Estate and Gift Tax Outline
I. Introduction
A. In General
1. Estate tax was designed to break up large estates. (Inherited economical power is
like inherited political power.)
2. Who pays the estate tax?
a. 24 billion was paid in estate tax, more than half of which came from 3600 estates
(smallest being 5 million). This is a tax being paid by the wealthiest individuals.
b. The 3600 was .0015% of the people who died in 2000.
c. 52,000 were required to file estate taxes.
d. This truly applies to only a small amount of tax payers.
3. Promotes Charitable Giving
a. One of the good things about the estate tax is that it forces the wealthy to decide if
they are going to give their estate to the government or to a charity.
b. When we repeal this tax will they still leave their money to charities? Many who
have done this in the past were motivated by this tax.
c. These charities may provide jobs for their families, but the IRS watches these
carefully to ensure that there are a requisite disbursements made
B. Nature of the Tax We Have
1. Estate Tax
a. this is imposed on the decedent’s estate (as opposed to an inheritance tax imposed
on the heir)
b. This must be paid before there can be a distribution
c. Before 1981, only 50% of what was left to a spouse was exempt. This changed in
two ways:
i It is unlimited
ii before you had to give it outright or you had to put it into a trust (power of
appointment) in which the spouse had the general power of appointment –
 We created the Q-Tip trust – property will qualify for the marital
exclusion if it is left in a trust such that the surviving spouse receives all of
the income from the estate and then dictate where it goes at the time of the
surviving spouses death. We can make provisions to this such that the
trustee can go into the principle of the trust when it is needed for health,
maintenance, etc.
d. Gross Estate
i Property owned at time of death passing through the will.
ii Testamentary Substitutes
 Life Insurance
 Pension/Retirement
iii Trusts – we will spend a lot of time on this (§§ 2036, 2037, 2038)
 Raise questions of a gift being given in the lifetime of the decedent
 Raise questions of whether or not this is part of the estate
 Will there be a double tax?
 When the Grantor gives the right of the income of the trust it is a gift.
§ 2036 – estate will include the right that is transferred in the trust (all
of the property is included in the estate).
 This is not double taxation, it gives the government the opportunity to
tax the appreciated value of the property. We back this out when we
credit the Tentative Tax for all gift tax payable.
 In the Estate Tax we are trying to tax the transmittal of wealth at
death – so we do not want to limit to what the decedent leaves in his
will. We will also tax the appreciation on the property you gifted
previously.
e. Estate Tax is due 9 months after death and you can get an automatic 6 month
extension (this does not extend the time for payment). There are some things that
let you extend the payments over years – an estate with a closely held business.
The interest rate on this payment schedule is as low as 2%.
2. Gift Tax
a. Necessary back up to the estate tax (wealthier individuals were giving their assets
away to avoid the estate tax)
b. This is imposed on the donor, the donee is secondarily liable if the donor does not
pay
c. Cumulative form of taxation – the calculation is a cumulative process, you have to
add all prior gifts when you calculate the current years tax rate (you credit what
you pay by what you paid in previous years)
d. How do we get to taxable gifts?
i What is subject to a gift tax?
ii When is the Gift Tax applicable? Concept of completed gift – the gift tax is
imposed when the gift is complete. When is the gift complete for gift tax
purposes? When has the transferor given up dominion and control over the
property?
 Ex. Grantor puts property into a trust and provides that all of the income
will go to Y for Life and then to X. This is fine. (Note> there are two gifts
in this situation: Gift of Income and Gift of Remainder. Each of these gifts
would be taxed separately and can be completed and thus taxed at
different stages.)
 There are problems when there is a power to revoke. If there is a right to
revoke, a gift will occur at the first distribution to Y. Then if he gives up
his power to revoke, then the gift is complete.
 What if the Grantor retains only the power to change who receives the
income? The gift of the remainder will be complete, but the income gift
will not be.
iii What is the value of the property transferred (we will spend very little time on
this in this course, but know that this is very important in practice)?
 Do we have a transfer that is for less than adequate compensation? What
was the FMV of the amount transferred and what was given in exchange
for this FMV?
 When we are dealing with third parties, there will be a tendency to find
that it is not a gift, but when it is a family member, there it will be
more likely to be found a gift.
iv Exclusions
 Charitable Donations
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 Marital Deductions – no gifts given from one spouse to another included
 Annual per Donee Exclusion - $11,000. This is available to us in the
computation of the taxable gift.
 ***You want to take this out when we compute taxable gifts****
 If you use gift splitting between you and your spouse, then you can get
$22,000.
 Tuition or medical payments made on the behalf of another directly to the
institution providing the service. No Limit on this!!! (Note> this cannot
be an exclusion if the child does not go to school there.)
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e. Gift Tax is filed with your income tax return. You do have to file a return if you
make gifts hire than the per donee exemption. If you do not do this then the SOL
will not run.
Note> Audits in estate and gift often take place when you have limited
partnerships and what not in the estate
3. Generation Skipping Tax
a. Who pays this depends on the nature of the generation skipping transfer
i Tax Termination
ii Taxable Distribution
iii Direct Skip
 Parent makes a gift directly to a grandchild or when the parent creates a
trust when the first beneficiary is the grandchild –
 very costly because it causes 2 taxes – gift tax and generation skipping
tax
 That is why you want to have a trust that does not have a direct skip.
 Added in 1986 because we did not want the grandparent could go ahead
and just give the gift to the grandchild so that it would not be taxed twice
 You want the timing of the tax to be as many years after the creation of the
trust.
b. This first came along in 1976, but in 1986 it was substantially revised and the old
one was repealed retroactively to its origin
c. Why do we need this – trusts.
i A grandparent could place the property into a trust with the child as the
beneficiary. The child would get all of the income from the trust and then
have the property itself pass to the grandchild. There should be a gift of right
to income and gift of remainder.
ii We have adopted a system to ensure that some sort of federal tax will be
applied as the property moves from one generation to another. In the trust
example there is no opportunity for the property to be taxed as it moves
d. Fills in where property is transferred and the estate and gift taxes would not be
applicable.
e. When the generation skipping tax applies, it is taxed at the highest possible estate
tax rate for that year.
f. When you develop an exempt trust – and it goes to the grand kids, there is no
GST.
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i
Create the trust with 1.12mil (or whatever the applicable exclusionary amount
is for that year) of corpus and the whole thing would be exempt from GST (it
would be subject to gift tax).
ii When you file the gift tax you make your GST exclusion allocation. This will
be exempt for the rest of its existence.
iii The exempt status will remain no matter what the appreciation of the property
is – it can grow an unlimited amount. BUT you have to make sure you do not
do anything that would disturb its exempt status.
iv Estate Planning with Exempt and Non-Exempt Trusts – you would want one
of each.
 Exempt Trust
 The exempt trust is the one that you really want to preserve for your
skip generations – you want this to grow – so you want it invested in a
way that would appreciate the assets.
 You would provide that the child would receive distributions at the
discretion of the trustee – that way the grandchild is not the first
beneficiary.
 The exempt trust is designed to maximize distributions to skip persons.
 Non-Exempt Trust
 Then you can have a non-exempt trust – this is where you give the
child money.
 You can have this one distribute income and principle to the child.
Then you would want to give the child some sort of interest in the trust
so that it is included in his estate (because you know it won’t be taxed
at a rate higher than the highest).
 The non-exempt trust is going to be designed to maximize
distributions to non-skips.
 When you have a non-exempt trust, you have a special exclusion
 tuition and medical expenses for skip persons without being
subject to GST
 If the distribution would be exempt if paid by an individual by
paying it directly to the institution
 Never create a trust that has an inclusion ratio of anything besides 1 or 0.
You are better off having one that is totally exempt and another that is not
at all exempt. You always want to have two separate trusts – one for
current income (non-exempt) and one for growth (exempt).
Note> Each spouse gets the exemption. So you could have two totally
non-exempt trusts
g. Taxable termination is payable 9 months after death, Direct Skip and Taxable
Distribution are both files with the income tax
C. Estate and Gift tax have an important connection (needed for the calculation of the
estate tax)
1. Up until the Tax reform of 1976 there was no connection between these two – but
then we adopted a unified system for the purpose of estate and gif tax
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2. If he makes any taxable gifts prior to 1976, we have to add to the estate all taxable
gifts. The tax paid on the gifts will be credited to the amount you pay, this is just used
to calculate the tax rate
3. Work off of the same rate schedule for gifts and estates
4. Unified credit against the estate tax and Unified credit against gift tax (§ 2505) – this
can be applied to either gift tax liability or to estate tax liability. The code has kept the
same credit for gifts taxes, but it has gone up on estate taxes.
5. Estate Planning involves both gifts made prior to death and testamentary
dispositions
a. Gift programs giving the exclusion of 11K per donee per year (this can avoid the
41% tax rate of the first taxable rate)
b. Every person has an $1mil exemption – the husband and the wife. So with
spouses with at least $2mil you want to draft the will that will not waste the $1mil
exemption for. So you would will $1 mil to someone else and then the rest going
to the spouse.
i Bypass trust – keeps the first mil out of the first spouse who dies out of the
estate of the other. (have to make sure the spouses keep separate accounts)
c. Always preserve the exemptions of spouses in estate planning
6. The Unified Credit §§ 2010, 2505 – is available for either estate or gift tax
computation.
a. Why a credit instead of an exclusion – because the exclusion benefits the highest
tax brackets, the other takes it off at the lower
b. How is the credit computed? P. 93 of appendix. An estate has a credit equal to the
amount of the tentative tax from the applicable exclusion amount based on the
applicable tax rate for that year.
c. For Gift taxes this is frozen at the $1,000,000 applicable exclusion.
II. Estate Tax
A. § 2001 – Definition of the Gross Estate and Valuation
1. § 2031 – Definition of Gross Estate
a. Includes the value at the time of his death of all property, real or personal,
tangible or intangible, wherever situated.
b. Fair Market Value – the value spoken of in § 2031
i FMV – 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 having reasonable knowledge of relevant facts.
ii Liquid assets – FMV can be determined by reference to comparable sales in
the open market.
iii More problems when the item is not for sale in the open market:
 Only available on the black market – drugs have been advised by the
service to be valued at the price an ultimate consumer would pay in the
open market.
 Item is unique and irreplaceable in the market – rights to produce one play
and two motion pictures.
iv Factors to consider when determining fair market value:
 Income yield
 Appraisal –
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 Should represent the price that would be agreed upon between two
hypothetical parties, not the price that the actual parties to a transfer
would agree upon.
 There must be a sound basis for the appraisal and the performing
expert should be able to thoroughly explain it.
 Courts will discredit experts when they are unfamiliar with aspects of
the property or their analysis is poor or they contradict their own
opinions from different cases.
 Sales prices of similar property near the date of death
 Bids made for the asset
 General economic conditions.
v § 2032A Valuation of certain farm, etc., real property
 a special rule that allows us to alter the rule of 2031, to value property not
at its highest and best use, but to value it at its current use.
 This was designed to help family farms.
 There are a lot of requirements to use this special rule.
 This will ignore speculative value and development value
vi Valuation is usually at the moment of decedent’s death, BUT
 § 2032 Alternate Valuation Date
 Allows us to elect to use a different date for valuation – 6 months after
death.
 This is an all or nothing thing – you cannot pick and choose assets to
apply this alternate date.
 This was enacted to prevent over taxation when the value takes a dive
right after death. You cannot use this unless it lowers the tax
vii Valuation should not be effected by events that happen after death unless such
events were known or reasonably foreseeable at the moment of death.
 The value of an illiquid asset can be determined with reference to an after
death sale of the asset, however the longer the period of time between the
death and the sale, the less probative the sale is of the asset’s value.
2. § 2033 – Property in Which the Decedent Had an Interest
The value of the gross estate shall include the value of all property to the extent of the
interest therein of the decedent at the time of his death.
a. Beneficial Interest – The interest must be a beneficial interest; the burden is on the
estate to prove that it is not a beneficial interest.
i State Law
 State law creates legal interests and rights. The federal revenue acts
designate what interests or rights, so created, shall be taxed.
 State law would govern the relationship of the remainder person to the
trust property; but whether the relationship fixed by local law amounted to
an interest in the property would present a purely federal question.
ii State Decrees
 A federal court may decide whether the decedent had title to a property
only as a trustee or whether instead had a beneficial interest in the
property. BUT it will apply state statutory and common law principles in
the decision of that underlying issue.
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 The beneficial interest question can be re-litigated in federal court → The
Supreme Court said it will not give finality to a state court decision on an
underlying state law issue, unless the local decision is by the state’s
highest court. The fear here is that the decision will be made in nonadversarial conditions that are conducive to fraud and collusion.
 Federal Courts are to give “proper regard” to state decisions not coming
from the highest state court (this can be no regard if the decision was
handed down in a non-adversarial suit).
b. Routine Inclusions
i Real property solely owned by the decedent
ii Tangible personal property solely owned by the decedent (factual issue of
whether the item was actually owned by the decedent can be very troublesome)
iii Intangible items raising no questions such as:
 Currency in the decedent’s safe-deposit box
 Balance in decedent’s checking or savings account (this does not include
joint accounts)
 Any credit from one’s brokerage account
 Stocks, Bonds, CD’s owned solely by the decedent
 Amounts due to the decedent on notes arising out of the decedent’s
lifetime loans or deferred payment sales.
c. Income Items
Income rights of the decedent at death must be treated as property in which
decedent had an interest within the scope of § 2033.
i Salary due at death (Note this will be taxed as income to the decedent’s estate
under § 691 but it is still includible in the estate under § 2033.)
ii Bonuses payable to decedent at time of death
 Bonuses which the decedent had no interest in at the time of death, but
were awarded after death are not included in the gross estate even if they
are paid to the decedent’s estate.
iii Compensation due for services other than as an employee are treated the same
as salary
iv Rent accrued at death on real or personal property owned by decedent
v Accrued interest at death
vi Dividends on shares of stock that are payable to the decedent at the time of
death – right does not arise until the record date of the dividend.
d. Partial Interests in Property
i Shared Interest in Property – if the interest is one that the decedent can pass
on to others, it is generally an interest in the scope of § 2033.
