Estate and Gift Tax Outline
Professor Kirsch
Spring 2011
Gift Tax
§2512(b): “Where property 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.”
What Constitutes A Gift?
 Generally:
o Congress intended an expansive definition of what constitutes a “gift” so as to be subject to the
gift tax
o §2511(a) provides that the gift tax is to 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.”
o Reg. § 25.2511-1(c)(1) states that “any transaction in which an interest in property is gratuitously
passed or conferred upon another, regardless of the means or device employed, constitutes a gift
subject to tax.”
 Is Donative Intent Necessary?
o Transfer Without Valuable Consideration: Commissioner v. Wemyss (Mr. Wemyss gives widow
$150,000 as consideration for marrying him)
 Donative intent is not required for gift tax purposes (see also, 25.2511-1(g)(1): “Donative
intent on the part of the transferor is not an essential element in the application of the
gift tax to the transfer.”)
 A consideration not reducible to a money value, 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
o Transfers for Insufficient Consideration
 Reg. §25.2512-8: “Transfers reached by the gift tax are not confined to those only which,
being without valuable consideration, accord with the common law concept of gifts, but
embrace as well sales, exchanges, and other dispositions of property for 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 which
is a 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.”
 Thus, on finding that a transfer in the circumstances of a particular case is not made in the
ordinary course of business, the transfer becomes subject to the gift tax to the extent that
it is not made “for adequate and full consideration in money or money’s worth”
o Code/Regs:
 Code: § 2511(a)
 Regs: §§ 25.2511-1(a), (c), (d), (e), (g)(1); 25-2512-8
 Text: pg. 32-35
 Interest-Free and Low-Interest Loans
o The Potential Problem:
 Dad gives son $1,000,000 loan and son promises to repay the money without interest
 Son then takes the million dollars and puts it in the bank, collecting interest every year
 At the end of three years, Son pays Dad back the money of the loan
o Dickman v. Commissioner: The Supreme Court concludes that an interest-free loan results in a
taxable gift
 Only tax the resulting interest obtained from the loan, not the principle amount
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§2501(a)(1): “Subject to the limitations 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.”
 The statute was designed to encompass all transfers of all property and property
rights having significant value
 Congress intended “gifts” in its broadest and most comprehensive sense
 The USE of valuable property is itself a legally protectable interest; of the aggregate rights
associated with property interest, the right of use is in the highest order
 The gift tax is an excise tax on transfers of property; if the taxpayer transfers the money
to someone else, a taxable event has occurred
Statutory Response to Interest-Free and Low-Interest Loans
 Confronted with the growing tax avoidance threat, Congress responded by incorporating
§7872
 The practical effect of 7872 was to largely eliminate the tax advantages of interest-free or
low-interest loans, making such loans attractive only under limited circumstances
 Requirements of 7872(a): “For the purposes of this title, in the case of any below market
loan to which this section applies and which is a gift loan or a demand loan, the foregone
interest shall be treated as….”
 Must be a below-market loan
o Definition of below-market loan found in 7872(e) – interest payable on
the loan is less than the applicable federal rate
o Applicable Federal Rate is defined in 7872(f)(2) for both term loans and
demand loans
 Applies to gifts under 7872(c) which is defined in 7872(f)(3)
o Gift Loan under 7872(f)(3) means “any below-market loan where the
forgoing of interest is in the nature of a gift.”
o Demand Loans under 7872(f)(5) means “any loan which is payable in full
at any time on the demand of the lender.”
 The consequences of falling under 7872 – Break it into 2 steps… [Recreates the situation
that roughly would have existed if Dad had kept the money himself and then made a gift
to Son)
 Step 1: 7872(a)(1)(A): The foregone interest is treated as transferred from the
lender to the borrower (i.e. from Dad to Son)
o Dad is treated as if he made a gift in that amount
o Also applies in compensation related loans in employer/employee
relationship
 Step 2: 7872(a)(1)(B): The foregone interest is treated as retransferred by the
borrower to the lender as interest
o Means that Dad has to include the same amount as interest income
 What is foregone interest?
o Not necessarily what the son actually accrued while he was in possession
of the money
o See 7872(e)(2): “The excess of the amount of interest that would have
been payable on the loan for the period if the interest accrued on the
loan at the applicable Federal Rate” (expect son to at least pay the
market rate on what he borrowed)
 Exceptions: Congress has recognized that loans between family members have legitimate
purposes other than tax avoidance:
 General De Minimis Exception – provided for gift loans between individual not
exceeding $10,000 outstanding at any one time (§7872(c)(2)(A))
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However, this exception is not available if the loan is “directly attributable
to the purchase or carrying of income-producing assets.” (§7872(c)(2)(B))
o Therefore, if the borrower directly of indirectly invests the borrowed
funds in an asset that produces income, the $10,000 exception does not
apply
The more important exception applies to loans up to $100,000 (§7872(d))
o Designed for circumstances such as loans from a parent to a child to
enable the child to make a down payment on a personal residence
o If the loan arrangements do not “have as 1 of the principal purposes the
avoidance of any Federal tax” (§7872(1)(B)), the amount of interest
imputed is limited to the borrower’s net investment of the borrowed
funds (§7872(d)(1)(A))
o Note: eliminates only the imputed interest – not the imputed gift
Gifts of Services
o 2501(a)(1): “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 by any individual, resident or
nonresident.”
 “Property” does not generally include personal services
 Therefore, advice or directly clients to another person is not a transfer of property, and
cannot be taxed as a gift
 However, a gift of the right to income is clearly taxable as a gift, making the time of a gift
of services crucial (i.e. customer lists – transfers of “intangible” property – might be
treated as a gift)
o Revenue Ruling 66-167: Waiver of An Executor’s Fee
 When a decedent dies, a relative is appointed as the executor of a decedent’s estate
 The executor is generally entitled to receive compensation for their services out of the
assets of the estate
 This revenue ruling provides that as long as you waive the right to compensation within 6
months, the IRS will respect the waiver. Otherwise:
 The crucial test of whether the executor of an estate or any other fiduciary in a
similar situation may waive his right to receive statutory commissions without
thereby incurring any income or gift tax liability is whether the waiver involved
will at least primarily constitute evidence of an intent to render a gratuitous
service.
 If the timing, purpose, and effect of the waiver make it serve any other important
objective, it may then be proper to conclude that the fiduciary has thereby
enjoyed a realization of income by means of controlling the disposition thereof
and, at the same time, has also effected a taxable gift by means of any resulting
transfer to a third party of his contingent beneficial interest in a part of the assets
under his fiduciary control.
o Example of WHY you would want to waive the executor’s fee:
 Wife appointed executor -husband had assets of 800,000 in his estate
 Will provides that 1/2 of assets go to wife and 1/2 of assets go to the son
 Wife entitled to an executor fee of $10,000, so there would only be 790,000 left
 To help Son, Wife of the deceased could waive the fee so that the full 400,000 will go to
Son even though she would have gotten more if she had kept the fee and paid income
taxes on it
Gift by Agents (aka gifts made under the power of attorney)
o Two Issues:
 (1) Whether the decedent has executed a power of attorney that authorizes the agent
after the principal loses legal capacity? [Power of Attorney must be DURABLE]
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The power of attorney, at common law, was terminated by the principal’s
incapacity
 A “durable” power of attorney survives the principal’s incapacity, although
specific language is required to assure the “durability” of the power
 Failure to use the required language makes the power ”nondurable” and the
principal has the power to void the agent’s actions; in that event, gifts by the
agent will not be treated as completed during the principal’s life, and the
transferred property will be included and taxed in the decedent’s gross estate
 [See Indiana Power of Attorney Handout for language]
 (2) Whether the power of attorney – even if valid despite the principal’s incapacity –
confers authority for the agent to make gifts on behalf of the principal?
 Planner should draft the power of attorney so as to expressly and specifically
assure the necessary gift authority
 Four principal purposes for asset transfer: sale, lease, mortgage, and gift
 If all of these purposes but gift are expressly authorized in the power of attorney,
the court will assume the gift authority was not conferred
o Estate of Casey v. Commissioner
 Facts: did not expressly confer the power to make gifts in the power of attorney
 Agent was trying to take advantage of the gift tax exclusion as he had a durable
power of attorney and the principal had become incapacitated
 Principal had previously established a gift-giving patter, and the agent was simply
continuing it under the catch-all provision in the power of attorney (i.e. power to
do what the principal would have done)
 Issues: IRS argues, therefore, that the power of attorney did not authorize the agent to
make gifts on behalf of the principal
 Holding: The 4th Circuit concludes that the agent does not have the power to make gifts
as the document did not expressly authorize doing so, and that therefore the executor of
the estate had the right to revoke the gifts because they were not legally authorized
transfers (had the effect of being included in the gross estate for the purpose of the
estate tax)
o Estate Planning Note: Typically the principal is not comfortable granting an unfettered power to
make gifts
 Usually the primary tax objectives can be obtained by authorizing gifts not exceeding the
§2503(b) exclusion amount for each donee each year within certain categories of family
members
 If the principal is willing, it may be desirable in some cases to go further and authorize
more substantial transfers – i.e. up to the applicable exclusion amount under the gift tax
unified credit
Indirect Gifts
o A gift can occur without the direct transaction between a donor and donee; typically occurs in the
context of a closely held business
o Recall §2511 – a gift can be either direct or indirect
o Typically the crucial issue is indirect cases is valuation
o As with direct transfers, an indirect transfer will not constitute a gift unless the transferor receives
less than adequate and full consideration in money or money’s worth from the person receiving
the benefit - §2512(b)
Payments of Taxes on Trust Income
o The grantor is taxed on the income of a grantor trust if the grantor retains certain powers or
benefits with respect to the trust.
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The IRS has ruled that the grantor’s payment of income taxes imposed on the income of a grantor
trust does not constitute a gift to the trust or to the beneficiaries who receive the trust income.
 In the case of a grantor trust, neither the trustee nor the beneficiary has any obligation to
pay tax on trust income, so when grantor pays the income tax, it does not relieve the
trustee or the beneficiary of any legal obligation.
 However, generally for other situations, the gratuitous payment of a tax for which
another person is liable constitutes a gift by the payor.
Gifts by Trustees
o The gift tax cannot apply unless the transferor makes himself poorer while making the transferee
richer.
o 25.2511-1(g)(1): “A transfer by a trustee of trust property in which he has no beneficial interest
does not constitute a gift (but such transfer may constitute a gift by the creator of the trust, if
until the transfer he had the power to change the beneficiaries by amending or revoking the
trust).”
 Trustee has no beneficial interest – it is his fiduciary duty to watch over the money and
distribute according to the terms of the trust.
 There is no way for the trustee to access the money for himself; even though you can
technically transfer the money, the trustee is not the one who makes the gift (gift comes
from the creator of the trust)
o Two Exceptions:
 First, if the trustee is the grantor of a trust (i.e. the person who created the trust), the
transfer may constitute a gift because the transfer by the trustee completes a gift that
was initiated when the grantor transferred property to the trust (since you have the
power to revoke the money from the trust, no gift is yet complete when it is put into the
trust).
 Second, if the trustee has a beneficial interest in the property, the general rule is that a
distribution that diminishes the trustee’s beneficial interest but benefits the distributee
constitutes a gift by the trustee to the beneficiary.
 However, under 25.2511-1(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 the nonexercise of which is
limited by a reasonably fixed or ascertainable standard.” For example:
 Necessary for beneficiary’s medical care = fixed and ascertainable standard
 Pleasure, desire, happiness of beneficiary = not a fixed or ascertainable standard
Consideration
o 2512(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 property exceeded the value of the
consideration shall be deemed a gift.
o Two central concepts:
 Only consideration in “money or money’s worth” is sufficient
 “Adequate and full consideration”: in other words, there will be a gift to the extent the
monetary value of the consideration received is less than the monetary value of the
consideration given
o What constitutes consideration?
 Lack of full consideration becomes the acid test in determining whether a gift is present
for gift tax purposes (if the transfer is made for full consideration, the transferor is not
making herself poorer by the transfer; no tax is being avoided, because the transferor’s
estate, by reason of the consideration received, is just as large as before the transfer).
 2043(b)(1) expressly denies marital rights the status of consideration for purposes of
determining whether a death transfer is made for consideration (Merrill v. Fahs)
o Divorce Transfers
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For purposes of the gift tax, there is an unlimited marital deduction for transfers between
spouses
 However, the unlimited marital deduction does not apply to ex-spouses
 §2516 indicates that property transfers incident to divorce are fundamentally
arms-length transactions in which consideration of equal monetary value flows to
each party, therefore the gift tax should not apply
 §2516 requires both a written agreement and a divorce decree, and all transfers are
pursuant to the agreement are treated as made for full and adequate consideration;
transfers must be:
 (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
 Treated as if you didn’t make a gift at all
 The timing requirement does not relate to the timing of the property transfer itself
 Divorce must occur within a 3-year period beginning 1 year before the date of
when such agreement was entered in to
 1 yr. before date of agreement 1 yr.Date of Agreement2 yrs. Divorce
Discharge of Support Obligations
 A divorcing husband does not make a taxable gift when he transfers funds to his wife in
settlement of her support rights
 Exclusion of tuition – §2503(e) – and medical expenses – §2503(b) – even after the age of
majority
Adequacy of Consideration
 §2512 – the presence of consideration for purposes of contract law does not assure that
the transfer will escape gift tax
 THE VALUE OF CONSIDERATION MUST BE EQUAL TO THE VALUE OF PROPERTY
TRANSFERRED – consideration must be reducible to money or money’s worth
 Reg. §25.2512-8 states that even if the consideration is not objectively equal in value to
the property transferred, the IRS will not assert gift tax liability if the transfer was made
during the ordinary course of business.
Payment of Gift Tax as Consideration
 Donor parents may wish to transfer stock in a closely held family corporation, but may
not wish to give up the necessary cash to pay the gift tax on the transfer – in that event,
the son or daughter may agree to pay the tax
 Because §2503(c) imposes the primary obligation to pay the gift tax on the donor, the
donee’s payment of the tax must be viewed as an offsetting benefit to the donor
 Therefore, the net gift that is taxable is the difference between the value of the property
transferred and the amount of the donor’s gift tax obligation discharged by the donee
 The net gift may have income tax consequences as well
 In Old Colony Trust Co. v. Commissioner, the Supreme Court concluded that for
income tax purposes there was a sale, and the amount realized by the donor was
the amount of the donor’s tax obligation discharged by the donee which was
taxable as a gain
Gifts of Encumbered Property
 Crane v. Commissioner held that a party who conveys property subject to a liability must
be treated as receiving consideration in the amount of the liability because the transferee
can be expected to discharge the debt
Political Contributions
 §2501(a)(4) provides that any political organization is excluded from taxable gifts -NO
limitation
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Refers to §527(e) which defines political organization as any committee, fund, or
organization organized and operated primarily for the nomination, election, or
appointment of an individual to federal, state, or local office
When A Gift Occurs
 Introduction
o If a donor retains control over the property – either directly or indirectly – completion of the gift
may be prevented because the donor has the power to recall the property
o Timing questions also arise when multiple steps are necessary to place full ownership in the
donee
 Timing questions are important for determining if and when the gift tax applies
 Issue of Valuation: if the transfer did not constitute a completed gift during the
decedent’s life, the asset purportedly transferred during life will generally remain part of
the decedent’s gross estate for estate tax purposes and will therefore be subject to the
estate tax
 Retained Control
o Reserved Control: 25.2511-2(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.
 Focus on the value of the property at the time the gift is completed; doesn't matter what
it was worth when she initially put it in the trust
 Treat as if it was the donor’s up until she revokes control over the property as the gift tax
is primarily concerned with the passage of economic benefits conferred at the time they
were conferred
 If the donor can change the beneficial enjoyment among the beneficiaries, it is not a
completed gift
 25.2511-2(d): A gift is not considered incomplete, however, merely because the donor
reserves the power to change the manner or time of enjoyment.”
o Ability to Change Beneficiaries: 25.2511-2(c): 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 interests
of the beneficiaries as between themselves unless the power is a fiduciary power limited by a
fixed or ascertainable standard
 Still an incomplete gift if he can change beneficiaries
 The case law and the regulations have held that the ability to control property constitutes
sufficient control to justify saying that you still have enough involvement that you haven't
made the gift
 Exception: if Mom names herself as the trustee and the document says that the trustee
can change distributions among beneficiaries in accordance with fixed or ascertainable
standards (for the health, support, or maintenance of the children)
 This limits the discretionary power of the trustee
 Not viewed as having retained control over the property
 Estate of Sandford v. Commissioner
 Holding: the gift cannot be complete as long as the donor retained the right to
change beneficiaries.
 Retention of control over the disposition of trust property, whether for the
benefit of the donor or others, renders the gift incomplete until the power is
relinquished whether in life or in death
 Congress did not intend to tax gifts before the donor had fully parted with his
interest in the property given
 Property transferred to trust subject to a power of control over its disposition
reserved to the donor is required to be included in the gross estate
o Partially Complete/Incomplete: 25.2511-2(b): But if a transfer or property (whether in trust or
otherwise) the donor reserves any power over its disposition, the gift may be wholly incomplete,
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or may be partially complete and partially incomplete, depending upon all the facts in the
particular case
Substantial Adverse Interest
o If the grantor learns that her retention of control over a trust will have the effect of including the
trust in her gross estate, she might seek to avoid this rule by requiring that another person
acquiesce in the grantor's exercise of that control.
o Avoidance of estate tax in these circumstances is prevented by §§2036(a)(2) and 2038(a)(1),
which under certain circumstances, require inclusion of an asset in the decedent's gross estate if,
at the date of death, the asset is subject to a power of disposition exercisable by the decedent
either alone or in conjunction with any other person.
 25.2511-2(e): "A donor is considered as himself having a power if it 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."
 The gift will be considered complete and therefore taxable if the person holding power
jointly with the donor has a "substantial adverse interest in the disposition of the
transferred property or the income therefrom."
o What is substantial adverse interest? (Commissioner v. Prouty)
 A substantial chance of coming into a good thing may constitute a "substantial adverse
interest" especially where, as here, it is a chance to control the disposition of the entire
corpus of a large estate
 If there exists a substantial adverse interest, the gift is complete at the time it was
transferred into the trust, because there was no retained control by the donor
o Camp v. Commissioner definition: If the trust instrument gives a designated beneficiary any
interest in the corpus of the trust property or of the income therefrom, which is capable of
monetary valuation, and the donor reserves no power to withdraw that interest, in whole or in
part, except with the consent of such designated beneficiary, then the gift of that particular
interest will be deemed to be complete, for the purposes of the gift tax
 If the only power reserved by the donor is a power to revoke the entire trust instrument,
and this power may be exercised only in conjunction with a designated beneficiary who is
given a substantial adverse interest in the disposition of the trust property or the income
therefrom, then the transfer in trust will be deemed to be a present gift of the entire
corpus of the trust, for purposes of the gift tax
 If the trust instrument reserves to the donor a general power to alter, amend or revoke,
in whole or in part, and this power is to be exercised only in conjunction with a
designated beneficiary who has received an interest in the corpus or income capable of
monetary valuation, then the transfer in trust will be deemed to be a completed gift, for
the purposes of the gift tax, only as to the interest of such designated beneficiary having a
veto over the exercise of the power
Informal Reservations: if the actual disposition of the property is in fact controlled by the oral
understandings or other directions contrary to the documents, the facts -not the documents -will
determine taxability
Retention of the Power to Change Trustee
o IRS Response: If the donor can replace the trustee with himself, it is clear that the trustee’s
powers must be imputed to the donor, necessarily making the gift incomplete
o Court Response (won’t attribute donor’s intentions to the trustee)
 Will not automatically say that just because the donor can change trustees, that all of
their powers are attributable to the donor
 If the donor retains the power to replace the trustee with a person who is neither the
grantor nor a person related or subordinate to the grantor (as defined in §672(c)), the
retention of such power will neither cause the transfer in trust to be an incomplete gift
nor require exclusion of the trust property in the donor's gross estate
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As long as she has not named herself or related or subordinate parties, then she is
not considered having retained control merely because she has the power to
change trustees
 672(c) people: grantor’s spouse, father, mother, issue, brother, sister, employee
of grantor, corporation or employee of corporation in which grantor holds
significant voting control, subordinate member of a corporation in which the
grantor is an executive
o Keep in Mind: even if donor names herself as trustee, it does not mean she has retained the type
of control that keeps the gift from being completed
Promissory Notes
o Revenue Ruling 84-25
 The gratuitous transfer of a legally binding promissory note is a completed gift under
§2511 of the code
 In the case of legally enforceable promise for less than an adequate and full consideration
in money or money’s worth, the gift is complete under 2511 on the date the promise is
binding and determinable in value rather than when the promised payment was actually
made
 The amount of the gift is the fair market value of the contractual promise on the date that
it is binding
o Hypothetical: mom gives son promissory note in 2011 to pay $50,000 in 2014
 If the promissory note is legally enforceable, the gift is made at the time the note is
delivered
 The gift is the value of the transfer of the legally enforceable note
 Since $50,000 three years from now will be less than $50,000 today, the fair
market value of the gift is valued at slightly less than $50,000
 Whether a promissory note is legally enforceable depends on relevant state law (Bosch)
 If it is not legally enforceable, then the gift occurs when the money is actually
conveyed
 In this case, the value of the gift would be $50,000
 Must know relevant state law to know whether the note was legally enforceable
at the time of transfer
Checks
o When does the giving of a check become a completed gift?
 Reg. 25.2511-2(b) provides that a gift is complete only when the donor has put the
property beyond the donor’s “dominion and control”
 Under typical state law, the donor has the power to stop payment of the check at any
time until the check is actually accepted and paid by the drawee bank
o Revenue Ruling 96-56
 The IRS stated that the delivery of a check to a noncharitable donee will be deemed a
completed gift on the earlier of (1) the date on which the donor has so parted with the
dominion and control under local law as to leave in the donor no power to change its
disposition, or (2) the date on which the donee deposits the check (or cashes the check
against available funds of the donee) 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 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
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(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
 Note: this means that if donor dies before the check clears, the IRS will argue that the
check is included in the decedent’s gross estate as the gift would not be complete at the
time of death
o Metzger v. Commissioner: the time of the gift may relate back to the transfer of the check to the
donee if certain conditions are met (more taxpayer friendly than IRS Rev. Ruling)
 There is an unconditional delivery to the donee
 The check is deposited in the donee's bank account within a reasonable time
 Must have sufficient funds in the checking account at the time of delivery of the check
 The check is ultimately paid by the drawee bank -can't bounce
Co-Ownership
o If a title to property is conveyed to the transferor and another person as co-owners, treatment of
the transfer under the gift tax depends on both the nature of the ownership and the type of
property involved
o Joint Tenancies vs. Tenancies in Common
 Joint tenancies have a right of survivorship
 When the first joint tenant dies, the other tenant becomes the sole owner of the
entire property
 Joint owner would not have to go to probate court, and the property would not
be distributed in accordance with the terms of the will
 Tenancy in common: no rights of survivorship, therefore other half of property passes on
in the way described in will (or goes to probate court), not to surviving joint tenant
o §25.2511-1(h)(5): "If A with his funds purchases property and has the title conveyed to himself
and B as joint owners, with right of survivorship…there is a gift to B in the amount of half the
value of the property."
 Therefore, once donor has put property into a joint tenancy, it is irrevocable
 The gift tax regulation provides that half the total value of the property is treated as
having been a gift to the other joint tenant at the time the property is placed in joint
tenancy
o Co-Ownership of Bank Account (25.2511-1(h)(4)): "If A creates a joint bank account for himself
and B (or a similar type of ownership by which A can regain the entire fund without B's consent),
there is a gift to B when B draws upon the account for his own benefit, to the extent that the
amount drawn without any obligation to account for a part of the proceeds to A"
 Either one of them can withdraw the money from the bank account; easier for son to get
the money when mother dies
 If the property transferred to joint tenancy is a bank account (or any other similar
property that could be retrieved in its entirety by the donor), there is not a completed gift
 This is because the entirety of the funds could be withdrawn from the account by
the donor, thereby restoring the entire property to the donor
 A completed gift occurs only when and if the donee actually withdraws funds
from the account as the property would then be beyond donor’s dominion and
control
Gifts by Contract
o Hypothetical: When is the gift made?
 In 2011, Mom promises to pay $15,000 to son if he graduates
 In 2014, Son graduates
 Mom pays son his $15,000 in 2015
 Gift is considered to have been made in 2014, because the gift becomes legally
enforceable under the contract when the son completes college
o Revenue Ruling 79-384
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A promise to make a gift becomes taxable in the year in which the obligation becomes
binding and not when the discharging payment is actually made
 Therefore, when one promises to transfer property in the future, the gift tax
consequences of the promise are judged as of the first date on which it is possible to
