may distribute income to them.
They are all skip persons because they are two generations below Diane, the transferor. As a
result, the trust is a skip person, and the creation of the trust will be considered a direct skip and a
taxable gift.
Example 17-12–Diane establishes an irrevocable trust with FNB as Trustee. Diane provides that
the Trustee is to accumulate income until her youngest grandchild reaches the age of 21. At that
time, the Trustee has discretion to distribute income among the grandchildren in whatever
proportion the Trustee determines. At the death of the last grandchild, the trust property is to be
distributed to the grandchildren’s issue. Immediately after the trust is created, no person has an
interest in the trust as defined by § 2652(c) and no distribution may be made to a nonskip person.
As a result, the trust is a skip person, and the creation of the trust will be considered a direct skip
as well as a taxable gift.
GENERATION ASSIGNMENT
Generation assignment depends on the recipient’s relationship to the transferor.
3 DIFFERENT WAYS IN WHICH PEOPLE MAY BE ASSIGNED A GENERATION:
1) RELATED PARTIES—family relationship controls.
a. For example, your brother is in your same generation, and therefore a non-skip
person. Your son is one generation below you, and therefore a non-skip person.
2) TRANSFEROR’S SPOUSE—the transferor’s spouse is assigned to the transferor’s
generation, regardless of age.
181
3) UNRELATED PARTIES—Anyone who is not assigned to a generation based on family
relationship is assigned based on age.
a. A person born no more than 12.5 years after the transferor is assigned to the
transferor’s generation.
b. A person born more than 12.5 years and less than 37.5 years is assigned to the
next generation.
c. Each subsequent generation is 25 years.
d. THUS– anyone born more than 37.5 years after the transferor will be a skip
person. Anyone born before then will be a nonskip person.
PREDECEASED ANCESTOR RULE—Section 2651(e) provides an exception if the parent of
a lineal descendant is dead at the time of a generation-skipping transfer = if this is the case, the
child moves up one generation.
Example 17-13–Theresa has two children, Mary and Nancy. Mary dies, survived by her son,
Simon. Theresa dies and her will leaves half her property to Nancy and half to Simon. Because
Simon’s mother was dead at the time of the transfer from Theresa, § 2651(e) will apply and
Simon will move up to his parent’s generation. As a result, he will not be a skip person, and the
bequest to him will not be a generation-skipping transfer.
This rule applies to direct skips, taxable terminations, and taxable distributions. However, it
only applies if the parent is dead at the time of the initial transfer that subjected the transferor to
the gift or estate tax.
Additionally, this rule applies only to the transferor’s collateral heirs and descendants.
TAXABLE EVENTS
There are three events that trigger the generation-skipping transfer tax: a direct skip, a taxable
termination, and a taxable distribution.
1) DIRECT SKIP—
A directs skip is a transfer that is subject to the gift tax or estate tax that is made to a skip person.
A gift to a trust is a direct skip if (1) all interests in the trust are held by skip persons or (2) no
person holds an interest in the trust and there may never be a distribution to a nonskip person.
Example 17-16–Theo establishes an irrevocable trust to pay the income to his grandchildren for
their lives and, at the death of the last grandchild, to distribute the trust property to their
surviving descendants. All of the grandchildren’s parents are alive at the time Theo establishes
the trust. The creation of the trust is a taxable gift. It is also a direct skip because the only persons
with interests in the trust are the grandchildren and they are all skip persons.
Example 17-17–Tess establishes an irrevocable trust and directs the Trustee to accumulate
income until the death of her last child. After the death of the last surviving child, the Trustee is
to distribute the accumulated income and principal to Tess’s surviving issue. At the time that
Tess creates the trust no one has an interest in it because no one has either a present right to
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income or principal or is a permissible current recipient of income or principal. Distribution of
the trust property may only be made to skip persons. As a result, the trust is a skip person. The
creation of the trust is a taxable gift, and it is also a direct skip because it is a transfer to a skip
person, i.e., the trust.
2) TAXABLE TERMINATION—
A taxable termination is the ending–by death, lapse of time, release of a power, or similar event–
of an interest in property held in trust unless (1) immediately after the termination a nonskip
person has an interest in the property or (2) at no time after the termination may a distribution be
made to a skip person.
Example 17-18–Sam’s will establishes a trust to pay the income to his child for life and, at his
child’s death, to distribute the trust property to his grandchildren in equal shares. The trust
property is in Sam’s gross estate at his death. The creation of the trust is not a direct skip because
Sam’s child, who is a nonskip person, has an interest in the trust. The death of Sam’s child,
however, is a taxable termination because immediately after his death, the only persons with
interests in the trust are Sam’s grandchildren, who are all skip persons.