 Tenancy in common
 Community property
Note> These are shared interests that do not terminate at death, unlike
joint tenancy with the right of survivorship.
ii Successive Interests in Property
 A owns Blackacre and leases it to B for 20 years. Both have interests that
may be taxed under § 2033.
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 If B dies before the lease term is up he has an interest in the property
for the next 10 years and his gross estate will include the value of the
leasehold.
 If A dies before the lease term is up, he has a reversionary interest that
will be included in his estate.
 The interest in the property can be based upon the happening of an event
as well. Note> If the property is A’s for life and then to B or B’s estate.
There will be nothing includible in A’s gross estate under § 2033, but if B
were to die first, his estate would include the remainder interest in the
property.
iii Cautions
 The only question that has been considered here is inclusion under §
2033 – these interests that may not be includible here, may be includible in
the gross estate under another provision in the Code.
 Be careful with life interest that are not includible in the decedent’s
estate – these may give rise to generation skipping taxes.
e. Insurance Proceeds Under § 2033
i An insurance policy is property and the value of the decedent’s interest is
includable in his gross estate under § 2033 – this applies to the ownership of a
policy on the life of another person.
Note> § 2042 has special rules for insurance policies owned by the decedent
on his own life.
ii If owner and insured die simultaneously:
 And the owner is the primary beneficiary, then the Simultaneous Death
Act applies.
 And the owner is not the primary beneficiary, then nothing is includable in
the gross estate under § 2033. (This does not mean that it is not included
under another provision of the Code)
iii If the proceeds are those received before the death of the decedent, then it
depends upon the nature of the proceeds as to whether or not they are included
in the decedent’s estate.
 Annuity for life – nothing is included
iv Area of controversy → situation in which decedent is entitled only to interest
on insurance proceeds for life and then they are to be paid to the decedent’s
estate upon his death. These are not includible under § 2033.
f. Business Interests
i Corporations and Proprietorships
 Corporations – gross estate includes the value of decedent’s shares of
stock
 Sole Proprietorship – ownership of all of the various assets of the business
is attributed to the decedent and included in gross estate under § 2033.
ii Partnership Interests
 Decedent’s share in the partnership is included in his gross estate under §
2033
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 The decedent is not viewed as owning any specific assets of the
partnership, but rather his proportionate share of each of the assets of the
partnership.
 It may be difficult to determine what the value of the partnership is if it is
not terminated upon the death of the decedent.
 Different partnership agreements may dictate how the partnership is to
devise the partnership interest of a deceased partner to his estate, but this
may not be determinative of its value if the Service thinks that it is below
the market value of the partnership.
iii Limited Liability Companies – decedent’s share of the LLC is includible in
his gross estate under § 2033.
g. Compensation for Death
i “Survival” Statute – Recoveries under these acts for the decedent’s pain,
suffering, or related expenses during decedent’s lifetime are included in the
decedent’s estate.
Note> Survival statutes allow a claim brought by a decedent against a
tortfeasor to survive his death.
ii Wrongful Death Acts – rights to recover under these acts do not constitute an
interest in property owned by decedent to be included in his estate under §
2033.
3. §2034 – Dower or Curtesy Interests
a. Dower or Curtesy interests should be included in the estate of the deceased.
b. Important thing here is that this provision forecloses the argument that a
decedent’s gross estate should be reduced by the surviving spouse’s dower or
curtesy or similar interest in the decedent’s property.
B. §2035 – Adjustments for Gifts Made Within Three Years of Decedent’s Death
1. Introduction
a. The Commissioner had little luck under the “contemplation of gift tax” so
Congress expanded the rule to an automatic 3 year inclusion rule for all transfers
in years after 1976.
b. Result → if a transfer was made that would be subject to the gift tax, it pushes
increments of the estate into higher estate tax brackets, yielding a result much like
an estate tax on at least the lifetime value of the gift, reduced by the credit for the
earlier gift tax paid.
2. The First Prong
a. §2035(a) Inclusion –
i §2035(a)(1) – requires property to be pulled back into the decedent’s gross
estate if:
 there is a transfer if an interest in property or the relinquishment of a
power with respect to property inclusion AND
 the transfer or relinquishment is one that was made by the decedent within
3 years of death for less than adequate and full consideration in money or
money’s worth.
 This section is not applicable to any transfers made outside of the three
years before death.
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 The transfer date is the date when the gift is complete – look to local
law to determine.
ii § 2035(a)(2) – The scope of this section is narrowed to apply only if the
decedent transfers an interest or relinquishes a power over either
 an insurance policy that, without the transfer or relinquishment, would
have been included in the decedent’s gross estate under § 2042 OR
 The entire amount of the proceeds are included in the gross estate
because that is what would have been included under § 2042
 If you own a policy on your own life, give it away before you are close
to death – give it away early.
 If you want to purchase more insurance, then you want to take the
money that you would buy the insurance with and put it in a trust and
have the trust buy the insurance.
 (An irrevocable life insurance trust) – There is no way this will be
included in your account, because you never owned the policy.
 an interest in property or power over property that, if not transferred or
relinquished, would have required an amount to be included in the
decedent’s gross estate under §§ 2036, 2037, or 2038.
Note> This only applies to estates of decedents dying after 1981.
 Applies only if the interest transferred by the decedent was one that,
had it been retained by the decedent, would have enlarged the
decedent’s gross estate under the above listed sections.
 A transfer of property that, had it been retained until death, would have
been included in decedent’s gross estate merely by reason of § 2033
escapes inclusion under § 2035.
 We are targeting that their gift value is much lower than the value at
the time of death.
b. Exceptions to the §2035 (a) Inclusion
i §2035(d): bona fide sales
 If, in connection with a transfer, the decedent receives full consideration in
money or money’s worth, then the transfer amounts only to a substitution
or exchange of assets, the gross estate is not reduced, and no estate tax is
avoided.
 The statute does not specify what constitutes “adequate” consideration –
the statute also does not say for what the decedent must receive full
consideration.
 When confronted with the problem of the interest transferred being ofa
different value than the estate tax inclusion amount, a court created an
estate tax ownership concept requiring consideration equal in value to
the potential estate tax inclusion.
 Partial Consideration – when there is partial consideration that amount
will reduce the value that is included under § 2035.
 With life insurance policies, if the transferee pays the premiums after
the transfer we would exclude the proportionate amount of those
premiums to the total amount of premiums made from the proceeds
when including them in the gross estate.
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ii §2035(e): certain transfers from revocable trusts
 §2035 (and §2038) is inapplicable to “any transfer from any portion of a
trust during any period that such portion was treated under § 676 [the
revocable grantor trust rule] as owned by the decedent by reason of a
power in the grantor.”
c. Special Applications of the §2035(a) Rule
i §2035(c)(1) sometimes makes §2035(a)(2) inoperative – it requires all
transfers within 3 years of death to be included in the gross estate under
§2035(a) for purposes of applying § 303(b) (relating to stock exemptions),
§2032A (relating to special use valuation), and §§ 6321-6326 (relating to liens
for taxes).
ii §2035(c)(2) – imposes a dual test for purposes of meeting the 35% of the
adjusted gross estate test of §6166(a)(1)
3. The Second Prong – §2035(b)
a. The Gift Tax Gross Up Rule
i This provision requires the federal gift tax paid by the decedent or decedent’s
estate on any transfers made after 1976 by the decedent or the decedent’s
gross estate – this is a “gross up” of the gift tax.
 So – if a decedent makes a gift of 300K in cash, then pays a gift tax of
125K, the 125K will be pulled into his gross estate under this rule. This is
because gift tax is exclusive and estate tax is inclusive – when a gift of
300K is made, the decedent is reducing the size of his estate by the full
425K (the gift plus the tax), but when a decedent has an estate of 2Mil
then the estate is reduced by the estate tax amount before distribution to
the beneficiaries.
 It is still better to give the gift, because had we not the entire 425K would
be included in the estate instead of just the 125K.
ii This section is operative whether the gift is subject to § 2035(a) or not.
iii Gift Splitting –
 if the spouse makes a gift and the spouses elect gift splitting, then the
portion of the tax paid by the decedent will be included in his gross estate
 If the decedent pays all of the gift tax on the gift split transfer made by the
spouse, no gift to the decedent’s spouse results and the full gift tax is
included in the decedent’s estate
 If decedent makes a transfer and gift splitting is elected and decedent pays
full amount of tax on the transfer, the full tax is again pulled into the
decedent’s estate.
b. Gifts Made within 3 Years of Death – the transfer occurs when the gift is
complete for gift tax purposes.
4. §2043 – Transfers for Partial Consideration
a. The Affirmative Rule – the value of the consideration received by the decedent
can be subtracted from the applicable valuation date value of the property
included in the gross estate.
b. Note – this has to be consideration for money or money’s worth!!
C. §2036 – Transfers with Retained Life Estate
1. Excluded Transfers
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a. Sales for Full Consideration – this section is inapplicable to any transfers for
adequate and full consideration.
i In the case of a remainder interest, then it will be valued using the actuarial
tables in the back of the book.
ii This can be paid with a note, but it has to be true debt:
b. Pre-March 4, 1931 Transfers
2. Period for which Interest is Retained
a. In order for § 2036 to apply, the decedent must have retained an interest in the
property for a specified period.
b. Three-fold Test
i For the decedent’s life
ii For a period not ascertainable without reference to the decedent’s death
 Decedent is entitled to the income quarterly with the right to income
ending in the quarter of decedent’s death → stays in the decedent’s estate
 X for life, then to D for life, then to C → even if D predeceases X this will
be included in his estate less the value of X’s outstanding life estate
because the period for which D has a retained interest cannot be described
without reference to D’s death.
iii For a period that does not in fact end before the decedent’s death
 A retained interest for a term of years – A has a retained interest for 10
years then to B. If A dies in that 10 year period, it remains in his estate.
 Have to reference § 2702 – grantor retained trust – where a grantor retains
the right to income for a term of years. This applies to grantor retained
trusts to family members.
 If you have this kind of trust we do not apply the normal valuation
rules for this remainder interest.
 The remainder interest is valued at 100% of the value of the property
at the time of the gift. If it does not constitute ones family, then it is
valued like normal.
 If we have a GRIT (fixed number of years) we pay gift tax at the
time we create the trust
 The good thing about doing this is that you at least get the appreciation
out of the estate, but you will pay more gift tax at origination.
 This is also applicable if there is a retained interest for life (but this
rarely happens because this will be included in the gift estate and we
are trying to get stuff out of the gross estate.
3. Nature of Interest Retained
a. 2036(a)(1) – retained beneficial interests
i Invoked if the decedent retains “the possession or enjoyment of” or “the right
to income from” the transferred property or property interest
ii Requires a retention of an interest in the very thing being transferred
iii The decedent’s right to other property, such as an annuity, in return for the
transferred property does not trigger application of § 2036. (adequate and full
consideration)
b. 2036(a)(2) – retained control over other’s interests
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i
Retention of the right for life to say who may enjoy transferred property or
income therefrom
ii Does not have to be a power in which he can claim the enjoyment or interest
for himself
4. Beneficial Interests in the Decedent
a. Possession or Enjoyment – ex. When one makes a gift of a valuable painting but
reserves the right to keep it for life or a residence but retains the right to live in it
for life.
b. Right to Income
i Has to be more than a mere expectation – decedent has to have a right to it
ii Does not have to be received directly by the decedent to be a right to income.
If it is a trust with income to minor child, this is a discharge of a legal
obligation. The legal obligation must still exist at the time of his death if it is
to be included in the estate – so if Child reaches the age of majority, then this
is no longer indirect income to the decedent and the property will not be
included in the gross estate under § 2036 (like a trust for a term of years)
c. Enjoyment “Retained” – actual retention can turn into a rather pragmatic problem:
i Implied Understanding – mere fact that the decedent continues to occupy the
house:
 Where the family member transferee does not co-occupy, it looks like
there has been retention by the transferor.
 Where the family member transferee does co-occupy, it looks less like it
was retained.
ii Implied Agreement found where the transferor creates a FLP and transfers
interests in the partnership to other family members and, under the PA, the
partnership or other family members have right to income, but the transferor
diverts all of the partnership income for the transferor’s personal use.
iii Decedent has created a trust with income to X, but the trustee (not the
transferor) has complete discretion to make income payments to the decedent.
5. Control Over Other’s Interest
a. Right to Designate Retained Indirectly
i Transferor grants power to trustee to designate who shall enjoy the income
and retains the right to discharge the trustee and name himself as the trustee
with the same power
 When the grantor retains the right to remove the trustee (at any time and
without cause) and name himself trustee we have more concern – the
powers held by the trustee will be attributed to the grantor. So we have to
be careful about retention of powers removing the trustee.
ii Transferor’s reservation of the right to change trustees with a provision that it
will not be the transferor will not be an indirect retention.
 When the grantor has the power to remove the trustee but can only do so
when they appoint another trustee – for years they said that just having
this power was enough to include the property. BUT this was changed
and the service now says that you can do this because there is no power
given to the grantor to decide who gets income.
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 There is an exception to this – when the list of trustees that could be
chosen to replace the original trustee includes a related party (the service
will raise this issue). No one thinks this is the right result because § 2036
allows the grantor to select this person in the first place.
b. Illusory “Control” – he will still retain the control sufficient to pull the property
into the gross estate under this section when his right to designate an income
beneficiary must be consented to by another person (under this section it does not
matter if the person consenting has an adverse interest or not)
c. Right to Designate Who Benefits –
i Mere right to direct the accumulation of trust income.