determine that the transfer must be made and that the transfer will be of a determinable
amount
 §25.2512-8: only take into account consideration to the extent that it is reducible to
money or money’s worth (i.e. the consideration of seeing a child graduate is sufficient
consideration under contract law, but does not offset the gift)
Installment Transfers
o Timing issues often arise because of the dollar limit of the annual per donee exclusion under
2503(b)
 Because the exclusion is available for gifts to each donee in each separate calendar year it
is often important that a gift be treated as occurring in the calendar year which will
provide optimum benefit from the exclusion
 This situation is especially difficult when the property to be transferred is a single asset
having a value greater than the annual exclusion amount
 Therefore, taxpayers will often want to transfer such large gifts in installments rather than
all at once
o Haygood v. Commissioner (example of installment sale technique)
 Section 2512 provides that where the gift is made in property the value of the property at
the date of the gift and when property is transferred for less than an adequate and full
consideration in money or money's worth, that the amount by which the value of the
property exceeds the value of the consideration shall be deemed a gift
 The court held that the value of the property transferred to petitioner did not exceed the
value of the vendor's lien notes and deeds of trust received in return by more than the
$3,000 in the case of each son
o Revenue Ruling 83-180
 ISSUE: What are the gift tax consequences where the donor transfers specific portions of
real property equal in value to the annual gift exclusion allowable under section 2503 of
the Internal Revenue Code in effect for the years of the transfers?
 Revenue Ruling 77-299:
 Grandma sent grandkids a package of notes that indicated that they needed to be
signed and sent back; she said that she had no intention of enforcing the notes
 A sale, exchange, or other transfer of property made in the ordinary course of
business (a transaction which is bona fide, at arm’s length, and free from donative
intent), will be considered made for an adequate and full consideration in money
or money’s worth
 A finding of an intent to forgive the notes as they became due relates to whether
valuable consideration was in realty a bona fide sale or a disguised gift – nothing
can be treated as consideration that is not intended as such by the parties
 Since there was an intention to forgive the notes, the IRS treats them as if they
didn’t exist; this means that all the IRS sees is the property transfer that has no
consideration = completed gift
 Must be sure to make that the sale "look legitimate" – IRS may still challenge with
the benefit of hindsight (will see that you have routinely forgiven the notes each
year when money becomes due)
 HOLDING: Unlike in the case of 77-299, donor made separate completed gifts to donee in
separate taxable years; each annual gift consisted of a portion of donor’s interest in the
real property while retaining ownership and control of remaining portions.
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Estate Planning Note: 3 Options for Transferring Large Portions of Property Above the Annual
Exclusion (disadvantages/advantages for each)
 (1) The simplest approach is to transfer a portion of the property itself each year in an
amount below the annual exclusion
 Advantages: IRS clearly respects this as a completed gift
 Disadvantages:
o Loses all property interest in the land given each year
o Each year must appraise the land that is being given away to find how
much it is worth to make sure she stays under the annual exclusion
o If the value of the land goes up, will be able to gift smaller and smaller
portions of the property every year
 (2) Install sale technique used in Haygood
 How it works:
o Promissory notes in return for the purchase price of the land, but as notes
become due each year, forgives in the amount of the annual exclusion
o Initially received consideration for money or money’s worth in the form
of the promissory notes, but there was no intention to collect on the
notes (doesn’t want money in estate)
 Advantages
o No annual appraisal of land because at the time of the sale, the entire
property was legally transferred
o Does not matter, therefore, if the land increases in price; price at the time
of sale is the only thing that matters (VALUATION FREEZE)
o Won’t have the ownership divided between two different people,
although the person with ownership is not the seller
 Disadvantages
o Biggest concern is that the IRS will not believe that the notes were ever
meant to be enforced (Rev. Ruling 77-299)
o Will have to pay income tax on the gain (subtract the basis)
 (3) Contribution of the property to an entity such as a corporation, partnership, or limited
liability company. The donor can transfer the property to the newly formed corporation
without recognition of gain and the donor can then give shares or stock or interest in the
partnership to the donor each year.
 Advantage: donor retains control over all of the land for several years as long as
she owned more than 50% of the corporation’s stock
 Disadvantages
o Still requires annual appraisals in order to ensure that the amount being
given is equal to or less than the annual exclusion
o Extra complexity and expense to an overall structure of having to set up a
corporation, etc.
 Many planning options: depends on what is best for the client (i.e. do they want certainty,
simplicity, retention of control, etc.)
 Effect of Reversion
o The gift tax can be imposed only on the property actually transferred by the donor
o If the donor gives only a life estate to the donee, and the remainder is to revert to the donor, the
taxable gift consists only of the transfer of the life estate interest
Powers of Appointment
 Section 2514: An exercise of a general power of appointment…shall be deemed a transfer of property by
the individual possessing such power; but the failure to exercise such a power or the complete release of
such a power shall not be deemed an exercise thereof. If a general power of appointment…has been
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partially released so that it is no longer a general power appointment, the subsequent exercise of such
power all not be deemed to be the exercise of a general power of appointment.”
Gifts Made Pursuant to a Power of Appointment
o A power of appointment with respect to property exists when an individual (the “holder” or
“possessor”) has the legal right to determine who will become the beneficial owner of the
property
 Powers of appointment are often used in order to provide flexibility in an estate plan,
particularly when there is some uncertainty as to whether a potential beneficiary will
merit receiving a distribution at some future time – in such a case, a person trusted by the
donor of the property is given a power of appointment
 The difference between a power of attorney and a power of appointment is that in the
case of the power of attorney, the agent is acting in a fiduciary capacity on behalf of or for
the principal when the principal is unable to do so
o For transfer tax purposes, the code distinguishes between “general” powers of appointment and
“nongeneral” powers of appointment
o MAIN GIFT TAX ISSUE: Extent to which the powerholder is treated as having made a gift when she
exercises her power of appointment?
General Powers of Appointment – §2514(c)
o A taxpayer who holds a general power of appointment is viewed as having rights essentially
equivalent to full ownership
o Therefore, if the taxpayer exercises such power by appointing the property to another, the
exercise is taxable to the same extent as if the taxpayer had transferred property owner outright
(§2514(a) and (b))
o Subject to certain exceptions, includes any power the permits the property to be appointed to
any one or more of the following: the powerholder, the powerholder’s creditors, the
powerholder’s estate, or the creditors of the powerholder’s estate.
o Exception in 2514(c)(1) [Ascertainable Standards/Objective Standards so there is no Unfettered
Discretion]
 2514(c)(1) says: "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."
 “A power is a general power of appointment if it allows the power holder to appoint the
property to herself, her estate, her creditors, or the creditors of her estate, unless such
power is limited by an ascertainable standard relating to the health, education, support,
or maintenance of the holder.” See Code §§2514(c)(1) (gift tax); 2041(b)(1)(A) (estate tax).
o If a taxpayer holds such a general power but releases it or permits it to lapse, a taxable transfer
occurs, subject to certain exceptions (§2514(b) and (e))
 The taxpayer is viewed as having effectively dictated the disposition of the property by
releasing the power or by permitting it to lapse
 By voluntarily foregoing exercise of the power, the taxpayer has caused the property to
go to others
 Taxing releases and lapses in the same way as exercises, applies only to powers created
after October 21, 1942
 Powers created on or before October 21, 1942, are taxed only if actually exercised
(§2514(a))
 Takers in Default of Appointment: individuals who take if the power is not properly
exercised
o If the power is exercised or released, the amount of the gift is the value of the property subject to
the power
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A lapse is treated as a taxable transfer only to the extent that the value of the property
subject to the lapse exceeds the greater of $5,000 or five percent of the aggregate value
of the property out of which the power could have been satisfied (§2514(e))
 A power designed to maximize this advantage is called a “5 and 5 power” (ONLY applies
to lapses in power)
 Such a power permits the powerholder to withdraw the greater of $5,000 or 5
percent of the trust fund each year, and the power lapses at the end of each year
if not exercised
 Therefore, each annual lapse of such a power is fully covered by the $5,000 or 5
percent exception expressed in 2514(e), and no taxable gifts will occur unless the
powerholder actually exercises the power
 The limit, however, cannot be multiplied by giving the powerholder the "5 and 5
power" in multiple trusts
 Nongeneral Powers of Appointment
o A power is a nongeneral power if it is not exercisable in favor of the holder, her estate, her
creditors, or the creditors of her estate, or it is otherwise excluded from the definition of “general
power of appointment” under Code § 2514(c) (or, with respect to the estate tax, Code § 2041(b))
o These nongeneral powers of appointment escape taxation entirely – even if exercised
o Self v. United States
 Congress has chosen not to impose a gift tax on property transferred under special or
limited power of appointment and if the property was transferred under a special or
limited power of appointment, as it was in this case, it is not taxable
 The donor of the power of appointment is considered the transferor of the gift and the
donee merely acts as his agent and gives direct to the gift pursuant to the donor's wishes
 Estate Planning Application
o If you want the power of appointment to be nongeneral, indicate that they can give it to anyone
except the four groups that qualifies the power as general (it does not matter if the powerholder
actually exercises the general powers, but that she could)
o Reg. 25.2514-1(c): "...a power of appointment not otherwise considered to be a general power of
appointment is treated as a general power of appointment merely by reason of the fact that an
appointee may, in fact, be a creditor of the possessor or his estate"
Disclaimers – §2518
 What is a disclaimer? Example:
o Dad, Son, Grandson
o Dad dies with 1 million dollars and if he is without a will (intestate), the law of the state (state law
of intestate succession) determines who will receive assets (ordering rule)
o If you don’t want the money, you can execute a disclaimer – executor of the estate then gives it to
whoever is next in line according to state law (in other words, the person making the disclaimer
cannot specify who gets it)
o If the son disclaims, it will go to grandson. Is son, upon executing a disclaimer, indirectly making a
gift?
 Common Law
 At common law, an heir (person who was entitled to receive in absence of a will)
was not allowed to execute a disclaimer; not viewed as valid (son seen as making
a gift to grandson)
 However, if dad did has a will, son can execute a disclaimer (recognize the
transfer from directly from the estate to grandson)
 States, by statute, have done away with the common law approach so that a disclaimer in
an intestate situation is respected
 Congress then decided that there shouldn't be different federal gift tax consequences
based on the state, so it enacted §2518
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§2518(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 a person.
 There is still a potential, however, for the generation-skipping transfer (GST) tax
which would apply where is there is a transfer from grandparent to grandchild
Note: disclaimers used frequently when by surviving spouse upon the other spouse’s death if both estates
could not be sheltered under the exclusion amount upon surviving spouse’s death
o The first transfer to surviving spouse was sheltered under marital deduction
o However, with 2010 legislation changes, the code allows a surviving spouse to use a deceased
spouses’ exclusion amount (no longer must disclaim to avoid the tax, but expires in 2012)
If a disclaimer qualifies under §2518 rules, the interest disclaimed is treated as though it had never been
transferred to the individual making the disclaimer; therefore, the transfer of property that occurs by
virtue of the disclaimer is not treated as a gift for purposes of the gift tax
Must get a qualified disclaimer for federal gift tax purposes –to qualify under §2518(b), the disclaimer
must be irrevocable and unconditional. In addition, the following requirements must be met:
o The disclaimer must be in writing
o The disclaimer must be received by the transferor or the holder of title to the property not later
than 9 months after the transfer that creates the interest in the disclaimant. However, if the
disclaimant is under the age of 21 when the interest is created, the period for making the
disclaimer is extended until 9 months after the disclaimant has reached the age of 21
o The disclaimant must not have accepted any interest or benefit with respect to the property
disclaimed
o The interest disclaimed must pass to another person without any direct or control by the
disclaimant and must pass to a person other than the person making the disclaimer or the spouse
of the decedent (it can be a qualified disclaimer even if the spouse disclaims it but is still receiving
income from the trust; Qualified Terminal Interest Property – QTIP)
The requirements of §2518 are construed strictly
o Reg. 25.2518-2(d): Any "affirmative act which is consistent with ownership of the property," such
as acceptance of dividends, interest, or rent, can be treated as disqualifying acceptance of
benefits.”
 It is acceptable to disclaim a divisible portion of the property
 Permitted to immediately accept the benefits from the portion you don’t plan to disclaim
o The idea is that the disclaimant must truly renounce any and all dominion over the property
o §2518(b)(3): a disclaimer is not qualified under 2518 if, as of the time of the disclaimer, the
disclaimant has “accepted the interest or any of its benefits”
Special rules are applied to disclaimers of joint tenancy interests
o §2518 is premised on the concept that a two-step transfer is involved
 First, one-half of the property is deemed to be transferred when the transferor creates
the joint tenancy
 Second, the other one-half of the property is deemed to be transferred when the
decedent joint tenant dies
o In the typical situation, disclaimer of the first one-half would not be timely (unless the decedent
joint tenant dies within 9 months after the creation of the joint tenancy) but the surviving joint
tenant can disclaim the second one-half within 9 months after the death of the decedent joint
tenant
Disclaimers Can Be Dangerous
o A disclaimer that is valid for purposes of local property law may nevertheless be invalid for federal
gift, estate, and generation-skipping tax purposes
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o
Person disclaiming the property will be taxed as if she gave a gift to the next person in line even
though she does not possess the asset if the disclaimer is valid for state law purposes, but not
federal law (i.e. state law might not have the 9 month requirement)
Unified Credit, Exclusions, and Deductions
 Exclusion vs. Deduction
o Exclusions are not treated as a transfer by gift - not counted under the total amount of gifts under
2503(a)
o Deductions are transfers that ARE treated as transfers by gift, but then allowed to take a
deduction against that - 2503(a) - "total amounts of gifts made during the calendar year, less the
deductions"
o Same result - but done in a slightly different way
 Unified Credit
o §2505 provides a credit against the gift tax
o 5 million dollars that can be passed free of tax over lifetime gifts or at your death
o The credit is referred to as "unified" because it is available only once to each taxpayer and applies
to both inter-vivos transfers and transfers at death
o The objective of Congress in adopting the unified credit was to exempt modest estates from tax Congress chose a credit approach rather than a deduction approach so that the economic benefit
of the credit would be the same regardless of the size of the estate
 Annual Per Donee Exclusion
o In General
 $13,000 per donee annual exclusion to get assets out of your future estate
 Governed by §2503(b): “In the case of gifts (other than the gifts of future interest in
property) made to any person by the donor.”
 Future interest in property do not get the annual exclusion (see Present Interest
Requirement)
 §2503(a) defines what taxable gifts are – only taxable gifts are credited toward
the $5 million
 “Annual” because the specified amount is available anew each year
 “Per Donee” because gifts of the specified amount can be given to each and every donee,
without limitations as to number
 Exclusion is not limited to donees who are family members
 Also exempt from GST tax consequences under §2642(c)
 Tax Purpose: minimize future taxable estate by taking advantage of the annual gift tax
exclusion
 6019(a)(1): Under what circumstances do you have to file a gift tax return?
 Generally, if you make a transfer by gift, must file gift tax return
 However, if it is sheltered by 2503(b), you are not required to file a gift tax return
(although you may still want to file a protective return for estate tax audits later)
 Transfer between spouses is covered by the §2523 gift tax marital deduction, and no
return needs to be filed with respect to transfers that qualify for that deduction
 If both spouses agree to treat gifts of either spouse as if made one-half by each
spouse, each gift is split between the spouses for all purposes of the gift tax
o However, gift splitting is only available if gift tax returns are filed by both
spouses under 2513(b)
o Reg. 25.2513-2 requires consent to the application of the provisions of
§2513
 Alternative way of doing is to make a $13,000 gift to spouse (marital deduction
exempts gifts between spouses -also no filing requirement) and then each would
give $13,000 and then each would be under and wouldn't have to file a gift tax
return
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IRS, however, might then argue that one spouse is in reality making both
of those gifts and then wouldn't be under the exclusion for gift tax
purposes
o Could say that other spouse never really had control over that money -let
it sit in account for awhile to assure it's not treated as one transaction
(indirect gift) and therefore susceptible to gift tax
Present Interest Requirement
 Most important limitation on the annual exclusion is that it does not apply to gifts of
future interest -§2503(b): In the case of gifts (other than gifts of future interests in
property) made to any person by the donor during calendar year...etc."
 §25.2503-3(a): "Future interests is a legal term, and includes reversions, remainders, and
other interest or estates, whether vested or contingent, and whether or not support by a
particular interest or estate, which are limited to commence in use, possession, or
enjoyment at some future date or time."
 §25.2503-3(b): Present Interest defined as "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)"
 If the beneficiary's right to income is restricted or deferred in any way, the
income right is a future interest and does not qualify for the exclusion
 Indirect gifts may not constitute a present interest if there is no immediate right
to the benefits of the gift
 Rationale for Present Interest Requirement
o Per Donee Exclusion – might not really know who the donee is going to be
in the case of a future interest
o The annual exclusion was put in as a de minimis rule -lawyers used it as
an estate planning opportunity, but that wasn't Congress' purpose
 [See problems for notable application of present interest requirement]
 Trusts: Requirement of Incoming-Producing Property
 If property is transferred outright, and the donee if free to sell or otherwise
dispose of the property, the transfer constitutes a present interest whether or not
the property produces income
 If property is transferred in trust, however, the income producing capacity of the
property has a direct bearing on availability of the annual per donee exclusion for
an income interest
o The right to income is meaningless if there is no realistic expectation that
income will in fact be produced
o The annual per donee exclusion is not available for a gift of closely held
stock to a trust if the stock cannot realistically be expected to produce
dividend income -there is no income interest of ascertainable value (Stark
v. United States)
 The requirement of income production in the case of trust
interests (in order to make them present interest) has been
applied to assets other than closely held stock
 The rule enunciated in Stark only applies to gifts in trust. If the
property is given outright, and the donee is free to sell or
otherwise transfer the property, its income-producing capacity is
irrelevant because the donee could sell the property for its fair
market value and reinvest the proceeds
 Restrictions on Transfer (Hackl v. Commissioner)
 Mr. Hackl gave an outright transfer of publically traded stock, however, Mr. Hackl
still had control over the stock, therefore it was not a gift of the present interest
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o
The sole statutory distinction between present and future interest lies in the
question of whether there is a postponement of enjoyment of specific rights,
powers or privileges which would be forthwith existent if the interest were
present
The crux of the Hackls' appeal is that the gift tax doesn't apply to a transfer if all
the donors give up all of their legal rights
o In other words, the future interest exception to the gift tax exclusion only
comes into play if the donee has gotten something less than the full
bundle of legal property rights
o Because the Hackls gave up all of their property rights to the shares, they
think the shares were excludable gifts within the plain meaning of
2503(b)(1)
The government on the other hand interprets the gift tax exclusion more
narrowly
o It argues that any transfer without a substantial present economic benefit
is a future interest and ineligible for the gift tax exclusion
Thus, the Hackls' gifts, while outright, the donees did not have a substantial,
immediate, economic benefit from the stock so it could not be categorized as a
gift of the present interest
Gifts to Minors
 In General
 The annual per donee exclusion is not available unless the donee receives either
outright ownership or an unrestricted and immediate right to income from the
property (present interest)
 This requirement impairs the practical utility of the exclusion if the gift is to be
made to a minor
 Problem with gifts to minors:
o Whether the minor should be viewed as having a present interest even
though as a practical matter, the minor can't do anything with the
property
o There might not be a legal guardian who is authorized to deal with the
property on the child's behalf?
o Is it enough to transfer the property into the child's name?
 Outright Gifts - Revenue Ruling 54-400 (favorable to minors)
 Doesn't matter as a practical matter whether the child can do anything with the
gift as long as the property is legally transferred outright and the minor child is
the owner under state law - this is a gift of PRESENT INTEREST
o An unqualified and unrestricted gift to a minor, with or without the
appointment of a legal guardian, is a gift of a present interest; disabilities
placed on minors by state statutes should not be considered decisive in
determining whether such donees have the immediate enjoyment of the
property or the income therefrom within the purport of the federal gift
tax law
o It is held that a gift of the type involved herein to a minor is a gift of a
present interest unless the use and enjoyment of the property is in some
manner limited or restricted by the terms of the donor's conveyance
 It is only where delivery of the property to the guardian of a minor is
accompanied by limitations upon the present use and enjoyment of the property
by the donee, by way of a trust or otherwise, that the question of a future
interest arises
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How do estate planners transfer property as a gift of present interest while
restricting the child's ability to use the property in a way the donor wants?
o If you put in a trust and let them receive income interest, this constitutes
a gift of present interest – but does not restrict access
o Don't give income on annual basis – instead grant a permanent right to
withdrawal:
 Income and principal are to be accumulated in the trust until the
future at some point (no income automatically distributed each
year; note: this, on its own, would not be a gift of present
interest)
 Give the minor, instead, a right to withdrawal the principal at any
time in order to make it a gift of present interest
 As a practical matter, however, the grandson will not take
the money out of the trust
 However, there is the non-tax concern that the grandson
will take it out against Grandma's wishes or that future
creditors will gain access to that money since there are
no restrictions to taking money out
 Permanent right to withdrawal causes the transfer to the trust to
be treated as a gift of present interest (see "Trust Gifts in
General" below)
Trust Gifts in General
 Outright gifts always constitute a present interest - planners reasoned that if the
minor (or the minor's guardian) is given an unfettered right to demand the trust
property, the minor should be viewed as having the equivalent of outright
ownership
 The "Right to Withdrawal" Approach: The result was a creation of trusts for the
benefit of minors, with provision for discretionary distributions of principal and
income to the minor, and with the added element that the minor or the minor's
guardian could demand and receive the trust property at any time
o The annual per donee exclusion was allowed for the entire transfer of the
trust under the Seventh Circuit in Kieckhefer
o It was denied by the Second Circuit in Stifel saying that the minor’s access
to property must be evaluated in realistic terms, taking into account the
probability that the minor would actually need and be permitted to
access the funds
o The split between the circuit was resolved in Crummey
Crummey Trusts: General Rule (can come up in other context besides gifts to minors)
 IRS often looks at substance over form, but form prevails over substance in the
Crummey Case
 Duration of the right to withdrawal is a time limited right to withdrawal in the
case of Crummey powers as opposed to permanent right to withdrawal (i.e. first
30 days after transfer is made)
o Right to immediate economic enjoyment?
o Argue yes, because at the time it was transferred it was a gift of present
interest, because it could have been taken out immediately
o Right to withdrawal then lapses (Crummey power is a general power of
appointment because the beneficiary has the right to take it out for
himself), and beneficiary will never be able to take that money out until
the trust allows him to after that lapse
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In deciding whether the minor beneficiaries received a gift of a present interest,
the Ninth Circuit specifically rejected the test based on the likelihood that the
minor beneficiaries would actually receive present enjoyment of the property
Instead, the court focused on the legal right of the minor beneficiaries to demand
payment from the trustee
o All that is necessary for the court to determine is that the right to demand
cannot be resisted
o Interpret that to mean “legally existed” – the court does not generally
engage in the inquiry of the likelihood the demand will be made
 There are limits on the extent to which the withdrawal right can
be restricted
 The Commissioner has taken the position that the beneficiary
must be given a realistic and meaningful right to withdrawal
Private Letter Ruling 8004172
o IRS attempts to put some practical limits on how far Crummey Powers go
o The Problem:
 When a general power of appointment lapses (remember
Crummey power is a general power), they are deemed to have
transferred the money they could have withdrawn into the trust
 Section 2514(e) of the Code provides that the lapse of a noncumulative power of appointment is a release of that power
 Such a release is a taxable gift to the extent that the lapse
exceeds the greater of $5,000 or 5 percent of the value of
the assets over which the lapses power could be
exercised
 Treated as if the beneficiary put money into the trust
herself when she let the general Crummey power lapse,
therefore it is treated as if she made a gift to each of the
other beneficiaries in the trust (cross-gifting potential if
there are multiple beneficiaries)
o The Solution: donor must indicate that the maximum amount permitted
for withdrawal is limited by the 5 and 5 amount (cap the amount of the
general power of appointment so that when the power lapses, the it
sheltered by the 5 and 5 amount in 2514(e))
o New Problem/Tension: solve the cross-gifting problem between
beneficiaries, but re-creates the problem for donor
 Only those amounts covered by Crummey powers are a gift of a
present interest
 Since general Crummey powers are only given to the amount
within the 5 and 5 exclusion, there will be assets that are not
covered
 Therefore, the rest of the money in the trust is a taxable gift –
donor will have to use some of her aggregate $5 million in unified
credit
Procedural Concerns of the Crummey Trust Power
o IRS indicates that the beneficiary must be given a realistic and a
meaningful right to withdraw in order for it to be a gift of a present
interest
 Notice: beneficiary must be notified that the Crummey power
exists (any time donor makes a contribution, trustee must
provide notice to any beneficiary that can make a withdrawal)
20