Example 17-19–Tom’s will leaves his property in trust to pay the income to his Spouse for her
life. After Spouse’s death, the Trustee is to distribute income to Tom’s two children, Mark and
Luke, for their lives. After the death of both Mark and Luke, the Trustee is to distribute the trust
property in equal shares to Tom’s surviving descendants. The property will be in Tom’s gross
estate; it is irrelevant that it might qualify for the marital deduction. Spouse’s death is not a
taxable termination because after her death both Mark and Luke have interests in the trust and
they are nonskip persons
Mark dies before Luke. His death is not a taxable termination because Luke continues to have
an interest in the trust. If, however, the trust were to be divided into two separate shares at
Mark’s death and if Mark’s share were then distributed to his surviving descendants, his death
would be a taxable termination with respect to his share of the trust.
Example 17-20–Tom’s will leaves his property in trust to pay the income to his Spouse for her
life. After Spouse’s death, the Trustee is to distribute income to Tom’s two children, Mark and
Luke, for their lives. Tom’s will provides that at the death of the first child, the trust is split into
separate shares. Tom gives each child a power to appoint his share of the trust property to
whomever he designates in his will; in default of appointment, the property will be distributed to
the son’s surviving issue. There is no taxable termination at Mark’s death. He has a general
power of appointment, and, as a result, his share of the trust property will be in his gross estate
pursuant to § 2041. There is no need for a generation-skipping transfer tax on this transfer
because the property will be subjected to the transfer tax as part of Mark’s gross estate.
BUT: If Mark had a power to appoint only among his surviving descendants, however, the
power would be a special power and the trust property would not be in Mark’s gross estate. In
this case, Mark’s death would be a taxable termination.
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3) TAXABLE DISTRIBUTION—
A taxable distribution is a distribution from a trust to a skip person, if the transfer is not
otherwise a direct skip or a taxable termination.
Example 17-21–Sarah’s will creates a trust, giving the Trustee discretion to distribute income in
whatever proportion deemed advisable to any of Sarah’s children or grandchildren. The Trustee
also has discretion to distribute corpus to any of Sarah’s children or grandchildren for their
health, education, or in an emergency. A distribution of either income or corpus to a child will
not be a taxable distribution because the children are not skip persons. A distribution of income
or corpus to a grandchild will be a taxable distribution because the grandchildren are skip
persons.
THE RULE OF MULTIPLE SKIPS
§ 2653. Taxation of multiple skips.
(a) General rule. For purposes of this chapter, if–
(1) there is a generation-skipping transfer of any property, and
(2) immediately after such transfer such property is held in trust,
for purposes of applying this chapter (other than section 2651) to subsequent transfers from the
portion of such trust attributable to such property, the trust will be treated as if the transferor of
such property were assigned to the first generation above the highest generation of any person
who has an interest in such trust immediately after the transfer.
Section 2653 establishes a rule for multiple skips and prevents them from being taxed twice as
generation-skipping transfers.
Policy: The transfer of property should be taxed once, but only once, at each generation.
Example 17-22–Parent establishes an irrevocable trust to pay the income to Child for her life,
then to pay the income to Grandchild for his life, and then to distribute the trust property to
Great-Grandchild. The creation of the trust is a taxable gift. It is not a direct skip because Child
is a nonskip person. Distributions of income to Child are not taxable distributions because Child
is a nonskip person. Child’s death is a taxable termination. It is necessary to impose a generationskipping transfer tax at this time because the trust property is not in the Child’s gross estate.
Because of the rule of multiple skips, distributions of income to Grandchild after Child’s
death are not taxable distributions. Section 2653 achieves this result by moving Parent down
to the generation immediately above that of Grandchild. Since Grandchild is now only one
generation removed from Transferor, Grandchild is no longer a skip person and distributions to
Grandchild will no longer be taxable distributions because they are now being made to a nonskip
person.
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Example 17-24–Gretta established an irrevocable trust to pay the income to Abigail, her
granddaughter, until she is 35. The trust property is to be distributed to Abigail at age 35. If
Abigail dies before age 35, the trust property will be distributed to her descendants. Assuming
that Abigail’s parent (who is Gretta’s child) is alive at the time the trust is created, the creation of
the trust is both a taxable gift and a direct skip. Distributions of trust income to Abigail will not
be taxable distributions. Because the creation of the trust was a direct skip and thus subject to the
generation-skipping transfer tax, Gretta will be moved down to the generation immediately
above Abigail. As a result, Abigail will no longer be considered a skip person and distributions
to her will not be subject to the generation skipping transfer tax.