 O’Malley – If the accumulation will eventually pass to a third person
remainder person, then this is a retained right to designate who benefits.
 Struthers – If the accumulation will eventually pass to the beneficiary or
her estate, this court held that this is a retained right to designate who
benefits. But really, this should only trigger the § 2038 power to alter the
time of enjoyment.
ii Right to invade the corpus for another third party beneficiary
 G → X or X’s estate for G’s Life → remainder to Y or Y’s estate
 Retains power to invade corpus for Z – power that effects the enjoyment
all of the income of the property during his lifetime. We will include in
the gross estate the entire trust.
 If he had limited this power, the amount included in the gross estate would
be limited as well (if he can only invade 50% of the corpus, then only 50%
is included in the estate)
iii Right to invade corpus for the income beneficiary
 G → X or X’s estate for G’s Life → remainder to Y or Y’s estate
 The grantor retains the power to invade the corpus of the trust for X – The
corpus of the trust can be distributed to the income beneficiary of the trust.
 Is this a 2036 power? No this is not a 2036 power → Reg. 20.2036 – only
concerned with a power that will alter who receives the income or the
benefit of the property.
 When G has the power to give the corpus to the income beneficiary it
does not change who gets the income. It changes how he gets it, but it
does not alter the identity of who receives the property. Not included
in the decedents gross estate under § 2036.
 Caution> this will be included in his estate (though remainder interest only)
under §2038.
 If §2036 were to apply, the entire value of the trust would be
included in the estate – but § 2038 would only include the remainder
interest in the gross estate. You have to examine whose beneficiary
interest would be altered and value of that interest is included in the
estate.
6. Indirect Interests or Controls
a. Settlor Trustee
i It is possible for the settlor (transferor) to name himself trustee without
invoking § 2036.
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ii The settlor must restrict his powers to compliance with a reasonable standard.
The idea being that the trustee is not the innovator – he is simply carrying out
directions from the trust instrument.
 Beneficiary’s accustomed manner of living
 For the beneficiary’s educational needs
 In case of sickness
 When you say “the comfort of the beneficiary” you are going to have
questions about this.
iii Can the settlor freeze his tax liability to the value of the property at the time of
gift and yet work to enlarge his estate for life without estate tax attrition at the
end?
 While this seems to be against the purpose of this section, read literally it
could work – the power to control investments is merely fiduciary and a
restricted power over enjoyment meets the ascertainable standard.
iv G → X or X’s estate for G’s Life → remainder to Y or Y’s estate
 G names himself trustee (this always leads to problems – it could lead to
all kinds of violations – and we would only want to do this with the
greatest of caution) but puts limitations on his power. He is required
(note> this is not a right, but a requirement) every year to give Z the
amount needed for his support and maintenance and the remainder of
the income to go to X.
 There is no discretion in this power as trustee – this is an enforceable
distribution. This is not a § 2036 power and will not cause inclusion in
the grantor’s gross estate. There must be ascertainable standards.
b. Enjoyment Retained in Commercial Transactions – where donor transfers
property to another, but they agree that the donor will use the land rent free for his
life, there is a retention of the enjoyment of the property.
c. Rent Paid by Transferor – a gratuitous transfer of real property coupled with a
leaseback agreement under which the transferor pays rent for continued
possession.
i Business Setting – § 2036(a)(1) is inapplicable where the property is business
property that is leased back for its fair rental value.
ii Non-business Setting – The service says they are not going to follow this rule
where it is a residence (this is a meaningless distinction and the service should
not accept it)
iii Sale and Lease Back – will be included in the gross estate if it does not look
like it is true debt and the lease back provisions appear to pay the note.
 You would want a loan with a fixed end date, amortizing over the life of
the debt, you would want to cut out any provision in the will forgiving the
debt. You will have to enforce payment of the loan.
 A loan that has payments of interest only, the parent paying rent close in
value to the interest, the parent forgiving a portion of the principal each
year equal to the annual exclusion amount and forgiving the balance as a
provision in the will most likely will be seen as a gift – which is what it is.
 Installment sales are good estate freeze devices – but you have to make
sure it is pure debt.
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d. §2036(b) Transfer of Stock
i Under 2036(b) the direct or indirect retention of voting rights in a “controlled
corporation” is “considered” a retention of the “enjoyment” of transferred
property so as to trigger application of 2036(a)(1).
ii “Controlled Corporation” – one in which the decedent owns, either directly or
by attribution under § 318, stock possessing at least 20% of the combined
voting power of all classes of stock in the corporation. (This includes the mere
ownership of the voting rights)
7. Transfer by the Decedent – 2036 does not apply to transfers by others creating
rights in the decedent, except for others’ transfers imputed to the decedent, such as by
way of reciprocal trust doctrine.
a. Indirect Transfers
i D pays $10K to X to transfer real estate of like value into a trust – it is not
unrealistic to treat D as the one who transferred the real estate into the trust
even though he never owned it.
ii Where the beneficiaries in an executed will agreed in a settlement to a
distribution plan specified in an unexecuted – the beneficiaries will be treated
as having transferred the property.
b. Transfers by Election – ex. When you make an election on your insurance to not
receive the proceeds but to have them accumulate for your life then pass to your
children at death – this is a transfer.
c. Reciprocal Trusts
i You have siblings who each create trusts for the other giving income for life
and remainder to his children. When S dies, he has no interest in the trust he
created and the right to income he was not originally his property it just goes
on to his children. The problem is that if either of the siblings had created the
trust for themselves then they would have been subject to § 2036. So we treat
him as if he created a life estate.
ii Application of the reciprocal trust doctrine requires only that the trusts be
interrelated, and that the arrangement, to the extent of mutual value, leaves
the settlors in approximately the same economic position as they would have
been in had they created the trusts naming themselves as life beneficiaries.
iii If the amounts are different Rev. Ruling 74 – 533 → the amount that can be
included in either grantor’s estate under § 2036 is no more than the smaller
trust at the applicable estate valuation date.
8. Amount to be Included – the date of death value of the property interest transferred
in the proscribed manner (the trust corpus)
a. Accumulated Income – treated as if it was owned and transferred by the decedent
for purposes of measuring tax liability under 2036
b. Lifetime Relinquishment of Prescribed Interests – if the decedent relinquishes his
retained interest then it will not be included in his estate – NOTE> 2035 does
apply here, so if he relinquished his retained interest within 3 years of death then
it will be pulled back in under that provision.
D. § 2037 – Transfers Taking Effect at Death
1. Introduction
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a. § 2037 draws into the gross estate the value of some interests in property that the
decedent has transferred conditionally during life.
b. The section applies only if:
i The possession of enjoyment of the property is conditional upon surviving
the decedent AND
ii The decedent has retained an interest in the property that may bring the
property back to the decedent or to the decedent’s estate or back into the
decedent’s power of disposition. (Reversionary Interest)
2. Excluded Transfers
a. Inapplicable to bona fide sale for an adequate and full consideration in money or
money’s worth
b. Does not apply to transfers made before September 7, 1916.
3. The Survivorship Requirement
a. Can possession be obtained without surviving the decedent?
i If yes, then 2037 will not apply
ii If no, then it will apply
b. If there is an alternative contingency by which the interest can be obtained, then it
will not be included under 2037, but if the alternative contingency is unreal – will
never happen – then it will be knocked back into 2037.
c. When there is more than one interest in the property transferred, as there often is
in these situations, we need to be careful to find the interest that is contingent on
decedent’s death and only that interest is falling under 2037/
4. Retention of Reversionary Interest
a. Definition of “Reversionary Interest”
i The term is defined to include the possibility that the property may return to
the decedent transferor, as well as the possibility that it may return to the
decedent’s estate.
ii Even if the possibility ends with the decedent’s death, the decedent has
retained the requisite interest long enough within the statutory concept
iii Does not include a possibility merely that the income from property or the
power to designate who shall have the income may return to the decedent
(these would fall under 2036)
b. How the Interest is Retained
i Pre 1949 – only reversionary interests that arise “out of the express terms of
the instrument of the transfer”
ii Post 1949 – both the reversionary interests arising out of express terms and by
operation of law
c. Negligible Reversionary Interests – the reversionary interest must exceed 5% of
the value of the transferred property (its value immediately preceding death.
d. Mortality Tables and Actuarial Principles – the fact of the decedent’s death is to
be disregarded and the usual valuation methods are to be employed, including the
use of gender-neutral mortality tables and actuarial principles.
e. Decedent’s Physical Condition – taking this into account would largely nullify
this provision, so it is not taken into account.
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f. Application of the 5% Test – this becomes primarily a determination of the
decedent’s mathematical chances, on the basis of age just prior to death, of
surviving some contingency(ies).
g. Base for the 5% Test – in determining whether the value of the reversionary
interest exceeds 5%, it is to be compared with the entire value of the transferred
property, including the interests that are not dependent upon survivorship of the
decedent.
5. Pre-Death Termination of Reversion – if the reversion is terminated before death
then its value would be zero and would not be included in the gross estate under 2037.
Note> it can still be pulled in under 2035.
6. Amount to be Included – the gross estate shall include the value at the date of death
of any interest in property that has been transferred in such a way as to take effect in
possession or enjoyment at or after the decedent’s death
E. §2038 – Revocable Trusts
1. Introduction
a. It might be better named “alterable transfers” because all it takes is the power to
change the enjoyment of transferred interests to invoke the section
b. The transfer sections overlap quite a bit (esp. 2036 & 2038) – When two or more
of the transfer sections are applicable, obviously the Commissioner quite properly
will apply that section or combination of sections requiring the maximum
inclusion in the decedent’s gross estate.
2. Excluded Transfers
a. A bona fide sale for an adequate and full consideration in money or money’s
worth.
b. Transfers made before June 22, 1936
3. Any Change in Enjoyment
a. Whether the enjoyment of an interest in property transferred by the decedent
during life is subject to “any change” at the decedent’s death.
i If the decedent kept a hand on the property until death, even by a right to
accelerate the interest, it is so much akin to a testamentary disposition that the
affected interest should be subject to estate tax.
ii Ex – Where income beneficiary and remainder-man are the same person, the
right to terminate the trust and turn corpus over to him immediately.
b. Whether the possible change may be brought about by the decedent through the
decedent’s exercise of power.
i This would include any right to invasion of the corpus for the benefit of
another.
ii This also includes any right that would merely change the timing of when a
beneficiary received their interest.
4. Power in the Decedent – any of these powers will invoke 2038
a. Power to Revoke
i If decedent retains the right to get the property back
ii If state law provides that a particular transfer is revocable if not specifically
made irrevocable, then unless the transferor expressly makes the trust
irrevocable, 2038 will apply
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iii If creditors of the transferor, under local law, can reach the corpus of the trust,
then it is revocable and caught in 2038
b. Power to Alter or Amend
i Power generally to name new beneficiaries of a trust
ii Mere Power to change beneficial interests among a limited group of persons
already enjoying rights as beneficiaries
iii Sufficient even if the power can only be exercised by will and there is no right
during life to make the adjustment.
c. Administrative Powers
i Mere administrative or managerial powers over trust assets do not constitute
powers to alter beneficial interests in the trust within 2038.
ii What is considered to be an administrative or managerial power?
 Trustee Grantor has discretion to allocate stock dividends to principal or
income – administrative power
 Non-Trustee – Grantor has reserved complete allocation discretion with no
judicial restraint – not an administrative power (looking at unbridled
discretion)
 Allocation powers as trustee, if they are validly expressed in such a way as
to foreclose restraint by a court of equity, they go beyond the needed
flexibility, involve affirmative authority to tamper with beneficial
interests – not an administrative power.
iii 2038 does little more than require attention to be focused on any power to
determine whether under its terms and applicable law, it is properly
considered a fiduciary power or whether it really amounts to a power to
change beneficial interests.
d. Powers of Investment – any uncontrolled power over trust investments such that
the remainder person’s interests could be changed at decedent’s will or lifetime
interest beneficiary’s interest could be changed at his will, then it is a power
within 2038
e. Power to Terminate – expressly proscribed in 2038 and taxed as to the interest
that is subject to termination.
f. Gifts to Minors – a transfer to a minor with the decedent named as custodian will
result in inclusion under 2038 if decedent dies before child reaches majority.
g. Power in “Whatever Capacity” – this brings in the power to remove or discharge a
trustee at any time and to appoint the decedent as trustee
5. Powers Restricted by Standards
a. A power to change enjoyment only in stated circumstances does not invoke 2038.
b. Ascertainable Standard – a power that is restricted by an objective standard is not
a power within the meaning of 2038.
i Decedent’s power as trustee to give income to child “in accordance with the
station in life to which he belongs.”
ii Medical expenses, support, education,
c. The rationale is that such a power involves the authority to execute rather than to
determine or to change the terms of the transfer.
6. Power Exercisable Only With Another
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a. It does not matter who the other person is, the decedent’s power to alter or revoke
will still invoke 2038 when it must be consented to by another person (even if the
other person has an interest adverse to the exercise of that authority)
b. One exceptional case – if the decedent holds a power that is exercisable only with
the consent of all persons having an interest, vested or contingent, in the property
subject to the power and if the power adds nothing to the rights of the parties
under local law (i.e., a provision of local law that would allow such person to alter
the terms of the trust in any event), the power is ignored.
7. Source of the Power
a. It makes no difference “when or from what source” the decedent acquired the
power. However, there should be some linkage between the required transfer by
the decedent and the decedent’s power.
b. 2038 should be held inapplicable in situations where the decedent makes a
complete, absolute transfer and, by totally unrelated conveyance, the decedent has
some fiduciary power or control at death.