Time: beneficiary must be given an adequate time to exercise the
right to withdraw
 30 day time period at least
 Any shorter and the IRS will probably question it
o Even though as a practical matter, the Crummey beneficiaries don’t intent
to exercise their withdrawal power, it is still important to effectuate it
correctly (form over substance)
o Further, it is in the best interest of the donor to give more people
Crummey powers so that they can put more into the trust without
accumulating gift tax consequences
 See, e.g., Cristofani v. Commissioner, where donor created 7
Crummey powers so that she could transfer $70,000 each year
 However, the only beneficiaries of the trust after the
Crummey powers lapsed were just her two children
(whom she had also given Crummey powers)
 The IRS argued that to those persons given Crummey
powers but that weren’t beneficiaries of the trust, the gift
was not that of a present interest because they had no
substantial future economic benefit from the trust (if the
Crummey powers were really legitimate, they would have
been exercised because they gained nothing from letting
the right lapse into the trust)
 The court respected all Crummey powers as those
persons with Crummey powers had a legally enforceable
right to exercise the Crummey powers and court would
not engage into an inquiry of why they didn’t exercise it
 Note: The IRS has not acquiesced to the reasoning in Cristofani
 Technical Advice Memorandum 9731004 indicates that
“where nominal beneficiaries enjoy only discretionary
income interest, contingent rights to the remainder or no
rights whatsoever in the income or remainder, their nonexercise of the withdrawal rights indicates that there was
some kind of prearranged understanding with the donor
that these rights were not meant to be exercised or that
their exercise would result in undesirable consequences,
or both."
 The courts have adhered to the exclusive focus on the
legally enforceable right, but they did indicate that it
would a difference if there was a prior agreement
wherein those persons invested with Crummey powers
agreed not to exercise them
 Tax court might be willing to agree with the IRS – that
some instances of Crummey powers are not gifts of a
present interest – if it appears that there is an inferred
prearranged agreement
Another Crummey Power Solution: Hanging Power
o Instead of putting a limit on the withdrawal right to meet the 5 and 5
2514(e) criteria, put a limit on how much the withdrawal right will lapse
each y ear
o Allows both donor and Crummey Power holder to avoid the gift tax
problem
21
o