EXCLUSIONS, EXEMPTIONS, AND CALCULATION OF
THE TAX
§ 2631. GST exemption.
(a) General rule. For purposes of determining the inclusion ratio, every individual shall be
allowed a GST exemption amount which may be allocated by such individual (or his
executor) to any property with respect to which such individual is the transferor.
(b) Allocations irrevocable. Any allocation under subsection (a), once made, shall be
irrevocable.
(c) GST exemption amount. For purposes of subsection (a), the GST exemption amount for
any calendar year shall be equal to the basic exclusion amount under section 2010(c) for
such calendar year.
The GST exemption is the same amount as the unified transfer tax credit ($5 million indexed
for inflation). However, unlike the unified transfer tax credit, which is automatically applied to
the first $5 million of taxable gifts or of the gross estate, the transferor may allocate the GST
exemption in any way they choose.
TRANSFERS FOR MEDICAL EXPENSES AND TUITION:
Section 2611(b)(1) excludes transfers for medical expenses and tuition paid directly to the
provider, which are also excluded from the gift tax by § 2503(e).
Section 2611(b)(1) shelters not only transfers made directly by the transferor to the medical or
educational institution but also distributions for these purposes form trusts for the benefit of skip
persons.
Example 17-31–Gordon pays the $40,000 law school tuition bill for his granddaughter, Lily.
This transfer is not a taxable gift because of § 2503(e), and it is excluded from the generationskipping transfer tax by § 2611(b)(1). It does not use up Gordon’s gift tax annual exclusion,
applicable credit amount, or GST exemption.
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DIRECT SKIPS THAT ARE NONTAXABLE GIFTS:
Section 2642(c) also excludes direct skips that qualify for the gift tax annual exclusion by
defining the inclusion ratio for these gifts as zero.
This exclusion does not apply, unless:
(1) the trust is for the benefit of one individual,
(2) during the individual’s life no portion of the income or corpus may be distributed to
anyone other than that individual, and
(3) the trust assets will be in that individual’s gross estate if the trust does not terminate
before the individual dies.
P. 540 Problem 1: Teresa establishes an irrevocable trust by transferring $15,000,000 to FNB as
Trustee to pay the income to Paul (Teresa’s child) for life, then the income to Carol (Teresa’s
grandchild) for life, with the remainder to Edward (Teresa’s great-grandchild). The Trustee has
absolute discretion to pay any amount of income or corpus to either Paul or Carol during Paul’s
life. What are the generation-skipping transfer tax consequences of the following situations?
a. The Trustee distributes income to Paul.
b. The Trustee distributes income to Carol during Paul’s life.
c. The Trustee distributes corpus to Paul.
d. The Trustee distributes corpus to Carol during Paul’s life.
e. Paul dies.
f. The Trustee distributes income to Carol after Paul dies.
g. Carol dies.
a. Child = non-skip person = No GST Tax.
b. Granchild = skip person = GST tax (a taxable distribution).
c. Child = non-skip person = No GST Tax.
d. Grandchild = skip person = GST tax (a taxable distribution).
e. A taxable termination upon Paul’s death = GST Tax (a taxable termination) –Carol and
Edward move up a generation.
f. Carol is no longer a skip person, so no GST Tax. (We taxed this as a taxable termination at
Paul’s death—so under the rule of multiple skips—we only impose a tax once at each
generation—we won’t double tax this).
g. This is a taxable termination upon Carol’s death = GST Tax (a taxable termination). Edward
moves up a generation as a result.
P. 540 Problem 5: Tracy has four children and 12 grandchildren. On December 1, Tracy sends
each of them a check for $13,000.
a. What are the gift and generation-skipping transfer tax consequences?
b. What if Tracy is married to Frank, and she sends each child and each grandchild a check for
$26,000?
c. Same as 5.b., except that each check is for $250,000.
a. None—annual exclusion for gift tax—zero inclusion ration for GST tax purposes.
b. If they send them together—this can be a gift-split situation, and no tax would be imposed.
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c. Tax on the amounts above the gift tax annual exclusion—but then it just goes against the
unified transfer tax for gift tax purposes. For GST Tax purposes, it depends on whether you
allocate your exclusion to it or not.
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