8. When Power Must Exist
a. At date of death
b. Will be considered to be there at date of death even when there is a requirement of
notice before the exercise, despite no notice
c. Deferred effective date for the amendment, revocation, or termination from the
date of exercise
d. However, if there are other contingencies, 2038 will not apply
e. Relinquishment of the Power – if within 3 years of death then it will be included
in the gross estate (2038(a)(1) & 2035)
9. Amount to be Included – Any interest in the property transferred by the decedent if
the enjoyment of such interest was subject at the date of decedent’s death to change
through one of the proscribed powers.
a. Interests Subject to Change
i Only the interests that the power effects will be included in the gross estate
ii Requirement of giving notice makes this subject to adjustment – the
adjustment excludes the value of the interest that could not have been effected
by an exercise of the power if the decedent had lived.
b. §§ 2036 and 2038 Compared
i § 2036 – includes the value of the entire property
ii § 2038 – only includes the value of the effected interest
F. §2039 – Annuities
1. General Rule
a. The value of amounts received by beneficiaries by reason of their surviving the
decedent is to be included in the decedent’s estate.
b. Three Requirements:
i Under any form of contract or agreement
ii If under such contract
 An annuity or other payment was payable to the decedent
 Decedent possessed a right to receive such annuity or payment for
 His life
 Any period of time not ascertainable without reference to his death or
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 For any period of time which does not in fact end before his death
iii Receivable by the beneficiary by reason of surviving the decedent
2. Exceptions Expressed in §2039(a)
a. Life Insurance Policies – expressly inapplicable to life insurance policies (2042
controls). In the combination policies, the regulations say that “if the decedent
dies after the reserve value equals the death benefit, there is no longer an
insurance element under the contract” and 2039 will control.
b. Pre-1931 Contracts – limited to estates where decedent dies after August 16, 1954
and then only to contracts entered into after March 3, 1931.
3. Qualifications
a. Contract or Agreement
i There must be a contract or agreement → includes understandings,
arrangements or plans or combinations of arrangements, understandings, or
plans arising by reason of decedent’s employment
ii Does not include → benefit payments paid under public laws where decedent
has no voice in the designation of beneficiaries; where beneficiaries have only
a mere expectancy; salary payments to which decedent had a right to (these
are included on the decedent’s final income tax return)
b. Period for which Interest is Retained – the question is whether the decedent had a
specified right or interest
i For his life
ii For a period not ascertainable without reference to his death
iii For a period that did not in fact end before his death.
c. Nature of Decedent’s Interest
i Payable to the decedent – where the decedent at death was actually receiving
payments without regard to the question whether the decedent could require
their continuation
ii Possessed the right to receive – if the decedent had an enforceable right to
receive payments at some point in the future, whether or not, at the time of his
death, he had a present right to retain payments, i.e., it is not necessary that
he have met the conditions at the time of his death
iii If the payments to the decedent have not commenced at the decedent’s death,
2039 will not apply unless, at death, the decedent’s rights to future payments
are non-forfeitable.
d. Nature of Beneficiary’s Interest
i same as the decedent’s
ii Right to payment is by reason of surviving the decedent
4. Amount to be Included – the value of the amounts receivable by beneficiaries “by
reason of surviving the decedent.”
a. Valuation
i Annuities under contracts issued by companies regularly engaged in their
issuance – cost of comparable contracts issued by the company
 What it would cost at the date of death to acquire a policy for the survivor
with benefits such as exist under the contract in question.
ii When it is not issued by a company engaged in issuing these contracts – value
is determined in accordance with appropriate valuation tables.
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b. Percentage Restriction –
i the amount actually includable in the decedent’s gross estate under 2039 is to
be determined by reference to the following 2 factors:
 The value of what is payable to the survivors
 The portion of the purchase price of the annuity or other contracts that was
paid by the decedent
ii The amount to be included is only such part of the value of the annuity or
other payment receivable by beneficiary as is proportionate to the part of the
purchase price contributed by the decedent.
 Portions paid by the decedent’s employer will be considered as paid by the
decedent.
5. Private Annuities
a. Not an annuity in the context of employment or bought from a company in the
business of selling annuities. This is a related party selling the property in
exchange for an annuity.
b. The FMV of the annuity must equal the FMV of the property.
i Usually when you are trying to make sure that this is adequate consideration it
is unworkable because the payment is too large.
ii A lot of times there are not other sources of income with which to make the
annuity payments so you have to rely on the income of the property that was
exchanged for the annuity.
c. A better plan would be to give away portions of the property on a year by year
basis. These are discounted in their value. So you give a 20% interest to your
child and it will be discounted because it is not worth as much as just a portion –
you could work it so that each gift equal in value to the annual exclusion.
6. Exempt Annuities – the exclusions under this section were repealed under Tax
Return Act of 1984 for all estates of decedents dying after 1984.
G. §2040 – Joint Interests
1. Introduction
a. There are four possible rules
i If decedent’s interest and that of the other co-owners was acquired
gratuitously – each co-owner will be taxed at death for his ratable share
ii If the decedent’s wealth created all of the joint interests – the entire value of
the property is included in the decedent’s gross estate
iii If the decedent’s interest was created gratuitously by the other co-owner –
there is nothing from this property included in the gross estate of the decedent
iv If the both the decedent and the co-owner contributed to the acquisition of the
property – the portion of the property equal to the decedent’s share of the cost
of acquisition is included in his estate
b. Special Rule in 2040(b) for joint tenancies in which the co-owners are spouses
2. Forms of Ownership Covered
a. Joint Tenancies – property is held by decedent and another or others with a right
of survivorship
b. Tenancies by the Entirety – joint tenancy where the only tenants are husband and
wife
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3.
4.
5.
6.
7.
c. Joint Bank Accounts – specifically included in the statute where the deposit is
payable to either co-owner or the survivor
Some §2040 Misconceptions must be set aside:
a. It is immaterial that jointly owned property is not part if a decedent’s estate for
purposes of probate or administration.
b. The value of the decedent’s interest in the jointly held property prior to the
decedent’s death is by no means the measure of what is to be included in the
decedent’s gross estate.
c. The estate tax treatment of property owned by the decedent and another as joint
tenants is not affected by the fact that the creation of the tenancy was treated as a
gift for gift tax purposes, except with regard to the possible availability of a credit
for gift tax paid.
Amount to be Included – the value of the jointly held property, except to the extent
that the surviving tenant(s) contributed to the cost of the property.
Survivor’s Contribution –
a. the amount to be excluded as the survivor’s contribution bears the same ratio to
the entire value of the property as the consideration furnished by the survivor
bears to the entire consideration paid for the property
b. Amount Excluded = (survivor’s consideration/entire consideration paid) *
entire value of the property
Property Acquired by Gift From Others – upon the death of one of the owners, the
property is treated for estate tax purposes just as if each owner had contributed an
equal part of the purchase price (value included = value of property/# of owners)
Property Paid for by Co-owners
a. The Tracing Requirement
i Only contributions from separate funds of the survivor are taken into account
under the exclusionary rules.
ii A contribution originating as income from property acquired gratuitously
from the decedent constitutes contribution from the survivors separate funds.
What is income for these purposes?
 Dividends from stock, rent from property – clearly income when
contributing to the acquisition of a separate property
 Gains from the sale of property used to purchase jointly held property –
income constituting separate funds
 Appreciated property used as contribution – not income and will be
considered contributed wholly by the decedent
b. Additions and Improvements –
i The regulations state that the total cost of acquisition included the cost of
“capital additions.”
ii Three approaches
 Application of the regulations literally – the exact dollar amount actually
contributed
 Allocation to each of the co-owners a part of the appreciation
commensurate with the co-owners contributions prior to the appreciation.
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 Reduction of the cash contribution made by the surviving owner from the
total value of the property to arrive at the value to be included in
decedent’s gross estate
iii The first and third approaches should both be rejected and the second one
should be applied.
8. Burden of Proof
a. The burden of showing original ownership or contribution to the purchase price
by the survivor falls upon the estate.
b. In the case of a bank account – you have to show contribution by the survivor and
no subsequent withdrawals.
9. Termination Prior to Death
a. Creation of a tenancy in common near death – only half of the property would be
included in the decedent’s estate.
b. If the decedent and the surviving co-owner transfer the entire property to a 3rd
party, then none of it will be included in the gross estate – regardless of whether
or not he lives for 3 years after (gift of property not an interest in property so not
includable under 2035, but the gift tax associated with decedent’s portion of the
gift will be included)
c. If decedent and co-owner transfer to trust and retain a life interest – half of the
property will be included in his gross estate. Rationale – at the time of the transfer
the decedent had only one half interest in the property under local law, which is
all the decedent could have transferred.
10. The § 2040(b) Exception
a. General Rule
i (b)(1) provides a flat rule that ½ of the property jointly owned is included in
the estate of the predeceasing tenant in the case of a “qualified joint interest”
ii (b)(2) “qualified joint interest” – the co-owners are husband and wife
b. Exceptions:
i Inapplicable to qualified joint interests created prior to 1977
ii Inapplicable where the surviving spouse is not a U.S. citizen
 If non-citizen becomes a citizen prior to the filing of the decedent’s tax
return and is a U.S. resident at all times after decedent’s death and prior to
becoming a citizen then (b)(1) will apply
 To the extent it is included in the estate the spouse can transfer the
property to a QDOT and it will qualify for the marital deduction and
QDOT treatment resulting in the postponement of decedent spouse’s
estate tax.
c. One thing to be concerned with here is that you do not want to have too much
property to be held jointly because then there may not be enough to fund the
credit shelter trust – all jointly held property will go to the spouse qualifying for
the marital deduction. You want to make sure that each spouse owns enough
property individually to fund the credit shelter trust.
H. §2041 – Powers of Appointment
1. Introduction
a. Never applies to a retained power – this is reserved for 2036, 2038
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2.
3.
4.
5.
b. Only applies to a power conferred to the owner by another person or group of
persons.
c. There is a comparable provision in the gift tax area – see §2516
Powers within §2041 – a right that may be exercised either during life or by will, not
necessarily both, to direct who shall become owner of the property subject to the
power. Includes:
- right to consume the principal of the trust
- unrestricted right to substitute oneself for the existing trustee of a trust, if the
trustee has a power of appointment
b. Relationship to Other Sections
i §2041 never operates to exclude from a decedent’s gross estate the value of
property that is includable under other sections
ii Does not apply to powers “reserved by the decedent to himself” which are
within the scope of other sections
c. Powers that Overlap Interests – If decedent had an actual ownership interest in the
property it will be included in the gross estate under 2033.
Definition of a General Power – a power is general if it “is exercisable in favor of
the decedent, his estate, his creditors, or the creditors of his estate.” (one that can be
exercised directly or indirectly in favor of one’s own benefit)
Exceptions to General Definition
a. Power Limited by a Standard
i 2041(b)(1)(A) – if a power may be exercised only in accordance with an
ascertainable standard relating to the decedent’s health, education, support, or
maintenance, it is not treated as a general power of appointment.
 If it is an ascertainable standard not related to one of the above, then it is
not sufficient to limit the power
ii Critical Question – whether the power is limited by an ascertainable standard.
b. Post 1942 Powers with Another Person
i Power held with the creator of the power – the property will be brought into
the creator’s estate under 2036 or 2038
ii Power held with an adverse party – someone who has a substantial interest in
the appointive property, which interest will be adversely affected by an
exercise of the power in favor of the decedent
iii Power held with an equally interested party – if a decedent’s power to
appoint for his benefit can be exercised only in conjunction with one other
person in whose favor the power may also be exercised, only ½ of the
property will be treated as subject to a general power of appointment in the
decedent.
c. Judicious Use of Powers – congress has left considerable room for the judicious
use of powers of appointment in planning at substantial tax savings.
Treatment of Pre-1942 Powers – gives rise to estate tax inclusion only if the power
is a general power and the decedent exercises the power.
a. Exercise of Power
i Non-exercise of a pre-1942 power is not taxable
ii The power must be exercised by will or in some other manner akin to
testamentary disposition in order to cause estate tax liability
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iii If a pre-1942 power is exercised by a disposition of a type that would be
caught by 2035-2038 if an actual transfer of property were involved, estate tax
liability results.
b. Failure to Exercise – the statute explicitly states that failure to exercise shall not
be deemed an exercise
c. Complete Release
i A complete release shall not be deemed an exercise
ii What constitutes a complete release?
 There are no good guidelines in the regulations so inaction seems to be the
safest route
d. Partial Release of Pre-1942 Powers – when a general power is partially released
such that it is now a limited power, the exercise of the limited power will be
considered an exercise of a general power
6. Treatment of Post-1942 Powers – several tests determine whether the value of
property subject to post-1942 general power of appointment in the decedent must be
included in his gross estate:
a. Possession
i Did he have possession of the power at the time of his death?
ii It is irrelevant that he was under legal disability to exercise it at all times after
the power was created – mere possession.
iii Conditional power of appointment – triggering event:
 Decedent has no power over the triggering event – no possession of the
power at death
 Decedent has power over the occurrence of the triggering event –
possession of the power at death
iv Giving Notice as a Requirement of Exercise – value of the property to be
included in the gross estate will be discounted for the period required to elapse
between the time of the decedent’s death and the time the power could have
been exercised.
b. Exercise
i A pre-death exercise of the general power in a testamentary fashion requires
inclusion of the value of the property subject to the power in the gross estate
ii If the power is exercised through the will – inclusion of the value of the
property subject to the power
iii Exercise that involves a disposition that would be covered by 2035-2038 if it
were transferred in the traditional way
c. Release – a lifetime release of the power will be equivalent to an exercise of the
power
d. Disclaimer or Renunciation – 2518 provides a rule for disclaimers that allows an
individual who is given a post-1942 general power of appointment to avoid any
tax consequences with respect to the power.
e. Lapse – release of a general power includes the lapse of the power during the
donee’s lifetime, subject to some important exceptions
f. The Five or Five Rule – the exception to the general rule that a lapse = release
i The general rule is inapplicable if the power that lapsed was such that during
any calendar year its exercise was limited to $5K or to 5% of the value of the
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property out of which the exercise of the power could have been satisfied,
whichever is greater.