Example: donee can withdraw the full amount of the transfer for up to 30
days after transfer to trust is made
 If she doesn’t withdraw, at the end of 39 days, instead of the
entire Crummey power disappearing, only up to the 5 and 5
amount will lapse (gift of a present interest and no lapsing of a
general power gift tax consequences for donee)
 Donee then has the right to withdraw anything in excess of what
is left “hanging around”
 Year by year, the maximum amount of the power that can lapse is
the 5 and 5 amount until there is no general power of
appointment left
 The only downside to this method is that the donee maintains
control for a longer period of time (bigger risk, but no gift tax for
either donee or donor)
Contribution
Lapse
Hanging
Year 1
7000
5000
2000
Year 2
7000
5000
4000
Year 3
0
4000
0
More Vehicles for Making Gifts to Minors
o 2503(c) Trusts
 Not much practical use today; more flexibility with the ultimate distribute if use Crummey
 Trust that have certain provisions that come with 2503(c) – not a gift of a future interest if
these requirements are met:
 What happens with the property before 21
o May be expended for the donee’s benefit
o Trust must allow the trustee to use both income and principal to the
benefit of the minor if they deem it appropriate (CAN’T put any
restrictions on the trustee’s distribution power)
o “As may be necessary” restrictions were questioned in Heidrich v.
Commissioner)
 What happens with the property after 21
o Principal and income must pass to donee upon reaching 21
o Goes to beneficiary’s estate if the donor dies before donee reaches 21
o Does not immediately pass on 21st birthday; beneficiary needs to demand
it be distributed (was not deemed improper under Heidrich as long as
donee can gain access to it upon request)
o Uniform Gifts to Minors Act & Uniform Transfer to Minors Act – use beneficiary/minor state to
set up
 Achieve the same result as 2503(c) trusts without having to set up a trust – creates trustlike provisions set out in the state’s statute
 Just transfer whatever the property is to someone who would act as custodian of the
property for the benefit of the minor child until they reach they age of majority in the
relevant state
 Revenue Ruling 59-357 provides the tax consequences that flow from this
 Treated as a completed gift from the donor
 Treated as a gift of a present interest NOT as a gift of a future interest
 [Estate Tax] If donor had named herself as custodian, the value of the property at
the time she dies is brought back into her gross estate
22
o
o
o
One of the rare circumstances that a completed gift is includible in gross
estate
o Don’t name the donor as the custodian and no issue
Sec. 529 College Savings Plan/Qualified Tuition Programs
 If main goal of donor is to save for donee's college education, this may be more beneficial
 Nothing more than specialized investment vehicle (bank account, stock investment, etc.)
 Operated by the state and hire investment companies to run it although you don't have to
utilize your own state's plan (not tied into that state's college; just sponsoring that
investment vehicle)
 Income tax benefits - income builds up tax free; and no tax when they use it for their
college expenses (investment earnings never taxed)
 Also gives donor significant flexibility - can change the beneficiary to another family
member and can revoke it entirely (although then she would have to pay income tax on
the growth and a 10% penalty on the growth)
 Gift Tax Consequences - the transfer is treated as a completed gift for gift tax purposes
even though she can revoke, etc. 529(c)(2)(A)(i): transfer treated as a completed gift and
not treated as a future interest
 Contrary to the present interest and completed gift materials
 529(c)(2)(B) allows you to front load gifts - give $65,000 in first year and still get
all sheltered by annual exclusion amount over the next few years (treated as if
you gave a $13,000 transfer every year even though you did it all at once)
 529(c)(4) estate tax consequences are good as well - normally if you have the right of
revocation, will be included in gross estate - but this says that even though donor can
revoke, will not be included in gross estate
Reciprocal and Sham Transfers (Judicial Limitation 1)
 There is a great allure in finding additional donees, so that the benefits of §2503(b) can
be multiplied - the Commissioner is alert to circumstances in which taxpayers have
succumbed to the temptation to multiply donees through artificial transfers
 Reciprocal Transaction Doctrine developed out of these situations
 Involves situations where there is more than one donor and each donor has
intended beneficiaries
 Instead of just giving property to intended beneficiaries, each donor gives property
to the other donor's intended beneficiaries - beneficiaries end up with the same
thing their own particular donor wanted to give (see facts in Sather)
 Sather v. Commissioner
 FACTS
 Four brothers; three of the brothers have three kids
 Transfer $9,997 worth of stock to each of their children and to each of their
nieces and nephews (total of nine transfers per brother and their respective
wife)
 The IRS allowed only three $10,000 exclusions per year for each of the
donors, and assessed gift taxes and penalties on each of the remaining
transfers
 Relying on the reciprocal trust doctrine, the lower court found that the
cumulative transfers at issue lacked economic substance.
 ISSUE: Whether the gifts in this case, similar gifts made by the donors to each
other's children, are really cross-gifts, that is, indirect gifts to their own children.
 HOLDING: The transfers of stock to each donor's nieces and nephews were
reciprocal transfers, or cross-gifts, made in exchange for identical transfers from
the nieces and nephews' parents to the donor's own children. As such, the
transfers must be uncrossed and the tax code applied to the substance of the
23
o
transactions. The IRS correctly determined that each donor was entitled to three
$10,000 exclusions.
 RULES/RATIONALE
 The reciprocal trust doctrine (variation of the substance over form concept)
was developed in the context of trusts to prevent taxpayers from transferring
similar property in trust to each other as life tenants , thus removing the
property from the settlor's estate and avoiding estate taxes while receiving
identical property for their lifetime enjoyment that would likewise not be
included in their estate
 The Supreme Court held that the reciprocal trust doctrine applies to
multiple transactions when the transactions are interrelated and to the
extent of mutual value, leave the settlors in approximately the same
economic position as they would have been if they had created trusts
naming themselves as lifetime beneficiaries
 The doctrine seeks to discern the reality of the transaction: the fact
that the trusts are reciprocated or "crossed" is a trifle, quite lacking in
practical and legal significance
 2 PART TEST
 Were the gifts interrelated?
 Donors end up being in the same position as a result of cross-gifts that
they would have been in if the gifts would have been made directly
(receive something in exchange)
 Applying the reciprocal trust doctrine to the present case, there can be no
doubt that the gifts are interrelated. Would not have made gifts to nieces
and nephews if they had not known that the brothers would make similar
gifts to their own children...
 The donors were in the same economic position - the position of passing
their assets to their children - by entering the cross-transactions as if they
had made direct gifts of all their stock to their own children
 Uncrossing the gifts in the present case, the tax court made the factual
finding that each immediate family was in the same position as if each donor
had made gifts only to the donor's own children
 Estate of Grace Opinion
 Donor gave $10,000 to 27 her closes friends who then transferred gift to the
donor's family
 Prearranged plans are not allowed either - 10th Circuit concluded that the
retransfer to the family members had been prearranged by the donor, and the gifts
were actually made to the family members. Therefore, no exclusions were allowed
for the transfers to the friends
Adjustment Clauses (Judicial Limitation 2)
 Used in cases where what is being transferred does not have a readily attainable fair
market value (stock, etc.)
 Provision that the donor will gift back some of the original gift to bring back within the
annual exclusion amount
 Revenue Ruling 86-41
 ISSUE: What are the federal gift tax consequences where a donor transfers a
specified portion of real property under terms that provide for an adjustment
to the portion transferred depending on the determination by the IRS of the
value of the property for federal gift tax purposes
24



FACTS: Donor transfers a specified portion of real property under terms that
provide for recharacterization of the transaction depending on the Service's
valuation of the property for federal gift tax purposes
 HOLDING: Adjustment clauses are disregarded for federal tax purposes "condition subsequent" adjustment clauses are invalid for federal gift tax
purposes (can't revoke an existing gift to take into account IRS action, otherwise
no incentive to audit returns with adjustment clauses)
 RATIONALE
o The purpose of the adjustment clause was not preserve or implement
the original, bona fide intent of the parties, as in the case of a clause
requiring a purchase price adjustment based on an appraisal by an
independent third party retained for that purpose
o Rather the purpose of adjustment clauses was to recharacterize the
nature of the transaction in the event of a future adjustment to the gift
tax return by the Service
Exclusion for Educational and Medical Expenses
o §2503(e) provides for direct payment of certain educational and medical expenses
 Any qualified transfer shall not be treated as transfer of property by gift
 "Qualified transfer" means any amount paid on behalf of an individual (A) as tuition to an
educational organization…(B) to any person who provides medical care"
o This exclusion is unlimited in amount and is available over and above the annual per donee
exclusion provided by 2503(b)
 There is no requirement of a particular relationship with the donor (does not have to be
parents according to Reg. 25.2503(6)(a)): "Furthermore, an exclusion for a qualified
transfer is permitted without regard to the relationship between the donor and the
donee" (this is for all qualified transfers - both medical and educational)
 2503(e), however, is subject to important limitations
 In the case of educational expenses, the exclusion is available only for tuition
 In the case of both educational and medical expenses, the exclusion is only
available for payments made directly by the donor to the educational institution
o A transfer to the donee, who then remits funds to the educational
institution or medical care providers, is not excluded - Reg. 25.25036(b)(2)
o Also can't reimburse medical or educational payments or will be subject
to gift tax unless the amount is within the annual exclusion
 With respect to GST, all 2503(e) and 2503(b) gifts are nontaxable gifts according to
2642(c)(3) - without this, grandparents could not make these gifts to grandchildren
without being subject to generation skipping tax
Marital Deduction
o The gift tax marital deduction is embodied in §2523(a) - pg. 280 - which provides an unlimited
deduction for transfers between spouses during their lives
 2523(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."
 Get deduction amount equal to the value of what was given
 $1 million transfers = $1 million deduction (end up with no taxable gift)
 Donee must be donor's spouse at time of the gift
 Exception in 1 U.S.C. 7 - Defense of Marriage Act: same sex marriages are not
eligible for martial deduction even if the state in which they reside recognizes
their unions
25

o
Also doesn't apply to transfers that take place after divorce (but see, 2516 for
an exception to this exception - can make under here if done in a certain
amount of time)
 This reflects a policy judgment that spouses should be free to transfer their property
between themselves as they think best, without unnecessary tax obstacles
 In fact, so long as the transfer is between spouses, they do not even need to file a tax
return (§6019(a)(2))
 Only when the property moves outside the marriages partners – typically to the
children – a tax is imposed
Complication when transfers are made without giving the full interest in the property –
terminable interests:
 Example: Income in trust given to wife for $10 million, and remainder distributed to kids
when wife dies
 2523(b) deals with terminable interests upon the occurrence of an event (in this, case
the wife dying)
 2523(b)(1): Life Estate or Other Terminable Interest - "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, such interest transferred to the spouse will terminate or fail, no deduction
shall be allowed with respect to such interest (1) if the donor retain in himself, or
transfers or has transferred (for less than adequate and full consideration in money or
money's worth), an interest in such property, and if by reason of such retention or
transfer the donor (or his heirs or assigns) or such persons (or his heirs or assigns) may
possess or enjoy any part of such property after such termination or failure of the
interest transferred to the donee spouse."
 If, upon the happening of an event, the interest terminates then no marital deductions
is applied
 Marital deduction is not meant to eliminate the tax on property, just postpone
it
 Available only to the extent that it causes deferral in the eventual imposition of
the transfer tax on that property
 2523(e) and (f) allows deductions for terminable interests in certain circumstances
(exceptions to the terminable interest rule for marital deductions - also available in the
case of estate tax)
 2523(e)(pg. 281) - deals with a situation where there is a life estate with the
power of appointment in donee spouse
o Establish trust with income to donee spouse for life, payable at least
annually
o Donee spouse must be able to also appoint property to herself or her
estate (narrow general power of appointment)
o Donor spouse gets marital deduction but donee spouse must include in
her gross estate when she dies because she has a general power of
appointment
26
o
Problem: intended beneficiaries might not get the property, because
donor spouse has a general power of appointment and can take
everything out (kids would not get the remainder)
 2523(f)(pg. 282) - Qualified Terminable Interest Property Exception (QTIP exception)
 Donor spouse gets the full marital deduction and ensures intended
beneficiaries gets the property
 Downside: DONOR spouse must include full value of trust property in gross
estate when he dies because of §2044
 Charitable Deduction
o Gift tax has a generous deduction for contributions to charity - §2522(a)
o The deductions for gifts to charity are unlimited
o §6019(a)(3) - do not have to file a gift tax return when make gifts to charities
o 2522(a) specifies the eligible charitable recipients (pg. 276)
o If property is given outright to charity, the gift tax charitable deduction is allowed for the entire
value of the property. However, if less than all interests in the property are given to charity, the
deduction is limited to the value of the charity's interest and in some cases may be entirely
disallowed (Charitable remainder trusts or charitable lead trusts - income given to charity
instead of remainder - allowed if they comport with 2522(c))
o Very tightly defined set of requirements that must be met to obtain a gift tax deduction for a
gift of a partial interest gift to charity:
 No deduction is allowed unless one of the specified arrangements is used (2522(c))
 These rules are designed to assure that the charity will in fact receive value equivalent
to the deduction allowed to the donor
Gift Tax Returns and Administrative Requirements
 Return Requirements and Liability for Tax
o The gift tax must filed on form 709 by April 15 of the calendar year after the gift occurs, and the
tax must be paid in full with the return (6075(b)(1) - pg. 363)
o An extension of time to file a return does not mean you get an extension in time to pay your
taxes
o §6048 - transfers/gift to and from foreign trusts (pg. 357)
 If U.S. person makes a transfer to a foreign trust, you must record it, even if there are
no tax consequences
 Huge penalties if you failed to report it even if no taxes were owed (penalty is 35% of
the amount you transferred)
 If U.S. client receives gifts from a foreign person, they must report having received it if it
is more than $100,000 even though there are no gift tax consequences (not reporting
incurs a 5% penalty)
o The general rule is that a return must be filed if any "transfer by gift" is made during the
calendar year. There are four broad exceptions in 6019:
 (1) Annual per donee exclusion within §2503(b)
 (2) Education and medical expenses within §2503(e)
 (3) Transfers for which the §2523 marital deduction is allowed
 (4) Certain transfers for which the §2522 charitable deduction is allowed
o The donor has primary liability for payment of the gift tax (§2502(c))
 Spousal Gift Splitting
o §2513 permits spouses to treat gifts by one spouse as if made one-half by each spouse
o Gift-splitting and filing of a return may be avoided if one spouse makes an outright transfer of
money or property to the other spouse, followed by the donee spouse's transfer of the money
or property to another person
27


If the donee spouse has unrestricted dominion over the property and the donee
spouse's transfer to a third party is in fact independent of the transfer from the donor
spouse, each spouse can use his or her annual per donee exclusion to shelter the
transfer
 The unlimited gift tax marital deduction prevents any tax liability with respect to the gift
between spouses - §2523(a)
o Gift-splitting can also be used to take advantage of the nonpropertied spouse's §2505 unified
credit
 Gift-splitting can likewise be used to cause one-half of the transfer to be taxed at the
gift tax brackets applicable to the nonpropertied spouse, which may be lower than
those that would be applicable if the gift were attributed entirely to the nonpropertied
spouse
 In addition, gift-splitting under §2513(b) is honored for purposes of the tax on
generation-skipping transfers
o Gift splitting is not without cost: 2513(d) creates joint and several liability for the entire gift tax
liability of the transferring spouse for the year as to which gifts are split
Statute of Limitations
o §6501(a) (pg. 510) requires the United States to assess additional gift tax within three years
after the return is filed
o Several exceptions to three year limitation - 6501(c) gives circumstances that increase the
statute of limitations
 (c)(1): False or fraudulent return (can assess gift tax at any time)
 (c)(2): Willful attempt to defeat or evade tax (can assess gift tax at any time)
 (c)(9): Gift tax on gifts not shown on return (can assess gift tax at any time; statute of
limitations never runs)
 Great importance to full disclosure of gifts as long as disclosure is done "in a
manner adequate to apprise the Secretary of the nature of the item"
 If there is adequate disclosure, IRS cannot seek to impose gift tax after statute
of limitations runs (cannot increase the value of the gift after three years
either)
 If you mistakenly think that something is within the annual exclusion and don't
file a tax return, you leave yourself open to the IRS to come back and assess the
gift tax at any time (may want to file a protective return just in case - although it
opens you up to an audit - so you can start the 3 yr. period of limitations
running - pg. 1585 in regulations/example 2)
o Adequate disclosure (as defined by Reg. 301.6501(c)-1(f)(2))
 Description of transferred property
 Consideration received
 Identity and relationship of transferee
 Summary of the terms of the trust if transferred in trust (or give copy of trust
declaration)
 Describe the method used to determine the fair market value - CENTAL ISSUE is that of
valuation
 (Even if there is not adequate disclosure, the value established by a "final
determination" with the IRS is binding for all purposes)
28
Valuation
General Principles of Valuation
 General Rules
o Federal transfer tax system subjects the value of the property transferred to the tax rates of the
three taxes
 2001 for estate tax
 2502 for the gift tax
 2621, 2622, 2623 for generation skipping tax
o The regulations equate "value" to "fair market value," which in turn is defined as "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 sell and both having reasonable knowledge of relevant
facts" Reg. 20.2031-1(b) and 25.2512-1(gift tax regulations)
 The "willing buyer-willing seller" forms the foundation for all transfer tax evaluation
(objective measurement between arms-length people)
 Although numerous special rules have been developed for application to specific types
of property, all are necessarily founded on a free market approach: how would
independent actors value the property for purposes of purchase or sale?
 "Willing buyer" assumed to know all relevant facts that may increase or decrease the
fair market value of the property
o Regulations present special rules for the valuation of certain types of property
o Congress has also added statutory valuation rules - not generally favorable to tax payers
because meant to shut down abuses
o Attorneys don't generally come up with valuations - hire appraisers and experts to do their own
methodology (just must understand the basic issues and what the regulations/statutes are
requiring you to do to come up with the valuations)
o Estate of Andrews v. United States: can tax any asset to which the real world would attach
economic value (rights to the name of the deceased was an economic value that needed to be
included in estate)
o ESTATE TAX and GIFT TAX
 Estate tax: 20.2031 - each dash has rules for valuing different types of items (pg. 1083)
 Valuing stocks at bonds: - 2
 Valuation of interests in business: -3
 Valuation of notes: -4
 Valuation of cash on hand or on deposit: -5
 Valuing household and personal effects - 6
 Valuing annuities, life estates, remainder interests, term certain interests, etc. 7
 Gift tax: 25.2512
 Valuation Date
o For gift tax purposes, the valuation date is the date of transfer without any exceptions; this rule
is set forth in the statute - §2512(a)
o For estate tax purposes all property is valued at the date of death, pursuant to § 2031(a) unless
the alternate valuation date is elected
o Although it is clear that valuation is to be determined as of the date of gift (for purposes of the
gift tax) or the date of death (for purposes of the estate tax), the statute does not state whether
subsequent events can be considered
o Ithaca Trust Rule (subsequent events that change the value of the property are not relevant)
 The value of the thing to be taxed must be estimated as of the time when the act is
done. But the value of property at a given time depends upon the relative intensity of
the social desire for it at that time, expressed in the money that it would bring in the

market. Like all values, it depends largely on more or less certain prophecies of the
future, and the value is no less real at that time if later the prophecy turns out false
than when it comes out true.
 The Ithaca Trust Rule, however, does not prevent consideration of all subsequent
events
 Unforeseen event cannot change the value of an asset
 However, the post-death sales are not events that change the value of assets
(even though they are subsequent events), but instead simply evidence the
value of the asset
o i.e. the auction of a similar painting and using that price, is not change
in the value but evidence of the value
o Can look at evidence as to what the value on the date of death would
be - must still look at change between the date of death and the date
that the auction took place though
Alternate Valuation Date (taxpayer favorable provision)
o In the case of the estate tax, §2032 permits election of an alternate valuation date
 This provision permits the executor to elect on the original estate tax return to value the
gross estate assets as of the date exactly six months after the date of death
 §2032(c) adopted a rule limiting the alternate valuation date election to circumstances
in which the election produces both a decrease in the sum of the estate tax and the
generation-skipping tax that will be imposed with respect to the decedent's estate
 Although this change restricts the election to circumstances in which estate
values decline, the executor should nevertheless continue to weigh both the
income and estate tax consequences of the election
 While electing the alternate valuation date may lower the estate tax liability,
the estate tax saving may be less than the additional income tax liability caused
by the resulting lower basis
 The alternate valuation date election, if made, applies to all assets of the estate; one
cannot "pick and choose" and assets to be valued on the alternate date - §2032(a) ("all
the property in the gross estate")
o If the election is made, property sold, distributed, or otherwise disposed of prior to the
alternate valuation date is valued as of the date of sale or distribution, or other disposition §2032(a)(1)
o A special rule applies to property the value of which is affected by a mere lapse of time §2032(a)(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"
 Valuing such items on the alternate date without adjustment would allow the natural
and inevitable decline in value of such properties to reduce the estate tax even though
there is no general decline in market valuation of the underlying property
 Accordingly, the section requires that such property be valued as of the date of death,
with adjustment for any difference in value on the alternate date not attributable to
mere lapse of time - Reg. §20.2932-1(f)
 I.e. right to income of a term certain trust must be valued and included in the gross
estate (find PV of the date of her death for the remaining years in which she will be
receiving the interest from the trust)
o Revenue Ruling 63-52
 ISSUE: Whether the increase in the value of certain life insurance policies, by reason of
death of the insured during the alternate valuation period, would constitute “included
property” for purposes of valuing the gross estate under the alternate evaluation
provisions of 2032
30




Section 20.2032-1(d) of the Estate Tax Regulations provides that all property interests
existing at the date of the decedents’ death which form a party of his gross estate are
"included property" for the purpose of valuing the gross estate under the alternate
valuation method
 Such property remains "included property" for the purpose of valuing the gross
estate even though the property interest change in form during the alternate
valuation period by being actually received, or disposed of, in whole or in party,
by the estate
 On the other hand, the regulations provide that property earned or accrued
(whether received or not) after the date of the decedent's death and during the
alternate valuation period with respect to any property interest existing at the
date of the decedent's death, which does not represent a form of "included
property" itself or the receipt of "included property," is excluded in valuing the
gross estate under the alternate valuation model
Death of the insured was the precise event which caused the increase in the value of
the insurance policies as of the alternate valuation date. The increase in value is
occasioned by the death of the insured and not due to a "mere lapse of time" within the
meaning of section 2032(a)(3)
Accordingly, it is held that for federal estate tax purposes, the appreciation in the value
of life insurance policies which matured by reason of the death of the insured during
the alternate valuation period is not properly earned or accrued
Therefore, no part of the proceeds of the insurance is excluded property, but is
"included property" within the meaning of the estate tax regulations, so that the entire
value of the proceeds of the policies is includable in the gross estate
Actuarial Valuation
 General Principles
o The value of the remainder depends on the probable longevity of the life tenant - probable
longevity of the life tenant is determined actuarially, i.e., by reference to the average longevity
of all persons age 74, rather than by reference to the health or circumstances of the life tenant
individually
 Publishes tables based on the aggregate populations
 Once the probably longevity of the life tenant is determined, discounting principles
must be used to determine the value of the remainder interest
o Present Values = how much a buyer would theoretically pay right now for each interest
 PV of Income Interest + PV of Remainder Interest = Total Value of the Amount placed in
the Trust
 Want to value separately to find the value of the present interest (remainder is
not a present interest)
 Value of income interest must be included in gross estate if that person dies, so
must be able to calculate present value of that interest
 The Regulations approach the total of the present value of the income interest and
present value of the remainder interest to be the exact present value of the entire
property - based off the assumption that the total of all values for partial interests will
be 100% of the current value of the entire property
o §7520 (pg. 642) - establishes the guidelines for actuarial valuation, delegating to the
Commissioner the authority to promulgate specific formulas and tables
 Estate tax tables are set forth in Reg. §20.2031-7(d)(7); the tables apply to gifts and
deaths after April 30, 1999
 7520(3) says that every 10 years, produces values based on new life expectancy data
o PAGE 1087 of the Regulations for Tables
31
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


Table B (pg. 1087)– 20.2031-7(d)(6): value of a remainder for a term certain (certain
amount of time where we know the amount of time)
 Lists different interest rates
o The interest rate to be applied is 120 percent of the §1274(d)(1) Federal
Midterm Rate as determined and published by the treasury each month
- §7520(a)
o Commonly called the 7520 rate, it determines the discount rate to be
applied under Regulation §§ 20.2031-7 and 25.2512-5
 The lowest interest rate available is 4.2%
Valuation Under Table B
 Take decibel and multiply by the total amount transferred - this represents
the present value of the remainder interest NOT the present value of the
income interest
 20.2031-7T(d)(2)(iii) - subtract remainder value out of the underlying interest
so get the present value of the income interest
Table S (pg. 1102) – 20.2031-7T(d)(7)
 Gives value of the remainder for a single life (for life, then to someone else)
 Need to know applicable 7520 rate
 Need to know how long income interest will last – that is based on lifeexpectancy (built in; just plug in age)
 20.203107T(d)(1) - pg. 1099: "The age of that individual at the age of that
individual's nearest birthday"
 Make sure to look at the proper MEASURING LIFE to do this calculation (i.e. the
person who has the life estate)
Because the values of the remainder and income interests, respectively, vary with
interest rates, the Treasury tables set forth at Reg. §20.2031-7(d)(7) provide values
based on a variety of interest rate levels ranging from 4.2% to 14%
Type
Table
Regulation
Term Certain Remainder
B
20.2031-7(d)(6)
Term Certain Interest
1 - remainder
20.2031-7(d)(6)
Life Estate Remainder
S
20.2031-7T(d)(7)
Life Estate Interest
1-S
20.2031-7T(d)(7)
Exceptions – when these exceptions arise, DON’T use the tables to do the calculations
o Relevant Regulations
 20.7520-3 (estate tax provision interpreting 7520)
 25.7520-3 (gift tax provision interpreting 7520)
 Rules we talk about are the same under either grouping, although the facts wherein
they come up are somewhat different depending on the tax involved
o Commissioner’s tables are based on the assumption of average mortality and an average
income return from the property
 It is understood that various cases may vary widely from these assumptions and
incorporate a shorter or longer actual life expectancy or a lower or higher actual income
return
o In extreme cases, however, the real world facts may be so different from the assumptions
incorporated in the tables that reliance on the tables becomes inappropriate
 The regulations specify circumstances in which the tables are to be disregarded for this
reason (§§20.7520-3 and 25.7520-3)
32

o
o
o
Section 7520(a) decrees that the §7520 rate and the tables shall be used for valuation
of "any annuity, any interest for life or a term of years, or any remainder or reversionary
interest."
 The only exception to this mandate is §7520(b), which specifies that §7520 rate is not to
be applied to qualified retirement plans, or to "any provision specified in regulations"
 If tables are not applied, the value of the interest "is based on all the facts and
circumstances" Reg. §§20.7520-3(b)(1)(iii) and 25.7520-3(b)(1)(iii)
Longevity – “Terminally Ill” (pg. 1672 in the code)
 Table S does not look at individuals to see how healthy they are - look at an average
 The tables are conclusive despite the health and probable longevity of the specific
individual involved, unless the individual is "terminally ill" AT THE TIME OF TRANSFER
 Individual is "terminally ill" if he or she has "an incurable illness or other deteriorating
physical condition" and "there is at least a 50 percent probability that the individual will
die within 1 year" (§§20.7520-3(b)(3)(i) and 25.7520-3(b)(3))
 If there is a terminable illness, the "actual life expectancy" must be used in valuing the
transfer (Reg. §§ 20.7520-3(b)(4) Example 1 and 25.7520-3(b)(4))
 For life transfers aren’t worth as much if the life is known to be short – annuity has no
value if the person is terminally ill
Interest May Be Impaired
 Tables are not applicable if the value of the interest may be impaired
 For example, if the trustee or another party has discretion to invade principal, thereby
reducing the amount producing income for the holder of an income interest, the
income interest is considered impaired, and the tables are not used (Reg. §20.75203(b)(2)(ii)(B) and 25.7520-3(b)(ii)(B)
Unproductive Property
 Tables are not to be used unless the governing instrument provides for the income
beneficiary "that degree of beneficial enjoyment of the property during the term of the
income interest that the principles of the law of trusts accord to a person who is
unqualifiedly designated as the income beneficiary of a trust for a similar period of
time." Reg. §§20.7520-3(b)(2)(ii)(A) and 25.7520-3(b)(2)(ii)(A)
 If the beneficiary has no right to demand productivity and the property is unlikely to
produce income, the income and remainder interests will be valued in light of the
probable actual return rather than the §7520 rate (Reg. §20.7520-3(b)(2)(v) Example 1)
 When you have property in a trust that doesn't produce income, you don't have
to use the tables
 Overvalue the income interest when it's not really worth anything
 However, if the beneficiary has some right to require that the trust property be made
productive (even if it hasn’t been productive in the past), the income interest will be
valued under the tables without regard to the historic or prospective productivity of the
property
 25.7520-3(b)(2) (pg. 1671 of regulations): make sure income interest actually has some
meaning
 Shackleford v. United States
 Wins lottery, but $3 million spread out over 30 yrs.
 In effect, you've won an annuity from the lottery
 Present value is something less than $3 million b/c of the time value of money
 Taxpayers argue that it's not fair to them to use the table, because under the
terms of lottery, they're not allowed to actual sell that stream of payments
(should value at something less than what the tables say)
33

In some extreme circumstances, some courts have been willing to depart
(however, the vast majority of cases still have to use the calculations in the
tables)
o §2701 and §2702 (Deals with the Exploitation of Tables in Intra-Family Transfers)
 In transfers between family members, §2702 assigns a zero value to the retained
interest unless there is a required payment, at least annually, of a fixed dollar amount
or a fixed percentage of the value of the trust (§§ 2702(a)(2)(A) and 2702(b))
 This prevents exploitation of the tables by transferring property that will produce
income far below the level assumed in the tables
 Class Example:
 2702 deals with transferring a remainder to a close family member, but retains
the right to income interest as long as donor is alive
 Concern that will understate the value of remainder interest given to son
 Donor will just forego taking any income out - but will try to say that the income
was worth a lot while remainder interest not worth much (helps out donee)
 In that situation, must value the retained income interest at $0 (full amount put
into the trust is considered the gift given to the person who gets the remainder
interest)
Closely Held Businesses and Other Assets
 General Principles
o The starting point in valuing closely held business is §2031(b), which dictates that nontraded
stock and securities be valued by reference to the actual market valuation of similar enterprises,
the stock or securities of which are actively traded; Reg. 20.2031-2 expands on this mandate by
specifying the aspects of a closely held business that are to be given the greatest weight for
purposes of comparison with actively traded securities
o Reg. 20.2031-2 (pg. 1083) - Valuing closely held stock and bonds
 Must value stock to know what estate tax exposure is
 20.2031-2(b): If there is a market for stocks or bonds, on a stock exchange, in an overthe-counter 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
 Valuation date = date of death for estate tax or date of gift for gift tax
 Must look at lowest/highest selling price on the date of valuation and average
the two to get the price of the stock per share
o Estate of Cook v. United States: apply the general concept of basing valuation on competitors
that are similarly situated - but no corporation is identical, so must look at other factors that
differentiate the companies to adjust that price
o Revenue Ruling 59-60
 Purpose: Outline and review in general the approach, methods, and factors to be
considered in valuing shares of the capital stock of closely held corporations for estate
and gift tax purposes (also applies to stock on which market quotations are unavailable
or are of such scarcity that they do not reflect their fair market value)
 Definition: Closely held corporations are those corporations the shares of which are
owned by a relatively limited number of stockholders. Often the entire stock issue is
held by one family. The result of this situation is that little, if any, trading in the shares
takes place. There is, therefore, no established market for the stock and such sales as
occur as irregular intervals seldom reflect all of the elements of a representative
transaction as defined by the term "fair market value"
 Approach to Valuation: a determination of fair market value, being a question of fact,
will depend upon the circumstances of each case. No formula can be devised that will
be generally applicable to the multitude of different valuation issues arising in estate
34
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
and gift tax cases. Often, an appraiser will find wife differences of opinion as to the fair
market value of a particular stock
 Gold Standard: free and active stock market where the stock in question is
regularly traded (use this to calculate the average using high/low price of that
date)
 If the stock is closely held, is traded infrequently, or is traded in an erratic
market, the next best measure may be found in the prices at which the stocks
of companies engaged in the same or similar line of business are selling in a free
and open market (consistent with the statute itself in 2031(b))
Factors to Consider - the following factors, although not all-inclusive, are fundamental
and require careful analysis in each case (detailed description of each factor in CB pg.
189-193):
 The nature of the business and the history of the enterprise from inception
 The economic outlook in general and the condition and outlook of the specific
industry in particular
 The book value of the stock and the financial condition of the business
 The earning capacity of the company
 The dividend-paying capacity
 Whether or not the enterprise has goodwill or other intangible value
 Sales of the stock and the size of the block of stock to be valued
 The market price of stocks of corporations engaged in the same or a similar line
of business having their stocks actively traded in a free and open market, either
on an exchange or over-the-counter
Weight to the Accorded Various Factors
 Depending on the circumstances in each case, certain factors may carry more
weight than others because of the nature of the company's business
 I.e. appraiser will accord primary consideration to earnings when valuing stocks
of companies which sell products or services to the public; conversely, in the
investment or holding type of company, the appraiser may accord the greatest
weight to the assets underlying the security to be valued
-Summary of Premiums and Discounts (see below for details)
PREMIUMS: Control/Swing Vote
DISCOUNTS: Minority/Marketability
- Premium for Control
o A premium for control is generally expressed as the percentage by which the amount paid for a
controlling block of shares exceeds the amount which would have otherwise been paid for the
shares if sold as minority interests and is not based on a percentage of the value of the stock
held by all or a particular class of minority shareholders (Estate of Chenoweth v. Commissioner)
 For purposes of inclusion in the decedent's gross estate under section 2031, his assets
are to be valued at their worth at the moment of his death
 A block of stock which represents the controlling interest in a company may be worth
more than a block of stock in the same company that does not carry with it control of
the company
 Sec. 20.2031-2(e): If the block of stock to be valued represents a controlling interest,
either actual or effective, in a going business, the price at which other lots change
hands may have little relation to its true value.
35
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
Courts have likewise recognized that an additional element of value may be
present in a block of shares representing a controlling interest, for valuation
purposes under section 2031
 By the same token, a block of shares held in corporation which is a
noncontrolling minority interest may call for a reduction of its fair market value
o The magnitude of the control premium should vary from case to case, depending on the nature
of the business and the realistic economic advantages offered by control such as the power to
determine
 (1) salaries and other expenditures
 (2) the extent of dividend or other distributions
 (3) the extent to which earnings are reinvested and the business expanded
 (4) participation in mergers, liquidations, and substantial asset sales
o Policy Rationale for Premium for Control: will be making important decisions about the
corporation
 What a willing buyer would pay a willing seller = valuation
 Willing buyer would pay some kind of premium if, in buying those shares, they carry
some kind of control over the corporation
o Example
 $10 million company
 A owns 60% (controlling block) and either (1) dies (estate tax) or (2) gives to daughter
(gift tax)
 Pro Rata Valuation: 6 million (60% of 10 million)
 But must add some kind of control premium because a willing buyer would
actually pay more to control the company
 B owns 40%
 Even though he is entitled to 40%, he is subject to the whims of the controlling
block
 Therefore, an arms-length purchaser might pay less than 4 million as a practical
matter
 Subject to the minority discount (below)
 Subtract 30% of 4 million if you're applying a 30% minority discount
 **NOT always the case that the minority discount will exactly offset the control
premium (aren't necessary the same percent – see, e.g., Estate of Chenowith v.
Commissioner)
Minority Discounts
o Estate of Bright v. United States
 Facts:
 Mr. and Mrs. B collectively and undividedly own 55% of the stock
 Upon the death of one of the two, divided equally and can only exercise
testamentary disposition over his or her own half of the property
 The sole issue before the district court was the value of the estate's stock upon
Mr. B’s death
 IRS says should value the 55% block together and then divide by 2 to see what
each part was worth (would have a control premium this way)
 Bright argues that should be valued separately (minority discount would be
applied this way)
 BRIGHT RULE: negates aggregation of interest among family members
 The fact that Mr. and Mrs. Bright held their stock during their lifetime as a
control block of 55% is an irrelevant fact
 It is a fact which antedates his death and no longer exists at the time of his
death (when estate is valued)
36
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o
o
o
o
The value that must be determined is 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 sell and both having reasonable knowledge of relevant facts." Reg. §20.20311(b)
 The willing seller is a hypothetical seller, not the actual seller
 The estate tax is imposed upon the transfer of the property by the decedent,
not the receipt of the property by the beneficiary
 DISSENT contends that the fact Mrs. Bright owned the other 27.5% impacts the fair
market value of Mr. Bright’s interest
How far have the courts gone in the family nonaggregation principle?
 In Estate of Bonner v. United States, the Bright rule was extended so as to deny
aggregation in the case of separate interests included in the same decedent’s gross
estate
 Because those are different interests in the stock, they are not aggregated together treated as two separate blocks for estate tax purposes even though it all ends up being
included in gross estate
Point at which courts are willing to aggregate…
 Estate of Fontana v. Commissioner
 General power of appointment is viewed as "essentially identical to outright ownership"
 Short of this situation, just look at the specific block being valued and what a
hypothetical buyer would pay a hypothetical seller
Revenue Ruling 93-12 (agreed to go along with Bright decision for both estate and gift tax
valuation)
 FACTS: P owned all of the single outstanding class of stock of X corporation. P
transferred all of P's shares by making simultaneous gifts of 20 percent of the share to
each of P's 5 children, A, B, C, D, E.
 HOLDING:
 If a donor transfers shares in a corporation to each of the donor's children, the
factor of corporate control in the family is not considered in valuing each
transferred interest for purposes of section 2512 of the Code
 Consequently, a minority discount will not be disallowed simply because a
transferred interest, when aggregated with interest held by family members,
would be a part of a controlling interest
 Law and Analysis:
 Section 25.2512-2(a) of the regulations provides that the value of stocks and
bonds is the fair market value per share or bond on the date of the gift.
 Section 25.2512-2(f) provides that the degree of control of the business
represented by the block of stock to be valued is among the factors to be
considered in valuing stock where there are no sale prices or bona fide bid or
asked prices.
 In the case of a corporation with a single class of stock, the share of other
family members will not be aggregated with the other transferred shares to
determine whether the transferred shares should be valued as part of a
controlling interest
 Therefore, the minority interests transferred to A,B,C,D,E should be valued for
gift tax purposes without regard to the family relationship of the parties
Significant Impediments to Qualification for a Minority Discount
 One if the "swing vote" rationale (see below) - if the IRS can show the minority status of
the interest is offset by a "swing vote" value that hypothetical buyers would assign to
the minority interest, the minority discount otherwise available may be negated
37
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
Another obstacle to qualification for a discount is the possibility that a buyer of a
minority interest would have a right to demand liquidation of the enterprise, thus
ending the minority status and entitling him to receive a portion of the enterprise
assets outright
 Depending on local law, the purchaser of a minority interest may or may not have an
effective right to demand liquidation
 If there is an effective right to demand liquidation, the IRS will probably oppose
allowance of a minority discount and permit only a smaller fractional interest
discount
 On the other hand, if there is no effective liquidation right, a minority discount should
be allowed in the absence of a swing vote value
Swing Vote Premium: Technical Advice Memorandum 9436005
 FACTS


Before
After
Donor
100%
5%
Child 1
0%
30%
Child 2
0%
30%
Child 3
0%
30%
Spouse
0%
5%
ISSUE: Should the fact that each of three 30 percent blocks of stock transferred has “swing
vote” attributes be taken into account as a factor in determining the fair market value of
the stock?
APPLICABLE LAW AND ANALYSIS
 In general, in determining the value of shares of stock that represent a minority
interest, a discount may be allowed in appropriate circumstances to reflect the fact that
the holder of a minority interest lacks control over corporate policy, and thus for
example, cannot compel the payment of dividends or the liquidation of the corporation
 Where a donor makes simultaneous gift of multiple share of securities to different
donees, each gift is valued separately in determining fair market value for gift tax
purposes (BRIGHT RULE)
 Rev. Ruling 93-12 found that in valuing shares, a minority discount will not be allowed
solely because a transferred interest, when aggregated with interests held by other
family members, would be a part of a controlling interest
 However, in Estate of Winkler, the increased value attributable to the swing vote
characteristics of the stock offset any minority discount otherwise available
 In the instant case each gift, viewed separately, possesses swing vote characteristics
 As in the Estate of Winkler, this swing vote attribute of each of the transferred
blocks enhances the value of each block and is properly taken into account in
determining the fair market value of each block transferred
 The extent to which the swing vote potential enhances the value of each block
is a factual determination - all relevant factors, including the minority nature of
each block, any marketability concerns, and swing vote potential, should all be
taken into account in valuing each block
o CONCLUSION: In determining the fair market value of three 30 percent
blocks of stock transferred by the donor, the swing vote attributes of
each block are factors to be taken into consideration in determining the
value of each block
38

Marketability Discounts
o Some discount that a hypothetical buyer would pay if the purchase was difficult to turn into
cash (i.e. not traded)
o Discounts are often applied to reflect the lack of marketability of an asset
o The willing buyer-willing seller approach can produce unrealistically high values if the market is
thin, buyers are few, or the asset has unusual infirmities
o If a company is not regularly traded or listed on an exchange, it usually gets a marketability
discount
 Family Limited Partnerships
o Bright rule was a crucial turning point because families were able to obtain minority discounts
while maintaining family ownership and control
o The key lay in the creation of an entity to hold the assets, because the principal discounts are
available only as to interests in an entity, such as a corporation or a partnership
 The entity of choice became a partnership
 Where members of a family are the sole or principal owners, such an entity is referred
to as a "family limited partnership" or FLP
o Result of FLP's is that all the interest are valued at substantial discounts for gift and estate tax
purposes
 Mom and Dad transfer their assets to an FLP
 The minority interest initially transferred to children qualify for substantial discounts,
and Mom and Dad can make additional gifts of minority interests in later years
 At the death of Mom and Dad, each owns a minority interest that likewise qualifies for
substantial discounts
 Ultimately, after the death of Mom and Dad, all interests in the FLP are held by the
children, and at this point they can liquidate the partnership and distribute the assets
outright among themselves
 Overall result is simply a passage of Mom and Dad's assets to their children
o The IRS views FLP's as artificial tax avoidance devices, but the IRS acceptance of the principle
that ownership by different family members cannot be aggregated made is difficult for the IRS
to attack FLP's
 IRS finally achieved success by applying §2036 of FLP's
 Section 2036 is an estate tax provision that includes in the decedent's gross estate (and
therefore is subjected to estate tax) any asset as to which the decedent retains until his
death a right to the income from the property or a right to control disposition of the
income
 If it is determined that the decedent in fact retained such rights in an FLP, the result is
to include the underlying FLP assets in the decedent's gross estate
 Factors that tends to protect FLP's against IRS attack - the prospects for success are
greater to extent that all of these elements are present:
 (1) The FLP is not created shortly before the death of the decedent
 (2) There is a business purpose (other than tax avoidance) for creation of the
FLP
 (3) The assets transferred to the FLP are operating assets requiring
management, rather than passive investments, such as marketable securities
 (4) The decedent retains adequate assets to support himself without receiving
income from the FLP
 (5) There is not a pattern of distributions from the FLP to the decedent for his
support
 (6) All the formalities of partnership existence and operation are carefully
observed
Retained Interests and Value Freezes
39