 If the lapse exceeds these amounts, it is to be treated as a release only to
the extent of the excess
 5% of the value at the time of the lapse
 If the decedent’s power is limited to only part of the property, then only
that part is used to measure the 5% exclusion.
ii The failure to exercise the power that fits within this exception would have no
resulting estate tax consequence.
iii You would want to make sure that the power expires in a short time because if
the decedent died while the power was unexercised and the lapse had not
occurred then it would be included in his estate.
iv One way to set up one of these trusts:
 We have a list of beneficiaries who may make annual non-cumulative
withdrawals of the greater of 5K or 5%, BUT we never expect them to
make any of these withdrawals.
 This way we are passing wealth using the annual exclusion, and building
up the trust to pass to future generations. You can make the gift up to the
amount of the annual exclusion for each of the beneficiaries
7. Amount to be Included – it is the value of the property that the decedent could or
did appoint that is brought into the decedent’s gross estate
I. §2042 – Insurance
1. Introduction
a. Two Basic Inclusionary Rules → The proceeds of insurance policies on a
decedent’s life are to be included in the insured’s gross estate if they are:
i Receivable by the executor OR
ii Receivable by other beneficiaries and the decedent had any incidents of
ownership in the policy at death.
b. This section only applies to decedent’s ownership of a life insurance policy on his
own life.
c. This section is not necessarily exclusive.
2. What is Insurance?
a. In order to be insurance the policy must include the distribution or shifting of the
risk of premature death.
b. Conventional policies which guard against death (accidental or not) and a double
indemnity of a life contract.
c. Death benefits paid by fraternal beneficial societies operating under a lodge
system.
3. Amounts Receivable by or for the Estate
a. Meaning of Executor
i “receivable by the executor” – they are part of decedent’s gross estate for tax
purposes.
 “receivable by or for the benefit of the estate”
 when nominally payable to another beneficiary who is legally bound to
use the proceeds to discharge the estate’s obligations, such as taxes, debt,
or other charges.
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ii “executor” – the executor or administer of the estate or, if none is appointed,
“then any person in actual or constructive possession of any property of the
decedent.”
b. Simultaneous Death – If the primary beneficiary dies at the same time, then it will
go to the secondary beneficiary and whether or not it is included will depend upon
who is the secondary beneficiary.
c. Is Insured’s Wealth Transmitted – yes, it is something that is owned by the
decedent that happens to increase in value on the date of his death
4. Amounts Receivable by Other Beneficiaries
a. Incidents of ownership
i Full ownership is not required
ii House Ways & Means listed some incidents (not exhaustive):
 The right of the insured or his estate to the economic benefit of the
insurance
 The power to change the beneficiary
 The power to surrender or cancel the policy
 The power to assign it
 The power to revoke an assignment
 The power to pledge the policy for a loan
 The power to gain from the insurer a loan against the surrender value of
the policy
b. Reversionary Interest – this is an incident of ownership only if the value of the
reversionary interest exceeds 5% of the value of the policy immediately before the
decedent’s death
i Includes “a possibility that the policy, or the proceeds of the policy, may
return to the decedent or his estate, or may be subject to a power of disposition
by him.
ii Be careful of ultimate and indefeasible rights conferred by the policy on the
decedent and any remainder interest in the policy.
c. Effect of Policy Terms
i The express terms of the policy generally determine the incidents of
ownership, but where these are unclear, the courts will look to the substance
of the transaction.
ii The burden of proof is on the estate of the decedent to show that there are no
incidents of ownership when the terms indicate that there are.
d. Buy-and-Sell Agreements – usually these collateral agreements will provide a
surrender of all rights by the decedent and thus no inclusion under 2042
i When a transfer for value is made, the buyer loses the exemption for income
tax purposes – for example if X had an insurance policy on his life with ‘s
estate as the beneficiary and Y bought the policy such that he would become
the beneficiary, he would not have the income tax exemption.
ii 4 Exceptions:
 transfers to the insured
 transfers to a partner of the insured
 transfers to a partnership of which the insured is a member
 transfers to a corporation in which the insured is a key shareholder.
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5.
6.
7.
8.
9.
iii Note> in order to purchase life insurance on a person you must have a
relationship with that person rendering an insurable interest.
e. “Incidents” in Context
i if the origin of the insurance is such that some form of wealth transfer by the
decedent is evident, very slender 2036-2038 rights should be regarded as
incidents of ownership, but
ii if the policy is not generated at all by the decedent’s wealth or is disassociated
from the decedent by a prior outright gift, then the stronger 2041 type rights
should be recognized as incidents of ownership.
f. Economic Benefit – courts use this to narrow the meaning of “incidents of
ownership”
Incidents Incidentally Held
a. Shareholder in a Corporation
i Where corporation is the beneficiary and the decedent is a controlling
shareholder, then the incidents of ownership will be attributed to the
corporation
ii Where the Corporation is not the beneficiary and the decedent as legal or
equitable ownership of more than 50% of the combined voting power of the
stock of the corporation, the corporation’s ownership attributes will be
attributed to the decedent.
b. Partnership’s Insurance on Partner
i Incidents attributable to the Partnership
 When the proceeds are payable to the partnership
ii Incidents attributable to the Partner
 When the proceeds are payable to a third person (partner’s spouse)
 If under the policy the decedent has the right to change beneficiaries
Assignment of Group Term Insurance
a. An employee may effectively assign a nonconvertible group policy if the
employee assigns all of his rights.
b. No incident of ownership in the employee’s conversion privilege at employment
termination.
Amount to be Included
a. In General – the full amount receivable under the policy
b. Inclusion of Only a Portion of Proceeds – to the portion of the policy over which
incidents of ownership extend
Policy Purchased with Community Property Funds
a. Only ½ of the proceeds are to be included in the decedent’s estate (the surviving
spouse owns the other half.
b. Where the surviving spouse is not the beneficiary, ½ will be in the decedent’s
estate and the surviving spouse will have made a gift of ½
Relation of §2042 to Other Sections Defining “Gross Estate”
a. The Transfer Sections Generally
i §2037 – might be applicable if there is a lifetime interest in the policy
transferred, but it is difficult to see how this would produce a more onerous
tax result than 2042, so the government usually does not resort to this
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ii §2036 – not likely to be resorted to because rarely will decedent even want a
lifetime interest in life insurance
iii §2038 – this would satisfy the incidents of ownership requirement
iv §2039 – this is expressly inoperable to insurance
v §2041 – this will be treated as an incident of ownership
b. Near-Death Transfers
i §2035(a) applies only where decedent actually held an transferred 2042
incidents of ownership.
ii 4 possibilities:
 Transfers more than 3 years
 Beneficiary pays all premiums post transfer – nothing included in
decedent’s estate
 Decedent continues to pay all premiums – nothing included in
decedent’s estate
 Transfers within 3 years
 Beneficiary pays all post transfer premiums – the pro rata amount of
the proceeds attributable by the decedent’s payments
 Decedent pays all post transfer premiums – all of it would be included
10. Planning Aspects:
a. This is an asset that we typically want to divest our client of incidents of
ownership. We should be able to do this without any federal estate taxes. It has a
much higher value on the date of his death than it does when he is alive. You can
give it as a gift at a lower value when he is alive, but upon death, if it is still
owned, then it is included in his estate at face value.
b. Irrevocable Life Insurance Trust – we will use this trust to keep it out of the estate
of the insured, the insured’s spouse, and maybe the children of the insured.
i He would transfer any life insurance policies that he owns to the trust – whole
life, term, even group.
ii He makes the policies payable to the trust – but there are still risks of
inclusion under §2035 – the 3 year time frame we are concerned with. If the
transfer was within three years of his death, then if they would have been
included under §2042.
iii There will be a gift tax on the transfer of the policy – policy valued at CSV
J. Valuation
1. General Methods
a. Income Approach
b. Market Approach
c. Asset-based Approach
d. Combinations
2. Valuation Determined by Agreement – §2703
a. We do not take account of buy sell agreements when we value the business for
estate tax purposes – they will be binding on the members only.
b. Courts will usually give deference to the agreement if – bona fide business
transfer agreement AND the terms of this agreement are comparable to other
arrangements between 3rd parties.
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c. The failure to use a formula will lead to the belief that this will not be an excepted
agreement.
3. Adjustments for Discount
a. Discount for Minority Interest
b. Discount for Lack of Marketability – This can be argued whether or not you have
control of the company. If you have 51% there still may be a discount because
there is no market for the percentage share
Note> There is a wide range for the discounts to be applied.
There is a requirement of an appraisal of the interest of the entity – we need a
valuation of the partnership interest in the business.
- This takes account of any and all restrictions that may be in the partnership
agreement.
- The service does not like these discounts – and they have tried to get legislation to
limit the discounts.
c. Other Significant Discounts
i Fractional interest discount – this can be in percentage shares of commercial
property, timberland, etc. This works well the practice of asset protection
ii Blockage and market absorption discounts
iii Capital gains discount
iv Securities law discount
v Environmental hazards discount
vi Key person discount
vii Litigation discount
d. Combination of Premiums and Discounts
e. Nonbusiness Assets held in FLPS and FLLC’s
i A FLLP or FLLC can be used to shelter some of the property that would not
necessarily fall into discounts by forcing them to be discounted. These entities
will restrict the rights regarding the property.
ii Use of this can reduce the size of the estate by about 40%. Some people raise
the question of whether or not the formation of the partnership itself creates a
gift to someone – but who???
iii When you put this property into one of these entities, then you have to value
the entity, not the particular property. You have to be careful on how you do
this – you have to respect the partnership form.
 All of the assets need to be titled to the partnership and the income should
go to the partnership as opposed to the partner.
iv The service does not like these and has made it clear that certain FLLP’s had
to go to the national office for auditing:
 Substantial amount of marketable securities (we all know what these are
worth, by putting them in these entities the decedent is just trying the
avoid estate tax),
 Partnerships created within a short time before death
 makes it look like this is just a device to mitigate the estate tax
 they are trying to argue that the partnership agreement itself is a buy
sell agreement that should not be used in the valuation of the property,
 Powers of attorney
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v
4.
5.
6.
7.
Any of these will generate more difficulty in an IRS audit. The service has not
had a lot of luck with arguing these cases. (Case in Texas about a partnership
formed VERY close to death – the court found that this was okay)
§2701 – Certain kinds of interests in partnerships and corporations
a. Corporations
i A person who owns 100% of corporation – you would recapitalize with
common and preferred and we would create a class of preferred stock that has
a value of 100,000. Then we would give away the common stock to the
younger family members. The older family member would retain the frozen
capital and give away the growth portion of the corporation.
ii These transactions are no longer worthwhile under this code section.
iii The valuation principle that is applied is that
 The common stock will never be worth less than 10% of the corporation
and
 The preferred will not be worth the entire amount.
iv The statute makes you guarantee a regular right to payment.
v These are not worth doing any more – too costly.
vi Only apply this section if the transferor retains the frozen interest and gives
away the part that grows.
b. So what we set up is a partnership that has a corp as a GP and all of the members
of the LP have the same interest in the partnership. And this rule has no
application.
§2704 – Treatment of Certain Lapsing Rights and Restrictions
a. Ex: Contributed 50M of oil and gas property in an LP and took back an LP
interest with certain restrictions. The LP rights allowed him to force the LP to
give back the property, but upon death this right terminated. What was included in
the estate – the LP interest, but how should it be valued? And should be look at
the moment before death or the value at the moment of death. The court said that
the value that passes is that value right before death.
b. In valuing partnership interests, we ignore restrictions that lapse upon the death.
This increases the value of the property at the time of the gift of the property.
§2032. Alternate Valuation Date
a. We are given an alternate valuation date – this is an elective provision
b. Provides for an alternative valuation date of 6 months after the date of death
c. We can only do this to reduce estate tax liability – this cannot be used to try to get
a higher basis in the property.
§2032A. Valuation of Certain Farm, Etc., Real Property
a. Introduction
i Normal valuation says that we use the best use for the value of the property.
But, this provision allows us to value the property at its current use instead of
its highest and best use.
ii This provision was brought in the 70’s to help the estates of persons who own
family farms (there was a lot of speculation in land during this time and the
values were sky-rocketing)
b. Qualifications for Special Use Valuation in General
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an active business – the decedent was a material participant in at least five of
eight years prior to his death
ii it is passing on to a qualified heir and that party is going to be a material
participant in the active business.
iii Only allowed to use this if it is a substantial portion of the estate:
 50% of the value of the gross estate
 real property itself has to constitute at least 25% of the gross estate
iv This is limited to a reduction of 850K. So, when you value the property at its
highest and best use and then its current use is valued more than 850K less
than that, you are limited to the 850.
c. Election and Agreement
i This is an elective provision – you have to remember to make this election.
ii You have to comply with all of the requirements for the valuation, now it is
more like substantial compliance.
 There are certain statute authorized methods of valuation.
d. Recapture
i The Ten Year Period
 You are at risk (for 10 yr period) that the tax will be recaptured if certain
things occur and the service will impose the valuation that would have
been applied if this election was not applied.
ii Measuring the Recapture Tax
iii Liability for Additional Tax
iv Basis Adjustment for Additional Tax
8. §6166 Deferment of Estate Taxes
a. You can elect § 6166(only estate tax attributable to business value included in the
estate) to defer the payment of estate tax for about 15 years – then you will only
pay interest on the estate tax, then you pay the estate tax in installments for the
next 10 years. The interest rate is fixed at 2% plus 45% of the current market rates
b. The purpose of this is to not put too much burden on the estate when the decedent
dies.
c. This section also has provisions that if you dispose of the property then the tax
payable will be accelerated. This applies to the entire value of the business – not
just the real estate portion.