Introduction
o Special problems are created if a donor transfers to a donee only a portion of the donor's
interest in an asset - must take steps to assure that transferred interest and the retained
interest, respectively, are realistically valued for gift and estate tax purposes
 2701 - corporate stock concerns
 2702 - trust concerns
o For Example:
 A parent might transfer a partial interest in property to a child while retaining an
interest in the same property
 For gift tax purposes, a parent might treat the retained interest as having a value equal
to a large portion of the value of the entire property
 That would imply a modest value for the transferred interest and limited tax liability,
however, it often turns out later that the true value of the transferred interest was
much higher than the value originally determined by the parent, with the result that the
parent had successfully transferred a large part of the value of the property at little or
no gift tax cost
o Value Freeze Example:
 Two Classes of Stock in a Corp (both represent an ownership interest in a corporation)
 Preferred Stock: preference on the distribution of earnings (dividends) and
liquidation rights
 Common Stock: less valuable than preferred stock, but common share value
derives from the fact that they get all the profitability once the preferred stock
owners have been paid (can get larger returns)
 Dad may try to use characteristics of preferred stock and common stock to lock in the
value of the company at today's value so that future growth in the company will be
outside of the gift tax and the estate tax (future appreciation goes directly to kids)
 Makes gift of the common stock
o Future growth of company, therefore, won't be included in his estate
o Downside: high gift tax and also gives away the control of the
corporation
 Instead, he would recapitalize the corporation - exchange common stock for
some preferred stock and some common stock (no income tax consequences)
o Then gifts all common stock to daughter
o Dress up the preferred stock to make it appear really valuable by giving
it preferential rights (hypothetical buyer would deem it very valuable)
 Distribution rights
 Liquidation rights
 Voting rights that could control corporation as a practical
matter
 Normal Valuation Rules with Arms-Length Analysis:
 Common stock: $20,000 (value of gift)
 Preferred stock: $980,000
 Because this is family situation, he would choose not to take out dividends on
the preferred stock - wants to keep as much as possible out of future estate
(would probably not exercise liquidation or distribution rights)
o Therefore, arms-length analysis is not really accurate
o All growth in the corporation goes to the benefit of the common share
holders (daughter) when the only transfer cost was the gift tax on the
initial $20,000
What
2701
does:

40
o


If Dad makes a transfer of common stock to a family member while at
the same time retaining the preferred stock, commissioner takes a
cynical view of the value of that retained stock
o Statute says that the retained preferred stock is valued at $0 for
purposes of figuring out the value of the gift made to daughter (i.e.
common stock valued at the full value of the corporation - in this case,
1 million instead of $20,000)
Responses by Commissioner & Congress
o 2701 and 2702 are aimed squarely at value-freezing strategies involving retained interests
o In adopting §2701, Congress abandoned the §2036 effort to include Daughter’s common stock
in Dad's gross estate
 2701 focuses, instead, on proper valuation of the common stock for gift tax purposes at
the time the common stock is transferred to Dad and Daughter
 Applies stringent rules to valuation of Dad's preferred stock for gift tax purposes at the
time Dad transfers the common stock to Daughter
 These rules may dramatically decrease the value assigned to Dad's preferred stock,
necessarily increasing the value of the common stock transferred to Daughter
Section 2701 Valuation Rules
o The starting point is the general rule that any interest transferred will be valued according to
the usual fair market value standard, i.e., willing buyer-willing seller (see closely held businesses
rules)
o Special valuation rules of 2701 apply only if:
1. The transferor transfers an interest in a corporation or partnership to a member of
his family (as defined by §2701(e)(1))
2. The transferor or an applicable family member retains an interest in the same
corporation or partnership
o If 2701 applies, one or both of two special valuation rules (Minimum Value Rule and/or Zero
Value Rule) must be used to value the transfer for gift tax purposes
o MINIMUM VALUE RULE FOR TRANSFERRED INTEREST
 If common stock is transferred, all issued common stock, including that transferred,
must be assigned value equal to at least 10 percent of the total enterprise value
§2701(a)(4)(A)
 The minimum value rule is intended to reflect the "option value" of the right of the
common to future appreciation
o ZERO VALUE RULE FOR RETAINED INTERESTS
 If the transferor owns all interest in the corporation before the transfer, the value of
the retained interest is subtracted from the entire enterprise value to produce the value
of the transferred interest
 If the retained interest is valued at zero, the entire enterprise value will necessarily be
assigned to the transferred interest
 Zero Value Rule applies to 2 types of rights
 Liquidation
o Any liquidation is assigned a zero value unless that right must be
exercised at a specific time and at a specific amount
o If there is no requirement for liquidation, a family will forego exercising
that right
 Distribution
o The general rules is that a right to receive distributions from a
corporation are assigned a zero value if the transferor and the
transferor's family control the corporation
41
o




However, the zero value rule does not apply if a dividend of a fixed
amount must be paid at stated intervals and the dividend is not
cumulative
o If dividend is not cumulative, does not have fixed dates, or a fixed
payment amount, dividend right will be assigned a zero value
Other Aspects of Section 2701 Valuation Rules
o There remains the question of how Dad’s preferred should be valued at Dad’s later death –
double taxation would result if Dad’s preferred were valued at $980,000
o The result is avoided by §2701(e)(6) which requires that “appropriate adjustments” be made at
Dad’s Death “to reflect the increase in the amount of any prior taxable gift” the valuation of
which was affected by 2701
o The purpose of the adjustment is to prevent the double taxation of rights that were given a zero
dollar value under 2701
Practical Effects of the section 2701 Valuation Rules
o Whether or not the zero value for retained rule will apply depends on the nature of the
preferred stock Dad retains
o The practical result is that the value-freezing objective will be fully achieved only if the
preferred carries an adequate cumulative dividend that is actually paid
Transactions Not Subject to the Section 2701 Valuation Rules
o The general rule is that any transfer of an interest in a corporation or internship to a family is
subject to the §2701 valuation rules if the donor (or a member of the donor's family) retains an
interest in the same corporation
o The zero value rule for retained interests does not apply if any one of the following
circumstances is present:
 The corporation has issued only one class of stock
 The corporation has issued more than one class of stock, but the only difference
between the classes relates to voting rights
 The corporation has issued more than one class of stock, but all interests transferred by
the donor are in the same proportion as the donor's retained interest
 Market quotations are readily available for the retained interest on an established
securities market
 Market quotations are readily available for the transferred interest on an established
securities market
Trusts – SECTION 2702 (*Focused on 2702 over 2701 in Class)
o Example
 Dad puts a valuable painting into a trust b/c thinks it will appreciate significantly in the
coming years so worried about estate tax (1 million now)
 GRIT - Grantor Retained Income Trust
 Retained income interest = retained preferred stock (looks like it has a lot of
value, depressing value of remainder interest, but in reality, doesn't have much
value)
 Income retained by Dad for 15 years and remainder after 15 years goes to
Daughter
 Table B values income interest and remainder interest – just need to know
applicable federal rate and the number of periods
o The longer the income interest lasts, the less valuable the remainder
interest
o Therefore, want to make term as long as possible for gift tax purposes,
but if he dies during the term of 15 years, the entire value of trust must
be included in gross estate
42
o

Tension: want to minimize value of gift by making term longer, but
needs to actually outlive it so that the value of the painting is not
including in gross estate
 Table B works in an Arms-Length relationship
o Problem with this is that as a practical matter, Dad won't take any
income out of the trust (especially if the asset doesn't even generate
income - like in the case of the painting)
o Essentially just transferring the gift outright even if we give him the
right to force the trustee to make the income productive (recall:
exception to using table B is unproductive assets in a trust)
o Therefore, wants all the value of the trust to go to his daughter without
paying the full amount of gift tax
o Sec. 2702 (see tax code pg. 324-27) says that the default rule is that when a transfer of an
interest in a trust to a member of the family and the transferor retains an interest in the trust,
assumed that the value of retained interest is $0
o 2702 applies when two conditions are satisfied:
1. Transfer of an interest in trust to (or for the benefit of) a member of the family 2702(e) defines family which references 2704(c) (pg. 327)
2. Transferor retains an interest in the trust (or spouse retains an interest in the trust)
o Qualified Interest Valuation: if value of retained interest is a qualified interest, then retained
interest is not treated as being zero
 Qualified Interest (defined in 2702(b)): an interest is a qualified interest only if annual
payments are required and those payments consist of (1) a fixed dollar amount payable
not less frequently than annually or (2) an amount equal to a fixed percentage of the
trust value, determined annually
 Trust providing qualified interests that meet the requirements of 2702 have commonly
accepted names
 GRAT = "grantor retained annuity" (trust that provides for the grantor a
retained right to annual payments of a specific dollar amount)
 GRUT = "grantor retained unitrust" (trust that provides for the grantor retained
right to annual payments equal to a fixed percentage of the total value of the
trust assets, determined annually)
o Exceptions to 2702
 Does not apply to incomplete gifts - 2702(3)(A)(i)
 Does not apply to personal residences put into a trust - 2702(3)(A)(ii) (Qualified
Personal Residence Trust)
 Dad gets it for 15 years and then daughter gets it once that time has elapsed
 Retaining right to live in the home is the equivalent of retaining the income to
the trust (main annual value that the trust has is the right to live in the home)
Interests in Other Property
o Retained interest in property other than corporations, partnerships, and trusts offer similar tax
avoidance possibilities
o 2702(c)(1) treats any transfer of an interest in property as if it were a transfer of a trust interest
 This triggers the valuation rules of 2702(a), and the interest retained by the transferor
will be valued at zero unless it is a “qualified interest under 2702(b)
 If the retained interest is expressed as an annual payment of a fixed dollar amount or a
fixed percentage of the value of the property determined annually, the usual rules of
valuation under §7520 apply
 If the retained interest is not so expressed, however, the retained interest will be
assigned a zero value, and the entire value of the property will be assigned to the
remainder
43
Special Use Valuation
 General rule is that fair market value is determined by the willing buyer-willing seller rule set forth in Reg.
20.2031-1(b) and 25.2512-1
o This approach requires that the property be valued at the "highest and best use" to which the
property could be put, rather than the actual use at the time of valuation
o In the case of real estate, fair market value is typically derived from prices actually paid for
comparable properties in recent sales
 Problem: however, the economic return from farm use may be far below the level necessary to pay the
high estate tax based on urban development valuation
o Farm families tend to be "land poor" - their land may have very substantial value, but the actual
income produced tends to be relatively low
o This can result in heavy estate tax liability without income sufficient to pay the tax and as a result
many farm families fear that they may have no choice but to sell substantial acreage in order to pay
estate taxes which in turn may lower the farm size below an economically sustainable level
(ultimately forcing the family out of farming altogether)
 Solution: §2032A is designed to alleviate the problem by permitting valuation of farmland by reference to
its income-producing potential rather than its hypothetical sale value
o In other words, under 2032A, the value for estate tax purposes is a reasonable multiple of
hypothetical farm earnings, not the higher price the farm land might actually bring on the market
o Section 2032A is intended to benefit only families that retain the land in the family and continue to
use it for farming purposes
o Therefore, the availability of 2032A is tightly restricted and estate planners who seek to use 2032A
must give careful attention to the eligibility requirements before, at, and after death
 Eligibility Requirements of 2032A
o Substantial Portion: farm assets must constitute a substantial portion of the decedent's estate
 The real and personal property of the farm or other closely held business included in the
decedent's gross estate must have an aggregate value equal to 50 percent or more of the
decedent's gross estate, and the real property must have an aggregate value of 25 percent or
more of the decedent's gross estate (2032A(b)(1)(A) and (B))
 These computations are made using the "adjusted value" of each asset, i.e., the fair market
value less debt encumbering the asset (2032A(b)(3))
o Qualified Heir:
 The farm or other business must pass from the decedent to a "qualified heir"
 Qualified heir is defined as (1) an ancestor or spouse of the decedent, (2) a lineal descendant
of the decedent, the decedent's spouse, or a parent of the decedent, or (3) a spouse of such
lineal decedent
o 5/8 Requirement: In addition, during give of the eight years preceding the decedent's death, the
decedent or a member of his family must have owned the land and used it for a qualified use, and
the decedent or member of his family must have martially participated in the operation of the farm
or other closely held business (2032A(b)(1)(C))
 5/8: Test period may end prior to the death of decedent if he became disabled and began
receiving and continued to receive Social Security retirement benefits until his death
(2032A(b)(4))
 Material Participation
 Crucial in many case in which farm ownership is relatively passive
 20.2032A-3(e)(2) states the following general rules about material participating: "No
single factor is determinative of the presence of material participation, but physical
work and participating in management decisions are the principal factors to be
considered. As a minimum the decedent and/or family member must regularly advise or
consult with the other managing party on the operation of the business."
 Qualified Use
44


"Qualified Use" means an "equity interest" in the operation
The decedent or a member of his family must, both at the time of death and during the
five of the eight years preceding death, receive a return from the land that is dependent
on the economic productivity of the farm or business (Reg. 20.2032A-3(b)(1)
 I.e., if decedent or family member receives a fixed rent of an agreed number of dollars
per acre, regardless of production, qualified use is not present
o Timing/Agreement
 The election to make use of 2032A must be made no later than the time for filing the estate
tax return and must be joined with an agreement, signed by each person who has an interest
in the property, consent to the recovery by the united State of any tax that was saved by the
election if, within a period of 10 years after death, the qualified heir disposes of the property
or ceases to use it for the qualified purpose (2032A(d)(1) and (2))
 In the case of the disposition of the farmland, the recapture provision (2032A(c))
imposes a recapture tax, the value of which is the lesser of (1) the tax benefit
attributable to the special use valuation, or (2) the excess of the amount realized upon
the disposition of property over the value of the property as determined under the
special use valuation
 In the case of disqualification (i.e. change to a non-farming use), the amount of the
recapture tax is the lesser of (1) the tax benefit attributable to the special use valuation
or (2) the excess of the fair market value of the land over the value determined under
special use
 If the qualified heir dies without having disposed of the farmland or ceasing the qualified use,
recapture is no longer applicable to the farmland owned by the qualified heir
 Two Valuation Methods Available Under 2032A
1. Farm Method - involves capitalization of the average annual cash rent for comparable land used for
farming in the same locality
2. Multiple Factor Method - for those farms where no comparable cash rent may be determined, or
where the executor elects not to use the farm method, and for other closely held businesses, the
statute provides for the following factors in arriving at the value of the qualified land (2032A(e)(8)):
 Capitalization of the income reasonably expected to be derived from the property
 Capitalization of the fair rental value of the property
 Assessed land values in a state that provides a differential or use value assessment law for
farmland or closely held business
 Comparable sales in the same geographical area sufficiently removed from urban or resort
area that a nonqualified use would not be a significant factor in the price; and
 Any other factor that fairly values the qualified use of the property
 Section 2032A can have a dramatic impact on valuation of property for estate tax purposes, especially in
circumstances where sale prices greatly exceed the value justified by the income produced by the
property
 Section 2032A election has an important DOWNSIDE: the post-death basis of the property will be the
reduced value under 2032A, not the full fair market value
o If the land is later sold, the lower basis will increase the amount of gain - and consequently the level
of income tax due - on the sale
o However, many families have no expectation of selling, with the result that the basis is viewed as
having little importance (in any event, the prospect of immediate estate tax savings will likely be
viewed as outweighing future and perhaps long-delayed income tax cost)
Other Valuation Matters
 Blockage
o In the case of listed securities, the quoted trading price may not accurately represent the price
the decedent could have obtained for the securities at the time of death (taxpayer can receive a
discount for blockage if selling the property on the market would drive down the price)
45
o





It is obvious that if the decedent's holding were large relative to the usual trading volume in the
security, the market would be depressed if the decedent put all his stock on the market at the
same time
 This phenomena is called "blockage" and the Treasury has recognized that blockage
may dictate a lower price for the stock than the quoted trading price on the date of
death (Reg. §§20.2031-2(e) and 25.2512-2(e))
 Under the circumstances the value for estate tax purposes is the price at which the
decedent's stock could hypothetically be sold as one block outside the usual market,
i.e., through an underwriter
o Applies to a broad range of ownership interests - not just business
 Situations where there is a market for that asset (i.e. paintings by a particular artist
where only a few sell a year; but if estate tries to sell all of their paintings at once,
market price is driven down)
 However, if the estate tries to sell a large block of that property, the price itself would
be driven down because of the influx in the market
Unascertainable Value (Robinette v. Helvering)
o The Court concluded that gifts of future interests were taxable under the Revenue Act and that
they did not lose that quality merely because of the indefiniteness of the eventual recipient.
Because the agreement to create the trusts was not made in the ordinary course of business,
the transfers could not be considered as made for full consideration.
o The taxpayers were not entitled to deductions for the values of their reversionary interests
because there was not any recognized method for determining the values of the contingent
remainders in question.
Discovery of Commissioner’s Valuation Method
o §7517 permits the taxpayer to obtain information from the Commissioner as to the basis for
any value determination made for estate or gift tax purposes
o The Commissioner must respond within 45 days, must explain the basis for the value
determination, including computations, and must provide a copy of any expert appraisal
obtained by the Commissioner
Burden of Proof
o The general rule in Tax Court cases is that the taxpayer has the burden of proving the
Commissioner's asserted deficiency is invalid; if the taxpayer proves that the Commissioner's
deficiency is invalid, the burden shifts to the Commissioner to prove that there is a deficiency
o Under certain circumstances, however, §7491 imposes the initial burden of proof on the IRS
 Provision applies only to factual issues
 Has the greatest impact in cases in which the court must choose between two
conflicting positions; in valuation cases, however, it appears that a court can still adopt
a value between those proposed by the IRS and the taxpayer
o Requirements of using §7491:
 (1) The taxpayer must present credible evidence for the taxpayer's position
 (2) The taxpayer must comply with all substantiation requirements, and
 (3) The taxpayer must comply with all "reasonable" IRS requests for documents,
witnesses, and other information
Declatory Judgment by the Tax Court
o Section 7477 permits a donor to obtain declatory judgment from the Tax Court as to the value
of a gift, provided the donor has exhausted all available administrative remedies within the IRS
o Without 7477, Tax Court jurisdiction would not be available in many cases; ordinarily the Tax
Court has jurisdiction only if a deficiency in tax has been asserted by the IRS
Penalty for Undervaluation
o Often, appears that taxpayer has little to lose and much to gain from a substantial
understatement of value on a gift or estate tax return
46
o

Section 6662 deters such an approach by imposing a penalty of 20 percent of the
underpayment if the understatement of value is substantial
o The penalty does not apply if there is reasonable cause for the underpayment and the taxpayer
acted in good faith - §6664(c)
o If you underpaid, owe the underpaid tax - then might owe interest and might owe penalties
 Interest: Section 6601(a) - pg. 533
 Interest that applies is a market-based rate of 6621(a)(2) (pg. 543-4)
 Interest merely offsets the time value of money, because got to hold on to it
longer than you were supposed to
 Penalties: owed on top of interest and underpaid tax
 Section 6662(a) – substantial understatement penalty – owe 20 percent of
underpaid tax
o 6662(g) - pg. 565 - defines substantial understatement
o Is the reported amount 65% or less of the amount determined to be the
correct amount? If yes, penalty applies
 Section 6662(h)(2)(C): gross valuation misstatement - if you reported less than
40% of the actual value, then the owe 40 percent of underpaid tax penalties
 Section 6663: If due to fraud, owe additional amount equal to 75% of the
underpaid tax
 Accuracy-Related Penalties: 20 percent negligence penalty under 6662(b)
Penalty for Overvaluation
o There are circumstances in which overvaluation on the federal estate tax return may lead to
impulsion of the section 6662(e) penalty for overstatement of value with respect to the income
tax
47
Estate Tax
Main Estate Tax Provisions
 §2001(a): "A tax is hereby imposed on the transfer of the taxable estate."
 §2031: Definition of Gross Estate – “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 situation.”
 §2033: [Catch-All Provision] “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.”
 §2051: Definition of Taxable Estate – “For purpose 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 deductions
provided for in this part.” (i.e. marital, charitable deductions)
Property Owned
 Integration of Gift Tax with Estate Tax
o Upon the death of an individual, the taxable estate is determined under Chapter 11 (§2051) by
including all property owned at death (§2033) and not subject to an exclusion from the estate
tax (§§2031(c) and 2032A), and certain additional property transferred during life under
testamatory circumstances (§§ 2035 through 2042), and subtracting certain deductions for
administration expenses and debts, casualty losses, charitable gifts, marital bequests and family
owned business interests (§§2053 through 2057)
o Four additional steps are then taken to determine the actual dollar amount of the tax due from
the estate:
 (1) The taxable estate is then aggregated with all taxable gifts made during the
individual's lifetime since the effective date of the integration
 (2) A tentative estate tax is computed on the aggregate amount in step 1, using the
uniform tax rate provided in §2001(c) [see statutory modifications handout]
 (3) From the tentative tax determined under step 2, there is subtracted the total
amount of gift tax payable under Chapter 12 with respect to gifts made by the
individual after December 31, 1976, using the rate structure applicable under §2001(c)
at the time of the decedent's death
 (4) The excess of the tentative estate tax computed as in step 2 over the total amount
of gift tax computed in step 3 is the estate tax imposed on the estate. Against this
estate tax, the unified credit (§2010) is allowed on a dollar-for-dollar basis
o The benefit of a single unified credit is allowed to each individual for the individual's lifetime
and upon death
o There are three circumstances where gift taxes paid will not be available in full as credit against
estate taxes
 (1) First, where death occurs after repeal of the estate tax there will be no opportunity
to use any gift tax paid as a credit against the estate tax as none will be due; moreover,
because gift tax paid but not used as a credit is not refundable, the taxpayer's estate
will derive no financial benefit from any such gift taxes paid
 (2) Second, where the taxpayer dies with insufficient assets in his estate to enable the
full amount of the gift tax paid to act as an offset against the estate tax, full potential
use of the credit for gift taxes will not be made
 (3) Third, when gifts were taxed at a higher rate than they would have been taxed in the
year of death had they been made then, full use of gift taxes paid as a credit may not
occur
 Introductory Background
o Excise taxes are taxes imposed on specified privileged activities that are made subject to
taxation - the estate tax is a tax levied on the privilege of being able to transfer gratuitously title
to property at death and, as such, is classified as excise tax
o