K. §2053 Expenses, Indebtedness and Taxes
1. Introduction
a. We take these deductions to get down to the value of the estate that is really
available for distribution. This gets us down to the taxable estate. (also §§ 2055,
2056)
b. § 2053 this is about the expenses necessary in carrying out the distribution of the
estate.
c. We would look at all of the debts that he owed at the time of his death wanting
those to be appropriately taken care of. Ultimately we will be distributing assets.
d. We want to identify claims of the estate and total amount of debt.
e. Technically allows the expenses outlined under (a). The language after that talks
about expenses allowable under state law.
i
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i
Critical Question: Is the executor authorized to pay these things out of the
estate? He can only use the probate estate to pay these expenses.
ii All of the items that pass out of the probate estate will have some
administrative expenses – it may be necessary that some of these expenses be
paid from other parts of the gross estate.
f. But, (b) makes it clear that if we have similar kinds of expenses that would be
deductible if they related to probate assets, we will be able to take the deductions
for the expenses relating to the non-probate assets.
g. Limitation – Amounts actually expended
i There will often be expenses well beyond the filing – we can estimate these
executor fees, accounting fees, attorney fees, etc.
ii If you never paid the estimated amounts you are obligated to go back and
amend.
2. Funeral Expenses - very liberally, includes sending someone and the body to the
burial plot. It does have a reasonableness limitation for some items – silver casket
example from the book.
3. Administrative Expenses – The collection of the decedent’s assets, determining
what other claims exists, paying off those claims, and distributing the assets of the
estate. This raises several questions as to the scope of what is necessary.
a. We have to draw the line with what is necessary and what is not – if the will is
ambiguous there may be more expenses that are deductible. There is a prohibition
of paying attorney fees for the benefit of the beneficiary, but when there is a
disagreement or ambiguity in the will, then this might be necessary and thus
included.
b. The service says that cannot deduct all the administrative expenses arbitrarily
because they are in effect increasing the value of the marital deduction with
property acquired after death.
i The deductible administrative expenses are limited to the value of the
“property subject to claims.”
 That part of the gross estate that under local law will bear the burden of
such expenses, claims, and charges, reduced, however, by any casualty
loss deduction allowed under 2054.
ii The administrative expenses relate to the assets of the estate such that it
should be deductible on the income tax purposes.
c. Expenses associated with selling certain assets of the estate – is this necessary for
the proper distribution of the estate.
d. Interest for borrowing for the estate – is this necessary for the proper distribution
of the estates –
i Where we have highly liquid assets available, then you probably should not
borrow and the interest expense would not be deductible.
ii Where you have a business interest included in the estate or illiquid assets –
then borrowing might be necessary.
iii The payment of the interest is a proper payment for the estate to make and can
be deducted. BUT remember – this is an interest expense deduction as well.
 You have to make a choice as to which deduction you want – estate tax or
income tax.
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 The logical thing to do when you have an estate that will not have any
estate tax – you have a reduced to zero estate tax plan, then you will want
to use these deductions for income tax purposes.
 .
iv
e. Investment Expenses – there are arguments for and against these being deductible
expenses.
f. Expenses to maintain property – maintenance of the property for preservation
until the date of distribution is deductible – but you could not deduct
development expenses.
4. Debts and Claims Against the Property –
a. It must be a filed claim in order for there to be a §2053 deduction.
b. The Service’ position is that this is not something that the executor should pay – it
can only be claims for which a proper claim has been filed.
c. Revenue Ruling 60-47 – you cannot deduct a claim that will not be paid because
the creditor failed to file.
d. 2053(c)(1)(a) – Consideration for claims - Any claim must be supported by
consideration for money or money’s worth.
i A separation agreement with a spouse – the giving up of rights of support is
adequate consideration or if it is based on judgment or order of the court then
it is sufficient.
ii
e. When a claim is uncertain you can probably get an extension for the estate tax
filing because the amount could be significant – for example a litigation claim
that has not yet been settled.
5. Mortgages - can be deducted without filing to the extent of the value of the property
that is included in the gross estate.The accrued interest is something owed at death –
so there is no question that this is a §2053(a) deduction.
6. Subsequent Events
a. There is a moment that we value all of the property in the decedent’s estate (DOD)
and that same moment is when claims are valued.
b. But there is an extent that we will take into account subsequent events that effect the
claims against the estate.
i The example of the former spouse who has an right to payments until her death or
remarriage and she dies within the 9 month filing time – should we take her death
into account for valuing this obligation?
ii Courts are split on these issues when we know there is an obligation to pay – the
only question is the value of the asset
c. Subsequent events should not be taken into account in the valuation of the debt
EXCEPT when the validity of the debt is questionable at the date of debt.
d. The courts struggle with these issues – there can be a lot of money involved. Gives an
example of a 5th Circuit case – In re Smith(???) It is the value of the claim at death.
L. §2054 Losses
1. §2054 is very much like the income tax casualty loss deduction.
a. Prior to filing the estate tax return we might have an event that causes a casualty
loss.
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b. We are looking for events of a catastrophic nature.
c. This also includes theft.
d. We look to the income tax rules to determine what the casualty is. We also look to
the income tax rules to determine what the loss is.
e. A taxpayer can only take one of the two provisions – if his estate claimed the 165
deduction on his final income tax form, then he cannot take this deduction.
2. FMV before the event – FMV after the event = casualty loss. This is limited to the
FMV before the event.
3. Alternative valuation will take into account the reduced value so that you will not be
able to take this deduction if you have chosen the alternative valuation date which
was after the catastrophic event.
M. §2055 Charitable Deductions – this is limited to the value of the property transferred to
charity, but it is unlimited in the sense that it is not subject to percentage restrictions such
as are applicable to the income tax deduction for contributions to charity.
1. Qualified Recipients
a. In General
i The charitable contribution must get to the charity by way of bequest, legacy,
devise, or transfer by the decedent.
ii There will not be a deduction when the decedent’s will fails to identify a
particular qualified recipient.
iii Policy
 Charitable organizations perform services that are useful to the nation,
services that might otherwise have to be paid for out of tax revenues.
 Generally take one of two forms:
 Exemption of the organization from tax
 A deduction for taxpayer contributions to the organizations
b. §2055(a) Organizations
i The US, the several states and their political subdivisions, and the District of
Columbia
ii Corporations “organized and operated exclusively for religious, charitable,
scientific, literary, or educational purposes”
iii Trusts and certain fraternal organizations – bequests only deductible if they
are to be used solely for charitable and related purposes.
iv Veterans’ Organizations incorporated by an act of Congress and their local
chapters and posts
c. We see more donors creating their own private foundations that are qualified
charities.
i This carries with it some expense – you would want at least 1mil in order for
this to be worth it.
ii There is a lot of compliance that is required with these.
 If the private foundation is not in compliance there will be a penalty.
 These are heavily regulated – there is a lot of filing that is required.
iii These can help family members if you name an adult child to run the
foundation – they will be entitled to a salary and any necessary travel benefits.
Private Foundations have to distribute a certain amount of the assets every
year.
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2. Transfers to Charity
a. Outright Transfers – decedent leaves cash or other property → reasonably
confident that estate will get the expected deduction
b. Indirect Transfers – when the transfer occurs as a result of a will contest, an
assertion of an elective share, or a reformation of a will, in a manner that
otherwise qualifies for a charitable deduction and if it is condoned by the local
courts. (if it looks like it is simply a collusive effort to qualify property for the
deduction it will not be allowed.)
c. Disclaimers – if you have the lifetime interest in a property whose remainder is to
go to charity, you can make a qualified disclaimer of the interest and get the
charitable deduction.
d. Property Over Which Decedent Had a Power – there is a deduction for property
that is brought into the estate by means of 2041 when the power is exercised in
favor of a qualified organization.
e. Lifetime Transfers – property that is brought into the trust under 2036 will qualify
for the charitable deduction if the property goes to a qualified organization (ex –
lifetime transfer of residence to the Red Cross, reserving the right to its use for
life, the property is included in the gross estate but 2055 can be used to offset it)
3. The Amount of Deduction
a. In General – date of death value of the property is the amount to be deducted
b. Expenses of an Estate Affecting the Deduction
i Death Taxes – you have to take out whatever taxes were paid out of these
bequests in order to determine the charitable deduction. The deduction has to
be the amount that the charity actually received.
ii Administrative Expenses and Claims – amount of deduction is reduced to the
extent that any of these payments were made out of the property passing to the
charity. Note> Transmission expenses v. Management Expenses –
Management Expenses would have to be paid even if the decedent was still
alive and thus would not reduce the amount of the deduction.
4. Split Interests: Mixed Private and Charitable Bequests
a. Background
i These allow the decedent to take care of his survivors and take advantage of
the charitable deduction
ii The concern had been that there would be manipulation of the investment
policy – you want to make sure that everything was properly valued.
b. Present Law – only allowed in circumstances in which the valuation uncertainties
arising out of the beneficiaries’ income rights and the trustee’s investment
discretion are minimal or nonexistent.
5. Qualified Remainder Interests
Note> In order for a remainder trust to qualify, it must meet all of the requirements of
one trust and not mix and match.
a. The Charitable Remainder Annuity Trust
i Annuity Trust Requirements –
 A fixed amount at least annually that cannot be less than 5% nor more
than 50% of the initial FMV of the assets that go into the trust.
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 Annuity must be for the life of the annuitant or for a term of years not to
exceed 20 years.
 The remainder must go in whole or in part to a qualified organization or
held in trust for the organization’s use.
 The value of the remainder must be at least 10% of the initial FMV of the
property placed in the trust.
ii The Amount of the Deduction – the net FMV of the corpus of the trust less the
value of the non-charitable interest in the trust.
b. The Charitable Remainder Unitrust
i Unitrust Requirements
 a fixed % of the annual FMV of the assets in the trust that cannot be less
than 5% of the annual FMV of the assets
 May have multiple named non-charitable beneficiaries
 Each non-charitable interest must not extend beyond that beneficiary’s life
or a term of years not to exceed 20 years
 No other non-charitable interests
 The remainder must go in whole or in part to a qualified organization or
held in trust for the organization’s use
 The value of the remainder must be at least 10% of the initial FMV of the
property placed in the trust
ii The Amount of the Deduction – the net FMV of the corpus of the trust less the
value of the non-charitable interest in the trust
c. The Pooled Income Fund – donor contributes money to the fund which is
commingled with money from other donors and the charity invests the money.
i Pooled Income Fund Requirements
 Annual Fixed Payout - % determined by the charity
 When the donee dies, the money goes to the charity
 The value of the remainder interest is what qualifies this fund.
ii The Amount of the Deduction – the value of the entire interest contributed
less the value of the income interests
6. Charitable Lead Trusts – the qualified organization gets the first interest with the
remainder interest going to a non-charitable party
a. There is no imposition of the minimum 5% interest
b. Must be either Annuity or Unitrust
c. Not limited to 20 years
d. There is no income tax reduction – because the charitable donee will be exempt
from income tax and the income is for the trust and will not be included in the
donor’s income.
e. These can be used to take advantage of certain GST provisions – it will not
become applicable until the lead terminates (so you never know – Congress may
repeal the GST by the time the annuity interest for charity terminates).
f. These are used mostly by very wealthy individuals – if in life it is probably
because they give a lot to charity and are running into percentage limitations and
if in death it is probably to take advantage of GST provisions.
g. The lead interest is what qualifies these trusts
7. Exceptions to the Split Interest Rules
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a. Remainders in Residencies and Farms
b. An Undivided Portion of the Property
c. A Qualified Conservation Contribution
i These are most beneficial during life – there is an immediate income tax
reduction § 170
ii At death you get a charitable deduction for the value of the easement and you
can make an election about how this property will be valued § 2031(c) – this
election will reduce the value to be included. This allows you to exclude a
portion of the property as well as take the charitable deduction This is kind of
like a double benefit.
d. Works of Art and Their Copyright
e. Charitable Gift Annuity
N. § 2056 Marital Deductions
1. Introduction
a. The marital deduction is unlimited – it has not always been this way, but it is now.
It started when Congress was trying to equalize the community property states
and the others.
b. The marital deduction is meant to be a tax deferral tool. So, we want to allow a
deduction for items that will be included in the Surviving Spouse’s estate.
c. The marital deduction is generally mandatory – but it is hard to imagine when
someone would not want to use this.
2. General Description – Two Basic Features
a. Deduction allowed for any interest that passes at death or that passed during life
from a decedent spouse to a surviving spouse
b. Must be a deductible interest:
i It is included in the decedent’s gross estate
ii It is not otherwise deductible under some other estate tax deduction provision.
iii It is not a terminable interest.
3. Interests Passing to a Surviving Spouse – An interest shall be considered as passing
if it goes to the surviving spouse in the following manners:
a. By will or inheritance (2055(c)(1&2)) – this includes a deductible interest that
goes to the surviving spouse after a settlement.
b. Dower (2055(c)(3) – the statutory share must be claimed by a timely filing under
state law to qualify
c. Transfers (2055(c)(4)) – any transfer during life will be considered as having
passed to the surviving spouse – it does not matter is the SS was the decedent’s
spouse at the time of the transfer, but it does matter is SS was spouse at the time
of death.
d. Jointly held property (2055(c)(5)) – the deduction will be allowed for the value of
the property that would have been included in the decedent’s estate at the time of
death – tenancy by the entirety.
e. Property Subject to a Power (2055(c)(6)) – if decedent had a power over an
interest and as result of exercising, releasing, or non-exercise of the power, the SS
receives the interest. The giving of the power does not in itself constitute an
interest in the property passing to the spouse.