§2001(a) states that "A tax is hereby imposed on the transfer of the taxable estate"
 Because of the excise nature of the tax, the courts, when dealing with other than direct
transfers at death, often find it difficult to distinguished privileged, and consequently
taxed, activities from similar non-privileged, and consequently untaxed, activities
 In its original form, §2033 in United States v. Field, was limited to property owned by
the decedent in the conventional sense (i.e. property owned within the meaning of the
state law of property and estate administration)
 §2033 was also interpreted narrowly in Helvering v. Safe Deposit and Trust Co. of
Baltimore when the Supreme Court held that trust could not be included in the
decedent’s gross estate because it was not the intention of Congress to tax under 2033
property subject to a general testamatory power of appointment that went unexercised
(no longer good law; Congress changed code after narrow interpretation)
o In First Victoria National Bank v. United States, the Court interpreted “property” broadly
 The court held that since the rice acreage history was not only devisable and
descendible, but transferable, there could be no doubt that an interest with these
attributes must be included in the owner's estate
 The focus of the estate tax was on the passage of interests at death - intangible asset
that had value (and therefore must be included in gross estate)
o Technical Advice Memorandum 9152005:
 Even stolen property is property for the purposes of 2033, that must be included in the
decedent’s estate
 If the decedent, at death, possessed the use and economic benefits of the stolen
property that are equivalent to ownership, the decedent's lack of title to the stolen
property does not affect its inclusion in the decedent's gross estate under 2033 when
the decedent can successfully transfer the property to his heirs
Interests at Death
o Effect of Death on Interests Held
 At death, interest in property that are potentially includible in the estate are often
affected in a fashion that may have significant tax consequences - for example, on some
occasions such interests have their values dramatically enhanced and on others they
are terminated or voided - all with dramatic results for the estate of the decedent
 Death can:
 (1) Create or fix the value of items of wealth that are includable in decedent's
gross estate, or they can
 (2) Extinguish wealth possessed during life (Estate of Moss v. Commissioner)
o Interest in a debt owed to decedent was not includible in his gross
estate under 2033, because the notes contained a cancellation clause
providing that the principal and interest due under the notes would be
extinguished upon decedent’s death
o If a self-cancelling installment note (SCIN) is employed, the purchasers
must pay a premium that reflects the economic advantage to them
which results from the cancellation privilege
o Failure to provide for a premium would result in the vendor being
deemed to have made a taxable gift to the vendee equal to the fair
market value of the premium which should have been created
o In addition to being required to develop the value of the premium
component based on actuarial factors, the authorities also agree that
the taxpayer must then adjust the premium to reflect added
considerations regarding the vendor's projected life span
o Lapsing Rights in Family Controlled Businesses (Section 2704)
49




Suppose that a parent seeks to affect the value of property that the parents owns with
child by providing that some of the parent's rights lapse at death, thereby enhancing
the value of the child's rights in the property - because the parent has not formally
transferred property to the child, the parent hopes to escape the reach of §2033
 Fact Pattern
 Dad has 100 shares of class A common stock and Daughter has 90 shares of
class B common stock
 Dad's shares has very favorable voting rights or favorable liquidation rights
 Rights lapse at death so all of sudden daughter has all the value in the
corporation
 §2704 was added to cope with this problem
 Treat as if there was a transfer even though there is not an interest that was
directly transferred
 If death triggers a lapse of a voting or liquidation rights in a corporation or
partnership, the lapse is deemed to result in a transfer of the lapses rights for
estate tax purposes if the individual holding the lapsing rights and that and that
person’s family, both before and after death, hold control of the business
 Under §2704(a)(2) the value included in the gross estate of the holder of the
lapsing rights is the value of all interests immediately after the lapse
 In addition to the value determined under 2704(a)(2), there is also included in
the estate of the deceased under 2033 or other relevant sections the value of
the property owned by the deceased with respect to which lapsing rights
existed
Contingent Interests
o Under §6163, the executor may elect or postpone the portion of the estate tax generated by
inclusion in the gross estate of a reversionary or remainder interest until six months after the
termination of the precedent interest
o Section 6163 plainly contemplates that remainder and reversionary interests are includable in
the gross estate under 2033
o Under 2033, the proper method of computation in the case of a trust is to determine as of the
date of death the values of the decedent's rights in the trust property and to include in the
gross estate the sum of such values (In Re Estate of Hill)
o Exception: if the contingency is resolved within six months after the decedent’s death, the
option under §2032 to value the property as of six months after the date of death averts the
horrible prospect of paying an estate tax on a value that later evaporates
Claims Under Wrongful Death and Survival Statutes
o Under the pure wrongful death statute, a right to sue is created in a class of beneficiaries who
have statutorily defined familial relationship with the deceased - these parties are allowed a
recovery for their economic losses resulting from death
o Under the survival type statute, the executor or administrator of the estate sues as the
representative of the deceased and awarded damages based on the economic loss and pain and
suffering inflicted on the deceased
o Rev. Rul. 54-19 - IRS indicated that damages under a pure wrongful death statute were not
includible in the estate of the deceased since under the wrongful death statute, the decedent
never possessed any interest in property transferred at his death
o Where, as in the case of survival statutes, there was no property interest in decedent which
passed by virtue of his death, but rather one which arose after his death, such an interest is not
property owned at death and not part of the gross estate under §2033 (Connecticut Bank and
Trust Co. v. United States)
Community Property in Gross Estate
50
o
o
o
The respective rights of husband and wife in real property are governed by the law of the place
where such property is situated rather than by the law of the domicile of the parties (Rev.
Ruling 54-89)
Rev. Ruling 72-444
 Facts: purchased property in a common law state using community assets
 The Treasury indicated that the general rule in such situations is that the property rules
of the state or country where the realty is located determine its character as separate
or community property, whereas in the case of movable property, the law of domicile
of the owners will be used to determine its character
Income Tax Consequences for Community Property
 ½ of the value of the property is included in the decedent’s gross estate upon his death
in the case of community property (Rev. Ruling 54-89)
 What happens to the income tax basis?
 Surviving spouse owns the entire interest in the property
 Sec. 1014(a)(1) - when one acquires property from a decedent, the property
receives a step up in basis to fair market value [1014(b) defines property that
shall be considered to have been acquired from or passed from the decedent –
all these property interests receives a basis step in to market value]
 1014(b)(6) (pg. 126): If at least half of the total value must be included in the
decedent's gross estate, then the surviving spouse's half also gets a basis step
up to fair market value on the date of his wife's death
 If joint tenants with right of survivorship, then only gets a basis step up on deceased's
spouse's half of the property, but not on his own property
Joint Tenancies
 Introduction/Statutory Provisions of Section 2040
o Tenancy in Common
 Each tenant in common has a separate but undivided interest
 Can't use the property exclusively and can't exclude
 Each of the co-owners have all the fundamental attributes of property against all others
 Each interest is separate, in the sense that it is independently descendible, conveyable,
and devisable
 Since either tenant can unilaterally convey her interest to a third party, property held as
tenancy in common can be attached to creditors of each individual tenant
 Since each share is independently descendible, there is no right of survivorship
 No requirement that each tenant hold can equal share
 Each tenant in such a tenancy in common has an equal right to possess the whole, but
their respective shares of rents or profits will be determined by their percentage of
ownership
 Tenancy in common is generally presumed unless there is some other manifestation of
intent to create a joint tenancy or a tenancy by the entirety
 [O to A and B]
o Joint Tenancy
 Exactly like the tenancy in common, except for the treatment of survivorship (allows the
remaining owner to avoid probate)
 In a joint tenancy, a surviving joint tenant automatically acquires the interest of another
joint tenant when the other tenant dies (technically nothing "passes" - the deceased
joint tenant's interest is simply extinguished)
 Joint tenancy requires four unities at the time of duration (note: tenancy in common
only requires possession):
 Time - each interest must be acquired or vest at the same time
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
Title - each must acquire title by the same instrument or by joint adverse
possession, never by intestate succession or other act of law
 Interest - each must have the same legal interest in the properly, such as fee
simple, life estate, etc., although not necessarily identical fractional shares
 Possession - each must have the right to possess the whole
 If any of the first three unities are destroyed in a joint tenancy, then we say the joint
tenancy is severed and tenancy in common is created
 The joint tenancy is only appropriate for an intimate relationship such as a committed
relationship or family business
 Tenancy in common is usually presumed, although some courts presume a joint tenancy
is intended in the case of an ambiguous transfers to a married couple
 [O to A and B with the right of survivorship as joint tenants]
o Tenancy by the Entirety
 Only a minority of states have retained the tenancy by the entirety, which is only
available to married couples
 Each co-owner has a separate and undivided interest, and each has a right to the
possession of the whole
 Like joint tenancy, there is a right of survivorship, but in some states, neither spouse
can unilaterally transfer or encumber their share of property without the consent of the
other (no unilateral exit as long as they both stay married)
 Neither spouse acting on their own can sever the tenancy, other than by getting a
divorce - thus, to the four unities required by joint tenancy, a fifth (marriage), is added
o Community Property
 Some states of the south and west have community property for married couples
 Under community property, all property acquired during the marriage automatically
becomes community property
Section 2040(a)
o In the absence of 2040, in a joint tenancy, nothing actually passes to the estate(interest just
ends)
o 2040(a) applies generally to joint tenancies
 Three types of situations under which joint tenancies are found
 (1) Where the interest in the tenancy property has been acquired by the
decedent and the other joint tenants by gifts, bequest, devise, or inheritance,
the value of the property will be includible in the deceased tenant's gross estate
to the extent of the deceased's fractional share (2 joint tenants = 1/2)
 (2) In all other cases, except joint tenancies between spouses, the entire value
of the tenancy property will be includible in the deceased tenant's gross estate
except such portion thereof as is allocable to the part of the consideration
furnished by the other tenant or tenants for the acquisition of the property
o Starting point - entire value must be included in the gross estate
o The only way you can back something out of inclusion is to the extent
that executor can demonstrate that the surviving joint tenant paid for
part of the property himself - must be in full consideration for money or
money's worth
o For amount excluded in estate, see formula in Estate of Goldsborough
v. Commissioner
 (3) For joint tenancies between spouses only, a straightforward rule was
provided in 2040(b) prescribing that for such spousal joint tenancies one-half of
the value of the joint tenancy property is includible in the estate of the
deceased spouse (see below)
 Need to know:
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
o
How joint tenants acquired the property
o Gift
o Brought - need to know relative shares of purchase price
 Who the tenants were - 2040(b) applies to husband and wife
 Income and Profits on Gift Property: Estate of Goldsborough v. Commissioner (see
problems)
 Amount excluded = entire value of the property (on the date of death) x
(survivor's consideration/entire consideration paid)
 In applying the formula, ignore the portion that was acquired by the other joint
tenant without adequate and full consideration
 Section 2040 provides in general that the decedent's gross estate includes the
entire value of jointly held property but that section “except(s) such part
thereof as may be shown to have originally belonged to (the surviving joint
tenant(s)) 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 money's
worth.”
 Section 2040 further provides that if the decedent owned property jointly with
another, the amount to be excluded from the decedent's gross estate is “only
such part of the value of such property as is proportionate to the consideration
furnished by (the surviving joint tenant(s)).”
 History
 United States v. Jacobs dealt with the constitutionality of the joint tenancy
provision and also served to focus attention on the more difficult issue of
exactly what constitutes qualifying consideration provided by the surviving joint
tenant
 Court emphasized that Congress has the power to tax the occasion of a joint
tenant's acquiring the status of survivor at the death of the co-tenant
 The Court also held in Jacobs that where the deceased joint tenant had
previously given the other joint tenant the funds, the full value of the jointly
held property should be included in the estate of the decedent
 Services and Consideration
 Survivors, who succeed in establishing that their labor constitutes consideration
for the purchase of jointly held assets, find themselves having to establish the
existence of a business partnership for the operation of the jointly owned
enterprise
 If they labored together on the understanding that some or all of the fruits of
the labor of the survivor were to be invested in the jointly held property, this
provides the survivor with the opportunity to claim that the survivor provided a
portion of the consideration for purchase of at least some of the jointly held
assets
2040(b) applies to joint tenancies between husband and wife (must be the only ones in joint
tenancy or must be in a tenancy by the entirety)
 The rule of half includibility of 2040(b) supersedes the consideration rule furnished in
2040(a)
 The includibility of half a spousal joint tenancy in the estate of the deceased spouse
exacts no estate tax price because joint tenancy property qualifies for the marital
deduction which is now an unlimited marital deduction in respect to amount
 Consequently, spousal joint tenancy property will not be subject to estate tax in the
estate of the first spouse to die
53

Income Tax Consequences: One significant consequence of the spousal joint tenancy
rule is that only one-half of such joint tenancy property will qualify for a step-up (or
step-down) in basis presently prescribed by §1014 (see problem 1)
 Contribution and Changing Values
o 2040(a) permits exclusion from the gross estate of such part of the value of the joint tenancy
property “as proportionate to the consideration furnished” by the surviving joint tenant
 This exclusion contemplates the determination of a ratio or fraction by reference to the
total consideration furnished and the portions thereof contributed by the joint tenant,
all at values at the time of acquisition
 The fraction representing the surviving tenants contribution so ascertained is then
applied to the value of the property at the date of death for the purposes of excluding
the portion of the joint tenancy attributable to the surviving tenant
o Over the years, contributions of who contributed what and the ratio can get incredibly
complicated
o Value the property must be figured out at each point the joint tenant contribute – or each time
money is taken out
o Burden on executor of the decedent to prove what the exclusion ratio is
 Mortgages and Contributions
o Where the property is acquired in joint tenancy partially for cash an partially for mortgaged
indebtedness in which the tenants are jointly and severally liable, with either joint tenant being
entitled to contribution from the other in the vent that he is compelled to satisfy more than
one-half the debt, each tenant is treated as contributing toward the purchase price his or her
share of the debt, as well as the cash which each contributes
o Rev. Ruling 79-302 says that to the extent that joint tenants are jointly liable for mortgage treated as if pro rata portion of the loan was their own contribution, and therefore includible in
the gross estate
o Whenever one of the joint tenants makes payment on the principal of the mortgage debt, this
operates to increase the party’s contribution to the purchase price and reduce the contribution
of the other joint tenant
o See problem 5
 Simultaneous Deaths of Joint Tenants
o Rev. Ruling 76-303: the IRS indicated how jointly held property was to be taxed where one of
the joint tenants provided all the consideration and the parties (X and Y) died in a common
accident in a jurisdiction which adopted the Uniform Simultaneous Death Act, which provides
that: “where there is no sufficient evidence that two joint tenant or tenants by the entirety
have died otherwise than simultaneously the property so held shall be distributed one-half as if
one had survived and one-half as if the other had survived.”
o The net result is that the entire value of the jointly held property will be taxed in X’s estate and
one-half of its value will be taxed in Y’s estate
 Community Property
o One aspect of favoritism shown to community property is found in the income tax basis
provision of 1014(b)(6)
o This provisions prescribes that, on death of one of the spouses in a community property
jurisdiction, both halves of the community property acquire a “stepped-up” new income tax
basis equivalent to the value of both halves of the community property as of the date of death
of one of the community property spouses (see problem 1)
Life Insurance
 Introduction
o Main question: to what extent are the proceeds of life insurance included in the gross estate of
the decedent?
o General
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o
o
o
o
Insurance is a device whereby a group of individuals or enterprises, typically with the
aid of a corporate intermediary referred to as the insurer, share or spread a risk of loss
 On the estate tax side, it does not matter what type of insurance you purchase – just
need to know about the proceeds that are paid out when the decedent dies (2042
applies to both types of insurance)
Common elements that are relevant to estate tax determination
 The owner of the insurance policy is someone other than the insured person
 i.e. wife as the owner of husband’s life insurance policy
 State law limits the class of people who can own a life insurance policy on
someone else’s life – only someone with an insurable interest (usually requires
an “economic interest” to their continued survival) on the decedent can take
out a life insurance policy on someone else
 Who is the beneficiary of the policy?
 Beneficiary is the person designed under the terms of the policy to receive life
insurance proceeds when the insured person dies
 Proceeds could be paid to estate and then distributed by terms of the will
 Could also be distributed to a trust or a particular person
 Keep in mind that the beneficiary of the policy can usually be changed based on
the terms of the police (although there is such a thing as an irrevocable
designation of the beneficiary)
Congress passed a provision which included in the decedent's estate the proceeds of policies on
the life of the deceased payable: (1) to the deceased's executor; or (2) to "all other
beneficiaries as insurance under policies taken out by the decedent"
 IRS has made clear that encompassed by that language is life insurance which, while not
designated as payable to the estate, financially benefits the estate
 Requirement (2) initially began with the premiums payment test - under 2042, proceeds
of policy are now includible in the estate of the insured decedent under 2042 if (1)
payable to the decedent's executor; or (2) payable to others if the decedent retained
with respect to the policy "any of the incidents of ownership, exercisable either alone or
in conjunction with any other person"
2042(1)-(2) (pg. 193) - The value of the gross estate shall include the value of all property  (1) Receivable by the executor as insurance under policies on the life of the decedent
(does not differentiate between different types of policies received)
 (2) Receivable by other beneficiaries - 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 (turns on
whether decedent, at time of death, possessed any incidents of ownership - if he did,
then full amount paid to beneficiary is includable in the gross estate; if he did not, none
of the proceeds are included in the gross estate) (remember must be over 5 million in
gross estate to be subject to estate tax)
Application of Other Code Sections
 Under 2035, which covers transfers within three years of death, if the decedent
transferred the incidents of ownership in a policy on his life to other parties and died
within three years of the transfer, there would be an inclusion, under 2035, in the
decedent's estate of the amount paid to beneficiaries under the policy
 2042 applies only to policies on the life of the decedent and does not apply where the
decedent owned a policy of insurance on the life of another person and that other
person, the insured, survives the deceased owner of the policy
 Instead the policy is included in the deceased policy owner's estate (rather than
that of the insured) under 2033
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

Generally speaking, the value of the policy thereby included is its interpolated
terminal reserve, i.e. roughly its cash value plus unearned premium
Possession of the Incidents of Ownership
o Reg. 20.2042-1(c)(2) contains examples of incidents of ownership, but there is no set
enumeration (fundamentally the same as those in legislative history – below)
o Legislative History of 1942 includes these examples:
 Right of the insured or his estate to the economic benefits of the insurance
 The power to change the beneficiary
 The power to surrender or cancel the policy
 The power to assign the policy
 The power to revoke the assignment
 The power to pledge a policy for a loan
 The power to obtain from the insurer a loan against the surrender value of the policy
o United States v. Rhode Island Hospital Trust Co.
 The Court holds for the IRS, focusing on the policy facts of the situation, in determining
that since son had the legal right to change beneficiaries under the life insurance policy,
the proceeds were to be included in the son’s gross estate upon his death
 What Congress was attempting to reach through 2042 was the power to
dispose of property
 Power can be and is exercised by one possessed with less than legal and
equitable title
 The phrase “incidents of ownership” connotes something partial/minor – it
speaks more of possibility than of probability
 Policy Facts vs. Intent Facts
 Policy facts: legal rights the son possessed under the policy
 Intent facts: whether the son really intended to exercise the rights
o Morton v. United States: before applying federal estate tax provisions (2042), we must know
what legal rights the various parties have under state law (must know how state law looks at
incidents of ownership)
Harsh Results Under 2042 & Solution
o Proceeds paid to beneficiary, but included in gross estate despite the fact that they're not paid
to gross estate
o Therefore, can be a significant estate tax owed and nothing in the estate to pay it
o 2206 (pg. 243) addresses this situation and provides practical relief
o 2206 says: "Unless the decedent directs otherwise in his will, if any part of the gross estate on
which tax has been paid consists of proceeds of policies of insurance on the life the decedent
receivable by a beneficiary other than the executor, the executor shall be entitled to recover
from such beneficiary such portion of the total tax paid as the proceeds of such policies bear to
the taxable estate."
Avoiding Possession of the Incidents of Ownership
o An insured who wishes to avoid having proceeds of a policy on her life included in her estate
has two fundamental options:
 (1) she can avoid purchasing a policy on her life and leave the task to others making
sure that the policy is so acquired as it vests her with no incidents of ownership
 Since there is no longer a premium payment test, it matters very little if she
financially assists the holder of the policy in paying for it
 Care must be taken in planning the estate of the holder of the policy so that an
unanticipated sequence of deaths and failure to draft carefully the will of the
holder of the policy do not combine to produce unintended and undesirable tax
56
consequences (i.e. if wife acquires policy on the life of husband payable to
children and predeceases her husband with a will which leaves her entire estate
to the husband, she transfers him the incidents of ownership on a policy on his
life)
 (2) she can assign to others all incidents of ownership held by her in policies on her life
and can then hope to live at least three additional years thereafter; problems:
 Insurable interest rules of minority of states will allow insurers to void such
policies
 Under §2035, unless the insured lives three years after assignment of the
policy, the policy is included in the gross estate
 Goodman v. Commissioner (see problem 2): were a mother to acquire from an insurer a
policy on her husband’s life payable to a child as a revocable beneficiary prior to her
husband’s death, at the moment of her husband’s death the mother would be deemed
to be making a gift of the policy proceeds to the child
o Possession of Unretained Incidents Held as a Fiduciary
 Revenue Ruling 84-179/Estate of Skifter v. Commissioner: an insured decedent who
transferred all incidents of ownership in a policy to another person, who in an unrelated
transaction transferred powers over the policy in trust to the decedent as a fiduciary,
will not be considered to possess incidents of ownership in the policy for purposes of
2042(2), provided that the decedent did not furnish consideration for maintaining the
policy and could not exercise the powers for personal benefit
 The result is the same where the decedent, as trustee, purchased the policy with trust
assets, did not contribute assets to the trust or maintain the policy with personal assets,
and could not exercise the powers for personal benefit
o Irrevocable Life Insurance Trusts
 An individual who holds, or is about to purchase, life insurance on her life and who
wishes to avoid inclusion of the policy proceeds in her estate at death, but who wishes
at the same time to ensure the insurance will be available to benefit the insured’s
family in a flexible fashion, frequently seeks to attain these goals by effecting a transfer
of the policy to an irrevocable trust or by arranging for the trustee to purchase the
policy
 Trust is sometimes funded with property, the income of which is used to pay
policy premiums
 Since, at death, the insured will not possess incidents of ownership (bank or
trusted financial institution often appointed as trustee), the policy proceeds will
not be included in the decedent’s gross estate
 If an existing policy with incidents of ownership is transferred into the trust,
must live longer than three years so that it is not included under 2035
 Rev. Ruling 79-129: the right to borrow money against the policy is considered an
incident of ownership under 2042(2)
Retained Life Estates (§2036)
 Background and General Application
o Transfer property to trust but retains some power over the trust – 2036 might cause all property
in trust to be included in the gross estate; valued at the date of death
o 2036(a): (1) Retention of right or (2) Control of Right
 Won’t apply if trust is sold for adequate consideration in money or money’s worth
 Three main requirements:
 (1) Decedent transfers property during his lifetime (usually to a trust, but doesn’t
have to be)
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
(2) The transfers is not for adequate or full consideration in money or money’s
worth
 (3) He retained for one of three time periods, certain rights with respect to the
property; must retain either:
o Right to income or other possession or enjoyment of the property
o The right alone, or with another person, to designate the persons who
could possess or enjoy the property
 When he dies with these circumstances existing, entire valuation of the trust at the date
of his death is included in gross estate under 2036
 NOTE:
 Initial transfer is a gift (value of the remainder interest if he retains the income
interest in the trust)
 2702 says that when Dad retains income interest and gives remainder interest to
member of family, he can only attach value to retained income interest if it's a
qualified interest under 2702 (value of income interest is zero)
 One of Three Time Periods...
 Retained for life
 Any period not ascertainable without reference to his death (i.e. the year I die,
don't pay me, so can't be includable in estate - no, IRS says this won't work b/c
tied in to the time of death)
 Any period which does not in fact end before his death (dealing with situation
where retains income for a term certain and dies before term certain ends)
 2207B (pg. 245)
 Problem is estate will owe taxes on money it won't have
 2207B(a): If any part of the gross estate on which tax has been paid consists of
the value of property included in the gross estate by reason of section 2036
(relating to transfers with retained life estate), the decedent's estate shall be
entitled to recover from the person receiving the property the amount which bears
the same ratio to the total tax under this chapter which has been paid"
 Income Tax Consequences
 2036 says that if you retain certain interests or powers over the trust property,
then treated for estate tax purposes as if you own the property
 In the income tax area, there are analogous provisions (section 671-677), that say
if you transfer property to a trust and retain rights or interest in the trust, income
generated by the assets is yours even if you're not entitled to receive the income
(must report the trust income as your own)
o Powers and interests that cause you to be treated as the owner for
income tax purposes are not the same as those under 2036 which would
put all property in trust in your gross estate
o Mostly similar but do differ in certain ways
o Opens up the opportunity to intentionally set up the trust so that the
donor is treated as the owner for income tax purposes, but don't give
enough power/interest so that 2036 or 2038 kicks in [INTENTIONALLY
DEFECTIVE GRANTOR TRUSTS]
o WHY do this? When you realize that someone must pay income taxes,
maybe it would be better to pay income tax if goal is to transfers as much
as possible to kids (income tax on trust would deplete its value), because
don't want included in gross estate and paying income tax on the trust is
not treated as making a gift to the kids with respect to those payments
(because those payments are his legal obligation)
Information Reservations
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o
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
Estate of Maxwell v. Commissioner
 FACTS
 Mother allowed to stay in the house after the sale provided that she paid rent to
her son
 Mom must pay rent and son must pay interest on the note, but she forgave the
payments each year and forgave the entire thing when she died
 HOLDING: the court concluded that the sale and rent was not a bona fide sale for
adequate consideration and since she was still using and enjoying the transferred
property, it was includible in her gross estate
o If don’t intend to collect on the note that would furnish valid consideration, then adequate
consideration was not received and any interest retained is includible in the gross estate under
2036
Contingent Retained Life Estates – Section 2036(a)(1)
o When the decedent transfers the property to pay the income for life to the beneficiary and then
pay the income back to the transferor
o Commissioner v. Estate of Nathan
 Nathan is given the right to income from a trust if his sister dies first (she gets the income
until then)
 Remainder goes to others upon both of their deaths
 Nathan retained contingent right to get income from property (must outlive his sister to
receive the income)
 On the facts, he dies first and never actually received any of the income from the trust does 2036(a)(1) apply?
 Did he retain income when all he retained was a contingent right?
 Yes, that counts under 2036 - very broad interpretation even though contingent
and never actually received
o Reg. 20.2036-1(b)(1)(ii) (pg. 1173) supports the reading in Commissioner v. Estate of Nathan :
must include the full value of the trust property, but acknowledge that someone else also had a
property right so could subtract the present value of the sister's income interest
o 2036 does apply even to contingent retained interests
The Decedent – Transferor
o Section 2036 includes within the estate only property that was the object of a "retained" life
estate or power and does not include life estates given to the taxpayer by third parties
o Consequently, taxpayers will stumble into the grasp of section 2036 because they unartfully
retained a life interest
o Because the law of most states prohibits settlors from putting property beyond the reach of
creditors, the corpus of self-settled spendthrift trusts are deemed includible in the estate of the
settlor-beneficiaries based on their ability to thereby obtain economic access to such funds to
satisfy the claims of their creditors
o Exploiting choice of law principles, estate planners recently started created self-settled
spendthrift trusts in off-shore tax havens whose laws did not allow creditors to reach such assets
thereby hoping to put these trusts beyond the reach of creditors and the IRS
o Taxpayers may also attempt, with varying degrees of success, to avoid the reach of 2036 by
arranging for others to create or hold the critical interests
Support of Dependents and Other Beneficial Retentions
o Reg. 20.2036-1(b)(2): legal support obligation to support dependent through a trust is also
contained in gross estate because you're actually getting the income
 You would have had to pay for the child, so you're really benefitting from the money that
they're getting
 Treated as enjoying the benefits from the trust
59
o