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f. Insurance (2055(c)(7)) – insurance proceeds that are paid out to SS at he death of
the decedent. The deduction hinges upon whether or not the proceeds were
includable in the decedent’s estate.
g. Other “Passing” Problems – support payments will meet the passing requirements
if it passes the terminable interest rule.
h. Disclaimers – marital deduction is foreclosed for an interest that the SS disclaims
causing it to pass to someone other than SS
4. The Gross Estate Requirement - Can enter the calculation of the marital deduction
only to the extent that it is included in determining the value of the gross estate.
5. The Valuation of Interests Passing – must be undertaken with the valuation method
and the valuation date adopted for valuing the gross estate.
a. Taxes on Surviving Spouse’s Interest – if interests passing to a SS share the
economic burden of any death taxes, state or federal, the value of such interests
must be diminished accordingly in computing the marital deduction.
b. Encumbrances on Surviving Spouse’s Interest – 2056(b)(4)(B)
i Mortgages –
 If decedent is personally liable for a charge against a property, the entire
value of the property is included in decedent’s gross estate, but only the
value of the decedent’s equity in the property will be includable as a
deduction.
 This is because it would otherwise cause a double deduction – §2053
operates to reduce the value of the property for indebtedness whether or
not the decedent was personally liable.
ii Administrative expenses
 The marital deduction is reduced if administrative expenses are deducted
under §2053.
 The marital deduction is also reduced by the amount of administrative
expenses that are deducted under the income tax as a result of a §642(g)
election and are paid out of the marital share but are related to non-marital
property.
iii Assumption of an obligation – a bequest to a spouse conditioned on the
spouse’s assuming an obligation operates to reduce the value of the property
passing to the spouse for purposes of the marital deduction.
6. Formula Clauses
a. Types of Clauses determining the funding for the Credit Shelter Trust and Marital
Trust:
i Fractional Bequest – a specific fraction is given to each trust – ½ and ½.
ii Pecuniary Bequest – a specific $ amount is left to one trust with the other to
receive the residuary
iii Formula Fractional Bequest – The fraction is a fixed formula with the
numerator as the amount you want to fund the particular trust and the
denominator as the residuary value of the estate.
iv Formula Pecuniary Bequest – The pecuniary bequest is determined by saying
that the amount going to the trust is the smallest amount necessary to take full
advantage of the unified credit when the formula is for the marital trust or
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maximum amount to take full advantage of the unified credit when the
formula is for the credit shelter trust.
b. Special Problem with a Pecuniary Bequest to a Surviving Spouse
i A pecuniary marital deduction bequest using date of distribution value shifts
post death appreciation from the surviving spouse to the residuary legatees,
who are also called on to absorb post death shrinkage.
 The estate must recognize the gain for the appreciated value of property.
 Alternatively, if the estate goes down in value the marital trust portion will
be disproportionately large.
ii If the pre-residuary trust is the credit shelter trust using the date of distribution
values – then the credit shelter will get only the 1mil (or stated amount) and
then your marital trust will have all of the appreciation. A lot of lawyers use
this method because it is easiest.
iii If the pecuniary bequest is satisfied using the estate tax value of the property,
then you could fund the martial bequest with the assets that have depreciated
in value – this way the credit shelter trust could take advantage of any
appreciated assets.
 Rev. Ruling 64-19 - If you have a Pre-residuary marital bequest that is a
pecuniary formula and the executor is authorized to fund the trust with
property at estate tax value, then you have to modify your funding method
 Minimum worth – you can fund at estate tax value, however you must
also look at the value of the property funding the marital trust at the
date of distribution and they have to be at least the same amount as the
marital deduction taken on the estate tax return
 Aggregate sharing – fairly representative of the aggregate
appreciation of the estate.
You have to adopt one of these funding options or you lose the marital
deduction – most states have adopted a saving statute so that people will
not lose their marital deduction if they do not state how they want it
funded in the will.
 This is designed to prevent the funding of the pre-residuary pecuniary
bequest with all depreciated assets and will still eliminate the recognition
of gains and losses.
c. Outdated Formula Clauses
7. Terminable Interest Rule
a. General Rule and Purpose
i Non-deductible if:
 The interest is terminable;
 The decedent has also given an interest in the property to another; and
 On the termination or failure of the spouse’s interest, the other person may
come into possession or enjoyment of the property by way of that person’s
interest.
ii Seeks to assure that there is a transmission tax when the property is
transferred to others by allowing a marital deduction only where the nature of
the interest passing to the spouse is such that, if retained until death, it
unquestionably will be taxed in the spouse’s estate.
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b. Identifying Terminable Interests
i A legal life estate or life interest is a trust.
ii An interest is terminable if it will fail or terminate upon a “lapse of time,” the
occurrence of a contingency, or on the failure of an event or contingency to
occur.
 “widow’s allowance” – must vest at the date of decedent’s death to be
considered non-terminable
 Survival Clause – renders the interest terminable even if the spouse
survives because the interest is determined based on the failure of an event
to occur.
c. Other Elements of the Terminable Interest Rule
i No interest in the property has passed gratuitously to another
ii No other person will acquire the property on termination of the surviving
spouse’s interest by reason of any interest that person may have.
 Must have passed to the other person from the decedent for less than
adequate and full consideration in money or money’s worth.
iii The marital deduction is lost only if all three elements of the terminable
interest rule are present.
d. The Executor Purchaser Provision – if the decedent directs the executor to
purchase a terminable interest for SS, this is a terminable interest that is nondeductible. However, SS can voluntarily purchase a terminable interest with
money left outright to her.
e. The “Tainted” Asset Rule
i To the extent a bequest can be satisfied out of assets that would not qualify for
the marital deduction, it is so satisfied – it is enough that the bequest could be
satisfied out of the proceeds of such assets in order to run afoul of the rule.
ii This problem can be avoided by stipulating in the will that the SS’s bequest
cannot be satisfied with a non-deductible interest or the proceeds therefrom.
8. Terminal Interests that do qualify
a. Common Disaster and Related Provisions
The statutory provision is that an interest passing to a SS is not to be considered a
terminable interest if it will fail only upon
i The SS’s death within 6 months after the decedent’s death
ii The SS’s death as a result of common disaster, causing the death of the
decedent as well
iii The occurrence of either of such events if, in any event, such failure does not
in fact occur.
b. Life Interests with Powers – 2056(b)(5)
i 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 income from the entire interest
 Income is determined using trust accounting
 The regulations have been modified so that we can use the total return for
the payout to SS
ii The income payable to the surviving spouse must be payable annually or at
more frequent intervals
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 Income must be currently distributable to SS – any mandatory delay in
receipt of the income will render the income non-current
iii The surviving spouse must have the power to appoint the entire interest or
the specific portion to either surviving spouse or spouse’s estate
 Where SS has only the power to appoint to her creditor’s this will not
satisfy this requirement
 If SS can appoint also to another person, the exercise of her power in this
way will result in estate or gift tax and will thus not render the trust invalid.
iv The power in the surviving spouse must be exercisable by the surviving
spouse alone and (whether exercisable by will or during life) must be
exercisable in all events
 Any requirement that another person join with SS in exercise of the power
will defeat the exception.
 To meet the “all events” test the power must arise upon the death of the
decedent and be exercisable, for example, before the estate makes
distribution of the property subject to the power; but it is permissible that
actual distribution to the appointee be delayed.
v The entire interest or specific portion must not be subject to a power in any
other person to appoint any part to any person other than the surviving
spouse
c. Insurance with Powers - 2056(b)(6)
i The proceeds, or a specific portion of the proceeds, must be held by the
insurer subject to an agreement either to pay the entire proceeds or a specific
portion thereof in installments, or to pay the interest thereon; and all or a
specific portion of the installments or interest payable during the life of SS
must be payable only to SS
ii The installments or interest payable to the surviving spouse must be payable
annually, or more frequently, commencing not later than 13 months after
the decedent’s death
iii SS must have the power to appoint all or a specific portion of the amounts so
held by the insurer to either the spouse or the spouse’s estate
iv The power in SS must be exercisable by the spouse alone and (whether
exercisable by a will or during life) must be exercisable in all events
v The amounts or the specific portion of the amounts payable under such
contract must not be subject to a power in any other person to appoint any
part thereof to any person other than SS
d. Election with Respect to Life Estate for Surviving Spouse – 2056(b)(7)
This disposition of the property passes to the SS only a terminable interest that,
when coupled with the interests given to others, would not qualify for the marital
deduction absent some authority permitting us to pretend that the spouse is the
owner of the property for transfer tax purposes. QTIP
i The passing requirement – it must be included in the decedent’s gross estate
and pass from the decedent.
ii The qualifying income interest requirement
 Income Interest
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 Must have a right to all income payable annually or more frequently
commencing at the decedent’s death
 Spendthrift clauses may be allowable
 An annuity interest is not a qualifying income interest except:
 An annuity that is included in decedent’s gross estate under 2039
or is community property included under 2033, and is payable only
to SS during her life.
 An annuity that is not included under 2039 for decedent’s dying
before 1992.
 Powers over Property During SS’s lifetime
 No restriction on SS or anyone else having a power to invade except
that it be only for SS’s benefit
 Anyone can have a non-general power over the remainder “exercisable
only at or after” SS’s death.
 We want to make sure that the property will be included in the gross
estate of SS.
iii The election
 This is operative only if an election is made by the executor on the Estate
Tax Return
 If you are only electing this for a specific portion of the property – the
portion must be expressed as a percentage or fractional share of
identifiable property passing from the decedent.
iv Joint and mutual wills
e. Special Rules for Charitable Remainder Trusts - The terminable interest rule does
not apply to an interest in a CRAT or CRUT that passes or has passed to SS from
decedent, if SS is the only non-charitable beneficiary.
f. Interrelationship of the Terminable Interest Exceptions – there may be an overlap
between the (b)(5) and (b)(7) trusts making you think that both would work – just
remember, you cannot take double deductions.
9. The Non-Citizen Surviving Spouse – must use a QDOT for any deduction to be
allowed for a non-citizen spouse.
O. Credits
1. §2010 – Unified Estate Tax Credit
2. §2011 – Credit for State Death Tax – this is going away and it was rarely a full credit
anyway unless it was just a pickup tax. This can be included in the credit shelter trust.
3. §2012 – credit for gift tax paid on gift tax paid on gifts paid prior to 1977. Gift tax
paid on gifts since 1976 are taken out when calculating the estate tax payable –
included in the computation of the estate tax.
4. §2013 – available in estates of persons dying that is included in the estate of someone
dying in the past 10 years. Also available if it is included in an estate of someone
dying 2 years after D. These will be remainder interests and retained life estates, etc.
5. §2014 – credit for foreign tax
6. §2015 – postponement on the payment of estate tax on certain remainder interest.
III. Gift Tax
A. §2501: Imposition of a Tax
B. §2511: Transfers in General
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1. Direct Gifts – outright gift of property – cash, car, stock, etc.
2. Indirect Gifts - Ex – gift to a closely held company. If you have a closely held
company and you contribute property to the corporation, it will be treated as a gift to
the extent of the interest in the company of the other shareholders. This will not
qualify for the annual exclusion because it is not a present interest – a shareholder
cannot get to it right away. Also includes gifts in trust, gifts made through straw
persons, discharge of indebtedness, below-market interest rate loans (or the free use
of money), gratuitous services, gifts made by incompetents
3. Property Interests Covered
a. Remainders
i When the donor gives the remainder interest to a person then the value of the
gift is the value of the interest
ii If the person is related then the value of the remainder interest is determined
under §2702.
iii Contingencies go only to the value of the remainder – there is still a gift, it
will just have a lower value than one that does not have a contingency.
iv You can make a gift of a contingent remainder or contingent reversionary
interest that you own. Again – value will be low depending on the likelihood
of the contingency.
b. Uncertain Interests – just because it is uncertain does not make it any less a gift –
it will just have a lower value.
c. Insurance and Annuities –
i A purchase of a policy for the benefit of another, the transfer of an existing
policy to another, or the payment of premiums on an existing policy owned by
another, may all constitute gifts if the one making the purchase transfer or
payment retains no control over the policy.
ii If he has any indicia of ownership at the time of his death, the proceeds will
also be included in his gross estate.
4. When a Transfer is Complete – when the donor has relinquished all dominion and
control over the transferred property
5. Revocable Transfers – this is the greatest control a donor can retain over transferred
property. You must look to each interest in property to ascertain if the donor has
retained any power to revoke – each interest is determined on its own. Once the donor
terminates his right to revoke, then the gift is complete.
6. Power to Change Beneficiaries – any power held by the donor over the property,
even if it does not include the ability to transfer the property for the benefit of the
donor, leaves the gift incomplete. The gift will not be complete until to donor
relinquishes this power.
7. Power to Alter Time or Manner –
a. If the donor has the power to accumulate income in a trust in which the income
beneficiary and the remainder man are the same person, then the gift is complete
when the transfer is made.
b. If the donor has the power to accumulate income in a trust in which A is the
income beneficiary and B is the remainder man, the gift of the remainder is
complete upon issuance, but because income interest is alterable it is not complete.
8. Donor’s Power Exercisable Only with Third Persons
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a. If the one who must consent has no economic interest in the property interest
subject to the power, then it is not a complete gift.
b. If the one who must consent has an adverse interest in the exercise of the power,
then it is a complete gift.
9. Powers Held Only by Third Person
a. Generally, as long as the donor has not retained any control over the property, this
is a completed gift.
b. If the third party is required to distribute income to the donor as necessary for his
support, this is an ascertainable standard and we have a completed gift only to the
extent the value o the corpus exceeds the value of the donor’s right to support and
maintenance.
c. If the trustee has the power to distribute at his discretion, then as long as the donor
has no control, then we have a completed gift. But, if the donor’s creditors have
access to the corpus or income of the trust, then it is not a complete gift.
d. If the donor has any control over the distributions what so ever, then it is not a
completed gift.
C. §2702: Valuation for Transfers of Interests in Trust
1. The General Rule
a. §2702 merely effects the valuation of remainder interests – this only applies when
the trust or remainder interest is to benefit family members and a retained interest
in the donor.
b. §2702(a)(2) Valuation of retained interest:
i in general, any unqualified interest will be valued at zero
ii value of any retained interest will be valued under §7250
2. Exceptions:
a. In general
i If such a transfer is an incomplete gift
ii If such a transfer is a transfer of an interest in trust, all of the property within
the trust is a personal residence
iii To the extent the regulations provide that such a transfer is not inconsistent
with the purpose of this section.
b. Qualified Interest
i Consists of a right to receive fixed amounts payable not less frequently than
annually → GRAT
ii Consists of a right to receive fixed percentage of the FMV of the property
→ GRUT
iii Non-contingent remainder if the other interest are either a GRAT or a GRUT
These prevent the portion retained by the grantor being overvalued.
3. The Joint Purchase Rule – 2702(c)(2)
a. If two or more persons purchase property such that one person purchases the
income interest and the other purchases the remainder interest, then it will be
considered as if the person buying the income interest is buying the entire
property and giving the remainder interest to the other with the remainder bing
valued at 100% of the property. The amount paid in by the donee will be
consideration like a part sale part gift.
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b. The purchase of a remainder interest from a related person will be treated the
same way.
c. The remainder interests in these two situations will not be caught by 2036.
D. §2512: Valuation of Gifts
1. Timing – the value of the gift is determined at the date of the gift (the date of
completion)
2. Premiums and Discounts for Interests in Property
a. Premiums for Control Interests – this applies when the donor transfers a
controlling interest, but it does not apply when the donor transfers a minority
interest that will give the donee control when it is added to his other shares of the
company
b. Discounts for Family Limited Partnerships – When we look at the gift property
value, we will not look to the fact that the rest of the interests in the partnership
are family.
c. Discounts – we take discounts for minority, marketability, and no control. This
can be a huge estate planning tool to get the property out of your estate without
using all of your unified credit. The discount will be higher if it is an actual
business or real estate.
3. Consideration for a Transfer – the amount by which the value of the property
exceeded the value of the consideration
a. Must look to see if it was a bona fide business transaction without donative intent.
b. The burden is on the transferor to show that there is no donative intent. The
donative intent is presumed under gift tax.
4. Other Receipts for Money’s Worth – the donee pays the gift tax
a. Net Gift – the gift is made on the condition that the donee pay the gift tax. The
gift is the value of the property less the gift tax paid.
b. This is a part gift part sale and there will be a gain realized by the donor to the
extent that the gift tax exceeds the donor’s basis in the property. He is allowed to
look at his entire basis unless it is a gift to a charitable organization, in which case
he has to allocate.
E. §2514: Powers of Appointment
1. General Power
a. The basic rule is that the general power is one that can be exercised in favor of the
possessor of the power, the possessor’s estate, the possessor’s creditors, or
creditor’s of the possessor’s estate.
b. Exceptions:
i Ascertainable standard – a power that is exercisable in favor of the possessor
as needed for his support, medical expenses, educational expenses
ii Pre-1942 Powers – if they are exercisable with another person
iii Post-1942 Powers – if they are exercisable with another person if that person
is
 The creator of the power
 A person with an adverse interest in the power being exercised.
 A person with an adverse interest in a portion of the property subject to the
power only in respect to that portion of the property
2. Release or Disclaimer
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a. A release of a power is considered as a transfer, but a qualified disclaimer is not.
b. A qualified disclaimer must meet the requirements of §2518 must be met.
i Cannot be disclaimed after it has been accepted
ii Generally must be within 9 months of creation of the power
3. Lapse of Power –
a. in general treated as a release
b. 5 or 5 Power applies to lapse here as well and if the power meets the 5 or 5 rule
then it will not be considered a release.
F. Disclaimers and Transfers Between Former Spouses
1. §2516 Certain Property Settlements
a. If you enter into an agreement and divorce occurs within a 3 year period starting
one year prior to the agreement, the following transfers made pursuant to the
agreement will be treated as a for adequate and full consideration:
i In settlement of marital or property rights
ii To provide reasonable support of issue of the marriage during minority (Child
Support)
b. §2043 tells us that the giving up of marital rights is not full and adequate
consideration
i Exceptions (the following are for adequate and full consideration):
 Giving up of right to support
 If it is a transfer made pursuant to a decree of the court
ii §2516, on the other hand, allows a giving up of marital rights that is subject to
the agreement – so what happens if one of the other parties dies before the
transfer has occurred? In order to get the marital deduction it has to fall under
one of the following:
 It was a transfer in discharge of support obligations
 It was ordered to be transferred by the court
 It fits under the provision of §2516
2. §2518 Disclaimers
a. Purpose – to allow a person to disclaim a gift – no one should have a gift forced
upon them.
b. This gives us uniformity for determining disclaimers for estate and gift tax
purposes
i Otherwise each state would be different according to their property laws – so
it is possible for you to have effectively disclaimed the gift according to state
law, but not for estate or gift tax
ii If you do not disclaim in accordance with 2518 and it passes to the third
person, it will be treated as a gift from him to another person. If the disclaimer
is effective for state property law, look under the will to see how the property
would have passed had the initial beneficiary predeceased the decedent and
this is who gets the property – you have given a gift to that person. So, you
may have a disclaimer under state law, but not under tax law
c. Elements of an Effective Disclaimer:
i irrevocable and unqualified refusal to accept
ii in writing
iii writing must be received within 9 months of creation
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iv person has not accepted any interest of the property or any of its benefits
v passes without any direction on the part of the person making the disclaimer
and passes either to the spouse of the decedent or to someone other than the
disclaiming person (it is okay if the spouse is the disclaimer and by reason of
the disclaimer some interest in the property would go to the spouse – it will
still be effective – no one else can do this, just the spouse)
d. The spouse rule helps us with estate planning:
i H and W own the bulk of their property as joint tenants. We planned their
wills with the credit shelter trust and a QTIP, but H dies with 90% of property
in joint tenancy. The spouse needs to disclaim an amount necessary to fund
the trust – this can be done using a formula.
ii This may also be used to increase the amount of the marital deduction – if you
have a joint tenancy with the son, you would have the son disclaim so that the
marital trust (QTIP) will be sufficiently funded. Note> child can only disclaim
what they are inheriting (so you have to consider the amount that is included
in the gross estate of the decedent v. the amount attributable to the son.
G. §2503: Taxable Gifts
1. Annual Exclusion - $11,000 per year, per donee
a. Purpose of the Annual Exclusion – so that there would not be a need to keep track
of all the small gifts that are made during the year – this amount is large enough
so that it should take care of Christmas and wedding and other gifts.
b. Identification of Donees
i Gifts in trust – transfers in trust constitute gifts to the beneficiaries; a single
transfer to a trust may qualify for several annual exclusions limited only by
the number of beneficiaries and the future interest rule.
ii Gifts to other entities – gift to corporations is a gift to the shareholders, but it
runs afoul with the no future interest rule. Partnerships and LLC’s – indirect
gifts to the members.
iii Gift by an entity – deemed to be from each of the shareholders and goes
toward their annual exclusion for that person
iv Gifts to charitable organizations – a single gift to the entity
v Straw person – if you make a gift to A and a gift to a straw person who then
makes a gift to A – one gift and only 11,000 will be excluded
vi Joint donees – generally a gift to two people so you get two annual exclusions.
The problem arises in tenancies by the entirety when the spouses have
different life expectancies such that the proportionate value of the property
will be different – you have to find the value for each donee and they each
only get the 11,000 exclusion.
2. Future Interests Disqualified for Exclusion – remote or contingent future interests
in property may be very difficult to value and the ultimate donees may be difficult to
identify.
3. Definition of Future Interests – one that is limited to commence in use, possession
or enjoyment at some future date or time. Immediate right to use, possession or
enjoyment is the test.
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a. Separate Interests Tested – when you have a gift that is made up of several
interests, they are each their own gift and you have to separate all of the interests
and test each of them on their own to determine if it is a future interest
b. Non-Income-Producing Property – if a gift has no value, then it will have no
value for the exclusion – if valuation is prevented, then exclusion is precluded.
c. Powers Affecting Present Interests – if there is a power to invade the present
interest for the benefit of someone other than that beneficiary, then there is no
annual exclusion because the gift cannot be valued.
d. Brief Postponement of Enjoyment – any postponement of enjoyment defeats the
exclusion. If there is a gift of income, the income must be assured and not the
mere authority of the trustee to distribute income.
e. Right to Enjoyment Suffices – all we need is the right to the possession or
enjoyment, there dos not have to be actual possession or enjoyment – gift of a
trust with general provision to accumulate income, but beneficiary has the right to
draw down the income or corpus as they wish.
f. Crummey Powers – an interest will have the status of present interest if the donee
is also given Crummey Powers.
i Powers given to beneficiaries to demand outright ownership of property held
in trust – this is premised on the theory that the present right to possess is
equal to possession.
ii Crummey powers say that each beneficiary can withdraw his pro rata share of
the gift made to the trust, but we usually do not want them to exercise these
powers when they are granted. This presents the problem of lapse – so we
restrict the power to 5 or 5 Rule so that there will be no gift tax liability on the
part of the beneficiary.
iii Irrevocable Life Insurance Trust (ILIT)
 In the creation of a life insurance trust, we use withdrawal powers for
distributions so that there is an immediate right – a present interest for the
annual exclusion.
 A life insurance trust will not have anything to distribute for a while, but if
the beneficiaries have the power to invade then it is okay – thus we give
them Crummey Powers.
 We do not want the beneficiaries to exercise their power so we add the 5
or 5 restriction, but there is a further problem here when the policy
premiums are being paid – the donor will not get to take full advantage of
the annual exclusion to the extent it is more than the 5 or 5 restriction of
their power. So we create Hanging Powers.
 Hanging Powers - only allows the power to lapse for the 5 or 5 and the
other accumulates.
 The more power holders you have, the better – because it reduces the pro
rata share. These powers go only to the people who are beneficiaries of the
trust. We do not want to give this power to persons who have no other
interest in the trust – the courts have not ruled on this, but the service has
said that these powers will be presumed to be illusory.
iv The service has tried (unsuccessfully) to limit these powers:
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 Cannot be illusory because of lack of knowledge or unreasonable time
within to exercise the right,
 Holder of the power must have a substantial economic interest in the
property – courts have not let this fly
 Should not be recognized where it is shown that there has been a
prearranged understanding that the right to withdrawal will not be
recognized
g. Qualified Tuition Programs and Education Savings Accounts
i Qualified Tuition Programs – you can get up to 5 times your annual exclusion
per beneficiary and then you spread it out over the next 5 years. It is treated as
a present interest and there is no taxable gift when it is distributed to the
beneficiary
ii Education Savings Accounts – you are only allowed to contribute 2,000 per
year per beneficiary, so you do not have problems with the annual exclusion.
It is treated as a present interest and there is no taxable gift when it is
distributed to the beneficiary.
iii Note> Any transfer of beneficiaries that is not a family member or is in a
generation below the old beneficiary, it will be a taxable transfer.
4. Gifts to Minors – if it is a direct gift it will qualify for the exclusion, if it is an
indirect gift look to 2503(c)
5. Special Statutory Rule for Minor Donees
a. First Requirement – the property and the income therefrom may be expended by
or for the donee before the donee reaches 21
i the transfer terms are such that the property and its income are properly
expendable for the minor donee
b. Second Requirement – the property and income not so expended will pass to the
donee when the donee reaches age 21, or to the donee’s estate or pursuant to the
donee’s exercise of a general power of appointment if the donee dies before
reaching that age.
6. Medical Expenses and Tuition – unlimited amounts of tuition and medical expenses
for any number of donees is allowed – but it does have to be paid directly to the
institution.
7. Waiver of Survivorship Benefits – not treated as a gift when waived before the
participant’s death.
8. Loans of Qualified Artwork – not treated as a transfer if loaned to a qualifying
organization.
9. Gift Tax Returns – generally must be filed in the year the gift was made.
IV. Generation Skipping Tax
A. §2611. Generation Skipping Transfer Defined
1. Three Types of Generation Skipping Events: Taxable Termination, Taxable
Distribution, Direct Skip
2. Certain Transfers Excluded:
a. Medical and Tuition Expenses that are not treated as a taxable gift under §2503(e)
b. Transfers that have already been taxed
B. §2612. Taxable Termination, Taxable Distribution, Direct Skip
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1. Taxable Termination – the termination of an interest in property held in trust such
that the property goes to a skip person.
2. Taxable Distribution – any distribution from a trust to a skip person
3. Direct Skip – a transfer of an interest in property to a skip person
C. §2613 Skip Person and Non-Skip Person Defined
1. A natural person who is assigned a generation which is two or more below the
generation assignment of the transferor
2. A trust, if all of the interests in the trust are held by skip-persons and there are no non
skip-persons who hold an interest (interest being a present interest) in the trust or who
will have a distribution from the trust.
D. §2651 Generation Assignment
1. Transferor – you, spouse, brothers, sisters, for non-family:12 ½ older and 12 ½
younger
2. 1st Generation – children, nieces and nephews + spouses, for non-family: more than
12 ½ to 37 ½ younger
3. 2nd Generation – grandchild, great nieces and nephews + spouses, for non-family:
more than 37 ½ to 62 ½ younger (25 year increments)
4. 3rd Generation – great-grandchild, etc.
E. When you have a Generation Skipping transfer, you will be taxed on that transfer in
addition to your gift tax for the transfer. You are taxed on the property interest that you
transfer to that person.
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