What if trustees have discretion on dispersement of income, but they're not required to do so?
Trustee is not parent
 As long as irrevocable trust, would not be the discharge of an obligation
 See Chrysler case - dad did not retain right to enjoyment of income interest
o Estate of Chrysler v. Commissioner: the court ruled that the two trusts created by the decedent
for the benefit of his minor children were not included in his estate because the trusts were
irrevocable
 The decedent could not have availed himself at any time until his death of applying the
income for the support of his children, and accordingly, the court held that the
commissioner erred in including the trust funds in the decedent's gross estate
 There is an important different of fact between a trust set up for the very purpose of
providing for the settlor's legal obligation (to care for his minor children) and the one
which disinterested trustees have an option to apply a portion of the income for the
support of the settlor's minor child
o PLANNING NOTE: THE KEY IS TO GRANT DISCRETION TO THIRD PARTY
 If a responsive third party trustee is selected, the granting of discretion to that trustee to
make disbursements to income beneficiaries who are minor issue of the settlor and
whom the settlor is obliged to support provides an excellent means whereby the corpus
of the trust can be put beyond the reaches of section 2036
 Care must be taken to avoid reciprocal trust doctrine
Retention of Control – Section 2036(a)(2)
o 2036 applies if you retrain the right alone or in conjunction with another person, of deciding who
will possess or enjoy the interest (even if you can’t keep it for yourself)
 Value of trust property included in gross estate
 Gift tax: if you can revoke the transfer or change who is given beneficial enjoyment of
property, it is not a completed gift (Sanford Case; Reg. 25.2511-2(c)), but under 2036, is
includible in gross estate
o Control Over Timing and Enjoyment
 If you can just control the timing, but beneficiary will eventually get it anyway, still falls
under 2036, because determines the right of present enjoyment (Struthers v. Kelm)
 Although you're not designating the person (you've already decided who that is),
2036 still applies
 Don't name the donor as the trustee even if all the trustee can do is control the
timing
 Compare to gift tax purposes:
 When he first puts the property into the trust, it a completed gift under 25.25112(d) even if the donor can change the timing of the enjoyment
 Not retaining sufficient control for purposes of gift tax
 You can still have estate tax even if gift tax also applies because inconsistency in
the code between estate and gift tax
o Retained Power Subject to Standard
 Old Colony Trust case – apply the same standard for purposes of 2036(a)(2):
 Did the decedent have the right to control beneficial enjoyment?
 If the only ability is limited by an ascertainable standard, then not under
2036(a)(2)
 Interpretations of ascertainable standards are based on state law
 Support, maintenance, health, and education are nearly always considered
ascertainable standards
 United States v. Byrum (no longer valid law)
 Dad transfers stock into irrevocable trust for the benefit of rchildren
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However, retains the right to vote on the stock in the trust and retains the right to
veto the sale of any stock in the trust
 The court concluded that Byrum's retention of voting control was not the
retention of the enjoyment of the transferred property within the meaning of the
statute
o De facto control was not the same as the legal right to determine who
gets the benefits of the trust
o Had legal duties to minority shareholders not to abuse voting power
 Congress enacted 2036(b) in response to this case which overrules this case [Anti-Byrum
Provision]
 For purposes of 2036(a)(1), retention of the right to vote is a 2036(a)(1) power treated as retaining enjoyment if you have voting rights in the stock
 Thus, situations like the one in Byrum would include the trust property in
decedent's gross estate
 **In general, under the anti-byrum provision of 2036(b), the retention of the right
to vote stock of a controlled corporation is deemed to be a retention of the
enjoyment of the transferred property with the potential for inclusion in the
estate under 2036(a)(1)
 Creative alternatives
 Transfers 990 nonvoting shares to an irrevocable trust but also owns 10 voting
shares
 2036(b) does not apply to these types of situations because did not retain right to
vote over shares that actually got transferred to the trust
o Rev. Ruling 81-15 from the IRS agrees with this
o Indicates that since the donor could not vote the transferred stock and
since it was never endowed with voting rights, the donor could not be
viewed as having retained voting rights with respect to it
o 81-15 provides owners with a splendid means whereby they can continue
to control their enterprise and yet remove from their estates much of the
economic value of their companies
Amount Includible
o Significant questions occasionally arise as to the amount of property that is to be included within
the estate where an income interest was retained by the donor
 As a general rule, the entire corpus of a trust subject to a retained life interest is to be
included in the estate at its date of death value
 Exceptions:
 Where a donor retained an income interest in only a portion of an asset (i.e. a
one-third interest), just that portion of the trust corpus will be included in the
decedent's estate (Reg. 20.2036-1(a))
 If the decedent retained only a contingent life estate following upon the life
estate of another, which life estate was presently being enjoyed, the estate would
include the full value of the trust, minus the value of the life estate that was being
enjoyed at the decedent's death (Reg. 20.2036-1(b)(1)(ii))
o Another issue of interest involves situations in which income from a trust, with respect to which
decedent retained a prohibited interest or power, is retained by the trust and added to the
corpus. At the decedent's death, should the entire trust corpus be included, or, as is done under
§2035, should the value represented by the retained income be excluded?
 In United States v. O'Malley, the Supreme Court decided that in such a situation, the
entire trust corpus, consisting of the original corpus as well as retained income, should be
includible in the estate of the decedent.
 Court's Reasoning:
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With the creation of the trusts, he relinquished all of his rights to income except
the power to distribute that income to the income beneficiaries or to accumulate
it and hold it for the remaindermen of the trusts
 He exercised his retained power to distribute or accumulate income, choosing to
do the latter and thereby added to the principle of the trust
 All increments to trust principle are therefore traceable to the decedent himself,
by virtue of the original transfer and the exercise of the power to accumulate
 Under §2036(a)(2), the power over income exercised by decedent is sufficient to
require the inclusion of the original corpus in his gross estate - the accumulated
interest is subject to the same power and is likewise includible
 Relinquishment of Retained Income Interest Within Three years of Death
o United States v. Allen
 2035 says that for certain types of property interests, if they are transferred within three
years of death, and would have been includible in gross estate otherwise, these transfers
are not respected by IRS and still treated as if includible in gross estate
 Decedent tries to sell retained income interest, because with adequate and full
consideration 2036 does not apply
 10th Circuit says this won't work because adequate and full consideration exception only
applies at the time of the initial transfer to the trust
 Does not count if sell string, even for full and adequate consideration, if it could have
triggered 2035
o Planning Note
 A donor who has retained significant rights so that an inclusion results under §2036 often
finds as that it would be greatly to his or her advantage to sever the strings that bind
 Make sure to do it within three years of death
Powers to Alter, Amend, Revoke, or Terminate
 Historical Introduction
o Clearly, a taxpayer who once owned property and transferred it while retaining the right to
revoke the transfer should be deemed to be the owner of the property at death
o It is the death of the taxpayer holding such right to revoke that effectively transfers the
taxpayer's right to property
 Section 2038 ensures that all such property will be included in the gross estate of the
decedent taxpayer
 The Section goes somewhat further, and in general, sweeps into the gross estate property
transferred by an individual who retained the power, acting lone or in conjunction with
others, to alter, amend, revoke, or terminate enjoyment of the property transferred
o Because of retained interest, there may be overlap between 2036 and 2038
o Components of 2038(a)
 Previously made a transfer of the property, typically to trust (exception if it was a sale for
adequate and full consideration)
 At date of death, possessed the right to alter, amend, revoke, or terminate (doesn't
matter how got the power; just matters whether it was held at the date of death)
 Breadth of Power
o In defining the breadth of 2038, it is necessary to consider whether the section encompasses with
its sweep retentions of the right to alter enjoyment of property in a personally nonbeneficial
manner or the right to determine not who will enjoy the property but merely when the
designated beneficiary will enjoy it.
o Porter v. Commissioner [Nonbeneficial Manner]
 Supreme Court was asked to pass on a situation in which the grantor of a trust for benefit
of his issue retained to himself the power to alter or modify the terms of the trust
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indenture "in any manner but expressly excepting any change in favor of himself or his
estate"
 The executor of his estate argued, to no avail, that since the retained power could not be
exercised in fashion that would benefit the holder, it should not be included in his gross
estate under 2038
 Court said:
 2038(d) requires to be included in the calculation of all property previously
transferred by the decedent, the enjoyment of which remains at the time of his
death subject to any change by the exertion of a power by himself alone or in
conjunction with another
 So far as concerns the tax here involved, there is no difference in principle
between a transfer subject to nonbeneficial changes and one that is revocable.
The transfers are undoubtedly covered by (d).
 Porter definitively established that property is to be included within the estate of the
donor where the donor retains the right to determine the identity of the individual who is
to enjoy property or to choose among a class of potential beneficiaries.
o Lober v. United States [Timing of Enjoyment]
 Facts: Lober established three trusts; income from the trust payable to the children at 21
years of age and corpus of the trust to be distributed at 25 years of age. However, a
crucial term of the trust instrument was that any time Lober saw fit, he could turn all or
any part of the principal of the trusts over to the children.
 Issue: Is the property includible under 2038 when the retention only of the right to
determine the timing of enjoyment is retained by the donor?
 Despite the fact that the property was indefeasibly vested [irrevocable trust], "a donor
who keeps so strong a hold over the actual and immediate enjoyment of what he puts
beyond his own power to retake has not divested himself of that degree of control which
2038 requires in order to avoid the tax."
 Could alter the present economic benefit and the enjoyment of the property
 Similar issues in Struthers v. Kelm - right to control the timing was a retained right
under 2036(a)(2) (in fact, Struthers cites Lober)
 Holding: a power to alter or amend does not require that there by any power to shift
benefits between beneficiaries but that a mere acceleration or postponement is enough.
o Planning Note
 As in the case of 2036(a)(2), where the settlor of a trust wishes to retain some degree of
flexibility with respect to the enjoyment of the property and yet desires to escape the
reach of the estate tax, this goal can be accomplished by vesting the otherwise
troublesome powers in a trusted third party
 As previously shown, there are some concerns that go along with this, however
Joint Powers
o Section 2038 clearly states that, even if the prohibited power is exercisable by the decedent in
conjunction with another person, an inclusion in the estate will nonetheless, result
 Different from gift tax (inconsistency)
 25.2511-2(e) says that if the person whose consent was required had a substantial
adverse interest, then the gift was complete
o 20.2038-1(a)(2): If can revoke with the consent of all the beneficiaries, then not included in the
gross estate under 2038
 Helvering v. City Bank Farmers Trust Co. [Basic Parameters of the Problem]
 Issue: whether 2038 of the internal revenue act requires inclusion in the gross
estate of the value of the corpus of a trust established in 1930 where the creator
reserved a power to revoke or modify, to be exercised jointly with a beneficiary
and the trustee
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Holding: The court held that, even if exercised jointly with a beneficiary, the
trustee's power to revoke or modify caused the corpus of the trust to be included
in his gross estate for purpose of 2038.
o The purpose of Congress in adding clause (d) to the section as it stood
was to prevent avoidance of the tax by the device of joining with the
grantor in the exercise of the power of revocation someone who he
believed would comply with his wishes
o It is critical to the court's analysis that a settlor could modify, revoke, or
terminate the trust with consent of only one of the beneficiaries
Incompetency
o Assume that an individual, who established a trust under which she retained power to revoke the
trust, becomes incompetent and under state law may not during her incompetency exercise the
power to revoke - what are the estate tax consequences if she dies, unable to exercise her power?
o Round v. Commissioner (broad interpretation of 2038)
 The trust instruments provided that upon incapacity the corporate trustee shall act as
sole trustee, thus leaving decedent free to resume his duties as trustee upon the recovery
of capacity (implied that he could resume his power upon temporary incapacity)
 Hurd v. Commissioner: "The statute is not concerned with the manner in which the power
is exercised, but rather the existence of the power."
 So long as the powers retained by the decedent still existed in his behalf the trust
property was includible in his estate
 Judicial declaration of a trustee's incompetence is insufficient to terminate for tax
purposes a power held under a trust
o Circuit court wouldn't go that far; if there was a judicial declaration of incompetency under state
law, 2038 might not apply
o Planning Note: given the approach taken by the court in Round, estate planners who draft deeds
of trust for taxpayers who wish to retain revocable powers now have something to think about
 Possible Solutions [must take these steps BEFORE the person becomes incompetence]
 Make sure it's clear that upon incompetency, clear that permanently restricted
from exercising powers under trust deed
 It might be possible to avoid the problem in Round by providing that a power
lapses at incompetence
 Another way to deal with the problem is creating a durable power of attorney and
granting the holder of the power the right to terminate a revocable power in the
event of incompetency
 However, due to either 2035(a) or the three-year rule of 2038(a)(1), the former holder of
the power would have to live for three years after the durable power was exercised to
terminate the revocable power
 In the case of a lapse triggered by incompetence, however, the incompetent's attorney
could claim they since they neither "transferred" nor "relinquished" a revocable power, as
required by statute, it does not appear that in order to avoid inclusion it is necessary that
the former holder live three years after the lapse
Power Subject to Standard
o As in the case of 2036(a)(2), inclusion in the taxable estate does not result where the donor did
not retain a discretionary power with respect to transferred property but merely retained a
power subject to a fiduciary standard capable of being administered by a court of equity
 Since the trustees were not free to exercise untrammeled discretion but were to be
governed by determinable standards, their power to invade capital, conditioned on
contingencies which had not happened, did not bring the trust property within the reach
of 2038 (Jennings v. Smith)
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o
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Planning Note
 As in the case of 2036(a)(2), the donor who wishes to make a gift that escapes the power
subject to standard exception must be careful that the standard chosen is one that is
enforceable by a court of equity
 Consequently, standards should be expressed in terms of support, maintenance, health,
and education while general language such as "best interest" or "as trustee deems
advisable" should be eschewed
Uniform Transfers to Minors Act
o Where gifts are made to a minor under the Uniform Transfers to Minors Act or the Uniform Gifts
to Minors Act and the donor appoints himself custodian and dies while the donee is under the age
that custodianship terminates (generally 21), the IRS has two theories whereby it can seek
inclusion of the gifted property in the donor's gross estate
 First, if the donor is also the parent of the donee and appoints himself guardian, since the
donor has the obligation to support the donee and as a custodian has retained power to
use income from the gifted property to fulfill that obligation, inclusion in the taxable
estate follows under 2036(a)(2)
 Second, regardless whether donor is a parent, if the donor appoints herself as custodian
and dies prior to termination of the custodianship, because the donor, as custodian, has
the power to bestow upon or without from the donee enjoyment of the income from the
property (as well as the property itself), inclusion in the donor's taxable estate follows
under either 2036(a)(2) or 2038
o Where two donors seek to avoid §2036 or 2038 problems by appointing each as custodian for the
other's gift under UTMA or UGMA, they may run afoul of the reciprocal trust doctrine
 Rev. Ruling 74-556 decreed that where an individual appoints a spouse as custodian for a
gift under UGMA and that spouse joins in making a split gift, in the event of the death of
the custodian during minority there will not be an inclusion of one-half of the property in
the gross estate of the deceased spouse
 Rev. Ruling 70-348
 Facts: A donor makes a gift to minor children under UGMA, appointing his wife as
custodian. At her death he was appointed successor custodian. At the donor's
death, the children were in minority.
 Ruling: No inclusion could be made under §2036 since the deceased merely
possess, but had not retained, a 2036(a)(2) power. Since 2038 require that the
donor merely possess, not retain, the power to alter, amend, revoke, or
terminate, the gift was included in the donor-custodian's gross estate under that
section
Power to Substitute Trustee
o Reg. 20.2038-1(a)(3) indicates that inclusion results under 2038 where the decedent grantor had
the unrestricted power to remove a trustee and replace the trustee with the decedent, and the
trustee is invested with discretionary powers which if retained by the decedent would have
resulted in inclusion under 2038
o However, where the power of the decedent-grantor to appoint herself is limited to conditions not
present at the time of death (i.e. death or resignation of the trustee) there is no inclusion under
2038 (see Reg. 20.2038-1(a)(3))
o This is a critical distinction between 2036 which applies to contingent retained powers and 2038
which applies only to powers which are exercisable at death - except for this critical distinction,
the contingent power issue should be resolved similarly under 2036 and 2038
Overlap of Sections 2038 and 2036(a)(2)
o First Distinction
 Under 2038, court brings up "contingencies"
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Contingent retained interests are enough to trigger 2036(a)(1) even if at the time of death
you weren't in possession of the contingency (although in valuing property, can subtract
out the present value of the ongoing interest)
 In contrast, 2038 discusses powers actually held on the date of death (if you didn't have
right, but just a contingent right, then not includible under 2038)...see pg. 390-91
o Second Distinction (retained vs. held)
 Did you retain the prohibited right at the time of the initial transfer?
 If trustee can make discretionary allocations, and donor not originally trustee, but later
appointed
 Have a good argument that you didn't retain and 2036(a)(2) probably won't apply
 But 2038 probably will apply because you hold the powers at the time of death
o Third Distinction
 Type of beneficial enjoyment transferor's power can effect
 2036(a)(2), if donor has the right to alter the right of the beneficial enjoyment of the
income (or annual benefit that flows from property), then 2036(a)(2) can apply and so
would 2038
 Situation
 Mom retains right to accelerate transfer of corpus distribution
 Income to son for 10 years
 Everything in the corpus after 10 years
 Mom dies four years in
 Regardless of whether she exercise the power, son's interest in the income of the
property is not going to be affected (no ability to alter enjoyment of the income - will get
all the income each year either way)
 As a result 2036(a)(2) won't step in here - only deals with current enjoyment of
the property (i.e. the income here)
 Note: in Struthers (2036 case), donor had the right to play around with the
income, which is not the situation we have here
 However, mom controls possession of remainder interest, 2038 would catch that
retained power
o Final Distinction
 Amount included in gross estate when the provision is triggered
 2036 only focuses on income as the triggering event
 Once triggered, requires inclusion of all of the underlying property
 In contrast, 2038 will often have a narrower amount included
 "To the extent of any interest therein of which the decedent has at any time
made a transfer...where the enjoyment thereof was subject at the date of his
death to any change through the exercise of power…"
 Value of the interest where they controlled the beneficial enjoyment, must be
included in the gross estate
 Don't have to include both valuations, just the larger of 2036 or 2038
Transfers Geared to Grantor’s Life
 Introduction: §2037 - Transfers Taking Effect at Death
o Another situation where Congress felt the decedent had a sufficient connection to the property
at the time of death, that he had enough of a connection that the underlying property should
be included in gross estate
o Under 2037, property transferred during the decedent's life will be included in his or her estate
if: (1) possession or enjoyment of the property through ownership, can be obtained by an
individual only by the individual or another party surviving the decedent; and (2) the decedent
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has retained a reversionary interest in the property, which immediately before the decedent's
death, exceeds five percent of the value of such property
 It is important to remember that, for inclusion to result under 2037, both requirements
must be satisfied
 Moreover, situation where a reversion is present, but one or both tests under 2037
have not been met, taxation of the reversion in the decedent's estate under 2033
should not be overlooked
 Decedent has non-de minimus reversion interest in the property
 Survivorship Requirement – Estate of Marshall
o Being able to enjoy the property only by surviving the decedent
o Reversion: testamentary right under wife’s will or the wife’s heirs under Pennsylvania law
o Husband under Penn. law is entitled to 1/3 share – reversionary interest in 1/3 of trust prop.
 Is survivor prong requirement satisfied?
 Children still might get that 1/3 of the property even if husband is still alive (divorce…)
 When put all possibilities together, the contingencies are real enough that we should
respect them in applying 2037
 What is a reversionary interest? 2037(b)
o The term reversionary interest includes the possibility that the property transferred by the
decedent may return to him or his estate
o Does not include that the possibility that the income alone may return to him – 2036 might be
concerned with this; even a contingent right to the income will qualify
o Reversionary interest must also be valued at 5% of the value of the underlying property
 Based on actuarial tables (don’t look at health of decedent before death)
 If contingent on surviving several people, calculations are very complex
 Compare the lives of who must outlive the transferor to get the property
 Once you run afoul of 2037, must ask how much is included in gross estate? Rev. Ruling 76-178
o Valuation of the reversionary interest is not the amount that is included in the decedent’s gross
estate – just calculated to see if 2037 is violated
o 2037(a) – the value of the property that was subject to the survivorship requirement is the
value that gets included in the gross estate (value of remainder interest generally – use table S
b/c based on someone’s life)
 Distinguish between 2036 and 2038
o 2038: decedent had some kind of discretionary power over the just property – alter, revoke,
amend
o 2036(a)(2): some kind of ability to control who was going to get the beneficial enjoyment of the
income
o 2036(a)(1) triggered if decedent had an income interest
o 2037 – all future distributions will automatically flow, so decedent has no discretionary control
o 2037 – retains reversion interest
 Exceptions
o If the initial transfer was for adequate or full consideration in money or money's worth
o Effective date of 1916 (pretty much irrelevant now)
Power of Appointment
 Introduction
o Powers of appointment are classified as either general powers or special powers
 Special powers are those exercisable in favor of a limited group of persons - generally
speaking, neither exercise nor nonexercise of a special power of appointment has estate
or gift tax consequences
 General powers are those powers that may be exercised in favor of the powerholder's
estate, or the powerholder's creditors, or the creditors of the powerholder's estate 2041(b)(1)
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Because the holder of a general power can directly benefit from the power, the
powerholder's exercise of such a power will result in the property subject to the
power being included in the powerholder's estate if the power is exercise at
death (or being subject to gift tax if the power is exercised during life)
 Similarly, failure to exercise a power will also generally have either estate or gift
tax consequences, the reasoning being that the forbearance to exercise is a
decision committed to the powerholder and is truly effective control of the power
property that ends only when the power can no longer be exercised
o Section 2041 is the current provision that sets forth the complex set of rules governing the
taxation of property subject to the general power of appointment
 The present approach of 2041 is to classify all general powers in accordance with their
date of creation, between those existing on or before October 21, 1942 and those created
thereafter (2041(a))
 Preexisting powers [2041(a)(1)]are to be taxed only if the power is exercised (1)
by will or (2) by a disposition that would have made the property includible if the
disposition had been a transfer of property owned by the decedent - the
nonexercise or release of the power results in no tax
 Post-1942 powers [2041(a)(2)], under the statute, mere possession of such a
power at death will cause inclusion of the property in the gross estate of the
holder, even if the powerholder does not exercise the general power of
appointment
 The date the power is created is controlled by the date when the instrument creating the
power takes effect (Reg. 20.2041-1(e))
o 2041 is more taxpayer friendly than 2036 and 2038 because does not matter about deciding who
gets beneficial enjoyment as long as you weren't the original transferor of the property
What is a Power of Appointment?
o Keeter v. United States: look to applicable state law to determine whether the substance of the
property interests created by the settlor fits within the federal law’s definition of a power of
appointment (substance of state law is relevant, not the labels attached)
o Estate of Margrave v. Commissioner: in order for such a power to result in the inclusion of an item
in decedent's gross estate under 2041, the decedent must at least (1) possess a power within the
definition of "a general power of appointment," and (2) there must be a property interest to
which this "general power appointment" attaches
o Connecticut Bank and Trust Co. v. United States: 2041 is concerned with the power to deal with
property belonging to someone else
Distinguishing General and Special Powers
o Section 2041(a)(2) provides that the value of the gross estate shall include the value of all
property with respect to which the decedent had, at the time of her death, a general power of
appointment
o Section 2041(b)(1) defines what a general power of appointment is: a general power of
appointment is any power that is exercisable in favor of (1)the powerholder, or (2) the
powerholder's creditors, or (3) the powerholder's estate, or (4) creditors of the powerholder's
estate - 2041(b)(1)
o Revenue Ruling 69-342
 Makes clear that both testamentary and nontestamentary powers of appointment can
cause an inclusion
 Look to state law to determine whether there was a right to appoint the property to
himself, etc. (whether he had a general power of appointment is determined by state law)
o In Tech. Adv. Mem. 9431004, the IRS concluded that a power to mortgage was a power of
appointment when held by the holder of a life estate - rejected was the argument that the power
to mortgage was administrative only
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Invasion Powers
o Under 20.2041-1(b), defining a power of appointment, it is provided that a power to consumer or
appropriate property is a power of appointment if, for example, a trust instrument provides that a
beneficiary may appropriate or consume the principal of a trust
o The power of invasion not limited by an ascertainable standard, granted to the independent
trustee, cannot be imputed to the decedent so as to render the power taxable in the decedent's
gross estate under section 2041
o 2041 can arise in an indirect manner
 The power to remove and replace makes the power of the trustee attributable to Bob
 Estate of Wall v. Commissioner - if Bob can name himself the trustee or someone
subordinate or related, then attribute the trustee's powers to Bob (which could make it a
general power of appointment)
o 2041 and General Powers of Appointment in the case of minor children
 Treated as if he can distribute property to himself if he can withdraw the property for the
benefit of his minor children 20.2041-1(c)(1)
 Paying his legal obligation of support
Exception1: Ascertainable Standard
o If it is a standard that a court can objectively enforce, the power is not deemed to have sufficient
discretion to warrant having an inclusion in their gross estate
o The types of ascertainable standards that can be relied on are limited in this context - limited to
health, education, support or maintenance
o Test (Estate of Sowell v. Commissioner - the court held in this case that the phrase "in case of
emergency or illness" was an ascertainable standard related to Mrs. Sowell's health, education,
support, or maintenance.)
 First, the standard of invasion must be ascertainable, that is, capable of being readily
interpreted and applied by a court of law
 Second, the standard of invasion must be related to or reasonable measurable in terms of
the decedent's needs for health, education, support, or maintenance
Release and Disclaimer
o If you exercise or release a general power of appointment while alive, might have estate tax
consequences after you die (2041(a)(2))
o The property subject to the power will be included in the powerholder's gross estate if the power
is released in such a way that the property would have been included in the powerholder's gross
estate if it had been owned and so transferred by the powerholder, i.e., if the provisions of 20352038 would apply to the transaction
 If you hold a general power of appointment, it is kind of like it's your money because you
could take it for yourself
 2041(a)(2) causes an inclusion in the gross estate
Lapse
o When you have a general power of appointment, might choose to let it lapse - governed by
2042(b)(2)
o Generally speaking, if you have a general power of appointment and let it lapse, look at it in the
respect of a release - in other words, if that had been your own money, does it create a situation
that could be taxed under §§2035-2038
o 2041(b)(2) carves out an exception whereby the lapse of certain powers of appointment will not
be treated as a taxable release
 This exception, commonly-referred to as the "five-and-five power," provides that a lapse
is not to be considered a taxable release to the extent that the property subject to the
lapsing power, at the time of the lapse, did not exceed in value the greater of $5,000 or 5
percent of the value of the property out of which the exercise of the lapsed power could
be satisfied
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
The exercise or nonexercise of a five-and-five right to withdrawal power is generally
estate and gift tax neutral - one exception to this general proposition is in the year of
death, the powerholder's estate will be deemed to include the amount eligible for
withdrawal by the powerholder at the moment of death (Reg. 20.2041-3(d)(3))
o **Must analyze what happened to that property as if the trustee had put his own money in would it trigger 2035-2038?
 State Legislation to Limit General Power
o State legislators routinely add default rules to the state's probate cord or equivalent so as to
effect a "best results" or "most likely results" outcome in cases where the text appearing in the
governing instrument is susceptible of more than one meaning.
o Typically, the statutory interpretation is intended to prevail unless, in the specified instances, the
governing instrument is found to otherwise provide. In more recent times, legislatures have taken
to "fixing" instruments that might be construed to have a "bad tax result"
 Exception 2: Joint Powers
o 2041(b)(1)(C) = Joint Power Exception
o Post 1942: only get out of the general power of appointment exception if the joint power holder
is one of two types of people (can be either of these types of people):
 (1) The other power holder is the donor
 (2) The other holder has a substantial interest in the property adverse to that of the
donee
o Estate of Towle v. Commissioner illustrates that the other holder does not have a "substantial
adverse interest" unless that holder somehow has a personal stake in seeing that the power is not
exercised by the donee in the donee's own favor
 2041(b)(1)(C)(ii) was intended at the very least to require that the third person have a
present or future chance to obtain a personal benefit from the property itself
 At some point the other power holder must be in line to get the property (substantial
adverse interest in seeing the trustee exercise the withdrawal power)
 Facts
 The other joint power holder (bank) is going to be the trustee of the trust created
by the remainder interest of the present trust
 Does the bank have a substantial adverse interest? No.
 Holding: The bank did not have a substantial adverse interest - there must be a chance to
obtain a personal benefit of the property in order to have a substantial adverse interest.
Transfers Within Three Years of Death
 Introduction
o Gift Tax Benefits
 Annual per donee exclusion of $13,000
 Future appreciation is not included in the gross estate – not subject to the transfer tax
in your generation
 The gift tax is exclusive – get the amount of the tax out of the tax base
 The donor is responsible for paying the gift tax and can use other assets to pay
that gift tax (doesn’t come out of the asset being transferred)
 In contrast, all taxed included in gross estate are taxed and then those same
assets are used to pay the tax
o Section 2035 potentially eliminates two of these benefits
 Impacts the ability to get future appreciation out of the tax base and impacts the
exclusive nature of the gift tax
 2035(a) focuses on future appreciation
 2035(b) focused on the tax exclusive nature of the gift tax
o Section 2035 Before 1976
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Transfers in contemplation of death were swept back into the estate tax base by what is
now §2035
 But the question of whether the particular transfer was or was not in "contemplation of
death" provided a field day for lawyers who litigated the issue
 Juries, which passed on the factual issue of whether the gift was in contemplation of
death, seemed to regularly show their approval of these last-minute transfers
o 1976 Changes
 Section 2035 was amended to provide that all transfers within the last three years of
the decedent’s life should be swept into the taxable estate as death-related transfers –
along with the taxes paid on the gifts
 This accomplished the result of treating transfers during the last three years in the same
way as the rest of the taxable estate
o The 1981 Act and the 1997 Act of Congress
 2035 now provides that except in certain limited situations, there is no special rule of
inclusion in the gross estate for deathbed transfers
 All such transfers are subject to the gift tax and will, in addition, be reflected in the final
estate tax return as lifetime transfers, affecting the tax rate to be applied to the
property in the taxable estate
2035(b): Inclusion of Gift Tax on Gifts Made During 3 years Before Decedent’s Death – “The amount of
the gross estate…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”
o Fact pattern that this code is aimed at:
 Mom is terminally ill and has a large amount of assets – well over the 5 million
 Knows that if she holds on to it, it will all be included in the gross estate minus
exceptions
 Must pay the estate tax using some of the assets
 She makes a last-minute deathbed gift
 Donor responsible for paying the gift tax
 She would transfer the maximum amount she could transfer and still have
enough left over to pay the gift tax
 The kids would end up with more money than they would have if she had held onto the
money until her death
 The gift tax liability (what she kept to pay the gift tax) is never itself subject to
the transfer tax
 In contrast, if the money went through the estate, the money used to pay the
tax would also itself be subject to the estate tax
o “Grossing Up”
 Under 2503(b) gift taxes paid on gifts made during the last three years of the
decedent’s life are to added to the gross estate of the decedent
 This process is known as “grossing up” and has the effect of including the tax money,
i.e., the money used to pay the transfer tax, in the tax base
o 2503(b), therefore, looks back three years from the date of death and 2035(b) includes any
transfer subject to the gift tax
 Includes in the gross estate the gift tax that was paid on the gift
 Creates the situation that would have occurred she had held onto it until her death and
transferred it through the estate tax
 2035(b) does not look at subjective intent – whether it was made in the contemplation
of death does not matter
 If the donor who makes the taxed gift pays the tax and lives three years after the gift is
made, pays no additional estate tax due to the gift (if you die exactly three years after
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the gift is made, TAM 200432016 indicates that the IRS will not deem the gift to have
been made within the three years)
o What happens if the donee pays the gift tax on the gift?
 The courts are of the view that they are entitled to stretch the literal language of
§2035(b) to cover the gift tax payment by the donee to make the system work as
Congress intended
 Gift tax paid by donee is still swept back into the gross estate
o 6324(a)(2) looks at what happens when the gift tax is swept back into the gross estate but there
is no money left in the estate to pay
 The transferee who receives the property included in the gross estate, shall be liable for
the tax on the property
 The Armstrong case indicates that where the estate is unable to pay estate tax because
it has insufficient assets on hand, §6324(a)(2) imposes liability for the tax on the
transferees of property included in the gross estate
2035(a): Inclusion of Certain Property in the Gross Estate
o Addresses the use of lifetime gifts in order to avoid future appreciation of property in the gross
estate
o Only applies to certain types of gifts made within the last three years (i.e. cutting the strings
that would have triggered an inclusion in the gross estate had the strings not been cut)
 The three-year rule is preserved for certain gift tax inclusion transfers described by the
language of §2035(a) as transfers of property with respect to which “the value of such
property (or 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
 In such cases, the 2035(a) calls for the inclusion in the decedent’s gross estate of the
value which would have been included, had the transfer within three years of death had
not been made
o This provision applies most often in the case of life insurance (see life insurance transfers
below)
Life Insurance Transfers within Three Years of Death
o Quite clearly, where the decedent purchases from an insurer a life insurance policy and
transfers all incidents of ownership in the policy to another individual within three years of
death, the proceeds of the policy will be included in the gross estate of the decedent pursuant
to 2035(a)
o Of more interest are situations in which an individual taxpayer, within three years of death,
strongly suggested to another person that he or she purchase a policy on the taxpayer’s life and
then proceeded to furnish that person with the funds necessary to pay the premiums on the
policy
 The incidents of ownership test under 2042 control
 This means that, even though the decedent was the propelling force for the acquisition
of a policy on her life, if she never possessed (and consequently never transferred) any
of the incidents of ownership with respect to the policy within the three years prior to
death, there would be no inclusion of policy proceeds in her estate under 2035
 Estate of Headrick – the court held that the cross reference to §2042 in the revised
version of 2035 provided that the 2035 was viewed as:
 (1) Incorporating tests of that section for purposes of determining the tax
treatment of transfers of life insurance under §2035(a)
 (2) Rejected the “deemed transfer” test applied to pre 1982 deaths (deemed
transfer test stated that if the decedent was the propelling force in the
acquisition of the policy – even if acquired by another – and provided payment
for the premiums, the decedent may be deemed to be the transferor of the
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policy with the effect that the proceeds of the policy were to be included in the
gross estate of the decedent under 2035)
Expenses, Debts, Claims, and State Death Taxes
 Estate Tax Calculation
o 2051: the value of the taxable estate shall be determined by deducting from the value of the
gross estate the deductions provided for in this part
 Don’t just focus on the amount included in the gross estate under 2033
 Impose tax on the amount after deductions
 Two Broad Categories of Deductions
o Effort to more accurately measure the amount of assets that are actually available to the
transferred heirs
 2053 – expenses, indebtedness, and taxes
 2053(a) deductions from the gross estate
o (1) Decedents funeral expenses
o (2) Administrative expenses – 20.2053-3(a)
 Actually and necessarily incurred in the administration of the
decedent’s estate
 That is, in the collection of assets, payment of debts, and
distribution of property
 2053(b) deals with other administrative expenses that don’t
involve probate assets – these are deductible as long as they
would have been deductible under 2052(a) had they been
included in probate
o (3) Claims against the estate
 Decedent owed money toe people while he was still alive – can
file claims against the probate estate
 As long as they were allowable at the state level, deduction
applies to the value of what is owed
o (4) Unpaid mortgages on property
 Decedent owed money on real property that is included in
gross estate
 Debt is deductible in real property even if they don’t have a
claim against the gross estate
 Restrictions
o 2053(a) – expense/claim/debt must be allowable under relevant state
law
o 2053(c)(1)(A) – won’t give a deduction for the claim unless you have
received something of value back (when you incurred the obligation, if
you didn’t receive consideration in money or money’s worth, no
deduction)
o 2053(c)(2) – the total amount includible under 2053 cannot exceed the
value of the probate estate (property owned at the time of death that is
not subject to the claims of creditors) unless you paid an additional
amount to creditors through a different method (i.e. if there is a trust
set up specifically to pay creditors, then the deduction is allowed)
 2054 – losses (fire, storms, etc.)
o Meant to implement some other policy goal: charitable and marital deductions [see below]
Charitable Bequests
 8 million in gross estate – 1 million to charity = 7 million on taxable estate (sec. 2055)
 Partial transfers of property makes this a little more complicated
o If you put property into a trust – charitable organization to receive income or remainder
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o Concern that the charity won’t end up getting much out of their interest
o There are, therefore, specific rules that must be followed to claim the deduction
Marital Deduction
 Introduction
o 2056 governs the marital deduction
o The marital deduction is now unlimited – if you leave everything outright to your surviving
spouse, get a martial deduction for everything (taxable estate is $0)
 Requirements for Marital Deduction – Overview
o 2056(a) – only to the extent that the interest is included in the gross estate (see problem 1 on
pg. 706…lifetime interest expired at death so not included in gross estate)
o Must be legally married at the time of the decedent’s death – look to state/local law to
determine whether there is a valid marriage at time of death
 Exception: same-sex relationship is not treated as married for purposes of federal law,
even if local law recognizes the marriage
o Requires that the property pass to the surviving spouse at the decedent’s death
 Everything goes to wife if living, otherwise to son
 Qualified disclaimer under 2518 – would be treated as going straight from husband to
son
 No marital deduction would be given in such a circumstance
 Citizenship Requirement
o Surviving spouse must be a US Citizen
o Qualified domestic trusts are the only exception
 EXCEPTION to the Marital Deduction – primarily turning on situations where there is a terminable
interest
o 2056(b)
o Where the decedent dies and leaves the surviving spouse some kind of terminable interest
(typically a life estate – right to income for life), marital deduction is denied; do not even receive
deduction for the income interest received during life
o Marital deduction is denied in the case of a terminable interest – tries to treat marital couple as
a unit for transfer tax purposes, but when property is transferred out of the marriage, then
want to make sure that tax is imposed
 2033 would not generally impose a tax because interest terminates at surviving
spouse’s death
 Nothing would be included in the gross estate under 2033
o 2056(b)(1) – basic exception – interest that is given to the spouse could terminate upon the
passage of time or the occurrence of an event, generally not given a deduction; two criteria
 (A) Interest in the property is passed to someone other than the surviving spouse or her
estate – if the passing interest is placed in the surviving spouses gross estate, this is an
estate trust and gets full marital deduction
 (B) If by reason of such passing such person may possess or enjoy any part of such
property after such termination or failure of the interest so passing to the surviving
spouse
 EXCEPTIONS to the EXCEPTION – (b)(3), (5), (6), & (7) [aka even if it is a terminable interest under
2056(b)(1), still get the marital deduction for the full value of the property transferred
o (b)(7) – QTIP Exception
 If it is qualified terminable interest property, you get the marital deduction for the full
amount of the property
 Don’t have to give a general power of appointment like in (b)(5) LEPA exception so the
surviving spouse does not have ultimate control over the distribution of the assets
 Requirements for QTIP
 Must pass from the decedent
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o
o
Surviving spouse must have a qualifying income interest for life
o Entitlement to all the income from the property payable annually
o No person has the power to appoint any part of the property any other
person other than the surviving spouse
 2056(b)(7)(B)(i) – decedent’s executor MUST ELECT QTIP treatment if you
otherwise qualify
o Election will have estate tax consequences for the surviving spouse down
the road under 2044
o Election must be made in appropriate time period – usually 9 months
after death
 How does Congress tax the transfer without a general power of appoint like in LEPA?
 Taxes under 2044(b)(1)(A) against surviving spouse
 Get the upfront marital deduction but want to make sure it can be taxed still
 Also applies if you get a QTIP election on the gift tax side under 2532(f)
 2044 also mention 2519
o 2519 is a backstop to 2044
o 2044 assumes surviving spouse will hold on to QTIP interest until death
o 2519 addresses the situation where the surviving spouse gets rid of the
lifetime income interest – if she transfers away any interest while she is
alive, it will fall under the gift tax
(b)(3) – Short Survivor Requirements in Will
 Will might state that all property will be distributed outright to surviving spouse if she is
still living at the conclusion of deceased spouses’ probate; if not, then give to son
 This is a terminable interest – contingency if she were to die before probate concluded
 As a result of termination, property would go to someone else
 (b)(3) would not help on these facts – because it could be longer than 6 months
 If interest could terminate more than 6 months after the deceased spouse’s death, (b)(3)
will not apply
 Two wife is living six months after deceased spouse’s death, otherwise give it to
son
 This is fine because the contingency does not last longer than 6 months
 This provision is for the nontax purpose concerns about complications and costs of
probate (two rounds of probate is more expensive than one, so if wife dies within 6
months and ultimately going to same beneficiaries anyways, skip the second round of
probate)
(b)(5) – Life Estate with Power of Appointment in Surviving Spouse Exception (LEPA)
 Reg. 20.2056(b)-5(a) breaks out the five requirements of LEPA
1. The surviving spouse must be entitled for life to all of the income from the entire
interest or a specific portion of the entire interest, or to a specific portion of all
the income from the entire interest
2. Income must be payable at least annually
3. The surviving spouse must have the power to appoint the entire interest or the
specific portion to either herself or her estate (general power of appointment;
can give power to other people as long as SS also has it)
4. The power of the surviving spouse must be exercisable by her alone and must be
exercisable in all events
5. The entire interest or the specific portion must not be subject to a power in any
other person to appoint any part to any person other than the SS
 The general power of appointment required under LEPA causes everything to be included
in SS’s gross estate under 2041
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Tying the Martial Deduction into Unified Credit [see powerpoint slides]
 Option #1: Transfer all assets outright to the Surviving Spouse
o Estate of First Spouse to Die - 7 million dollars
o Tax consequences
 At first spouse's death, no tax (7 million dollar marital deduction - 2056(a))
 At surviving spouse's death, full $7 million included in her gross estate (1st spouse's unified
credit was wasted prior to 2010 legislation) - first $5 million sheltered by her own unified
credit
o Non-Tax Consequences
 Surviving spouse has full control over the $7 million
 Option #2 - Transfer all assets to QTIP trust for surviving spouse
o Payable to surviving spouse annually for life (remainder to children at S.S.'s death)
o Tax Consequences
 At 1st spouse's death, no tax (if 2056(b)(7) is satisfied and elected)
 At surviving spouse's death, full $7 million included in her gross estate (§2044 if §2056(b)(7)
QTIP election was made) (1st spouse's unified credit was wasted prior to 2010)
o Main difference from Option 1 is the non-tax consequences
 1st decedent controls the disposition of the property
 Option #3 - Typical A/B Trust Structure
o Estate of First Spouse to Die - $7 million
o Assets divided at first spouse's death
 A Trust (2 million)
 Marital Deduction Trust
 Use marital deduction on this trust so not included in gross estate
 Structure this trust so that it meets marital deduction
 Set it up based on what is important to the client (see slides)
 QTIP
 LEPA
 Distribute Outright
 B Trust (5 million)
 Bypass Trust/Credit Shelter Trust
 Use unified credit on this trust - therefore, can put up to $5million if there were no
lifetime gifts made while still alive
 Various ways to set up this trust
 Don't want to make QTIP election, because relying on unified credit to keep it out
of the surviving spouse's gross estate
 Typical approach is to give wife to income for life with limited power of
appointment, but need not provide anything to the surviving spouse
 Make sure if give power of appointment to herself, limited by ascertainable
standards so that she is not given a general power of appointment that
would make it includible in her gross estate
 Could also give limited power of appointment to appoint principal among
heirs
 The amount being put into each trust becomes complicated - the amount that could be
sheltered under unified credit has gone up (want to make sure that not too much is included
in that trust so that nothing is included into trust A for spouse)
o At surviving spouse's death
 A Trust
 If QTIP, distributed per 1st decedent's desires, else depends on SS's powers an whether
exercised
 This amount is included in SS's gross estate (along with her other assets)
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B Trust
 Distributed per 1st decedent's desires, unless SS had, and exercised, a limited power of
appointment
 NO TAX! Do no waste decedent's unified credit
2010 legislation - provides for portability of the deceased spouse's unified credit (SS later dies: she can use
her unified credit and can use unified credit of whatever her deceased spouse had not used up)
o Deceased's executor's must make an elective to allow the portability
o Why they may want to file return even if you're not otherwise required to
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