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The Federal Transfer Taxes
Solutions to Problem Materials DISCUSSION QUESTIONS
24-1 Both the Federal gift and estate taxes are computed with reference to a single rate schedule. Both taxes are imposed cumulatively. Upon an individual's death, his or her taxable estate is added to the amount of his or her inter vivos gifts to determine the base for imposition of the Federal estate tax. For 2011 and the forseeable future, the same exemption (unified credit) is available for both the gift tax and the estate tax. [See p. 24-3 and 2001(b).] The couple can be viewed as the taxable entity rather than each spouse due to the unlimited marital deduction allowed for both gift and estate tax purposes. Because amounts of wealth transferred at death to a surviving spouse are fully deductible from a decedent's gross estate, such amounts of wealth are not subject to the Federal estate tax until the death of the surviving spouse. Similarly, inter vivos gifts between spouses are not subject to the Federal gift tax. (See p. 24-28 and 2056 and 2523.) No. This transaction represents a valid "arm's length" sale between unrelated business parties. (See p. 24-6 and Reg. 25.2512-8.) The $50,000 payment constitutes a taxable gift from Mr. K to his son. The "consideration" that Mr. K received in return for the $50,000 payment (S's agreement to live in the same town as Mr. K) is not valuable in money or money's worth. (See p. 24-6 and Reg. 25.2512-8.) The creation of the joint bank account is an incomplete transfer and, therefore, does not constitute a taxable gift. The gift is created only when GS makes a withdrawal. [See p. 24-7 and Reg. 25.25111(h)(4).] The Federal gift tax is computed on a cumulative basis over a taxpayer's lifetime. [See Example 7, p. 24-11, and 2502(a).] The amount of the taxable estate that a decedent leaves is often thought as the decedent's final taxable gift due to the method of computing the tax. To compute the Federal estate tax, a decedent's taxable estate is added to the total amount of his or her adjusted taxable gifts. Tax is computed on this total base, and gift taxes paid during the decedent's life are subtracted to leave an amount of Federal estate tax payable. [See Exhibit 24.4, pp. 24-15 and 24-29 and 2001(b).] 24-2 24-3 24-4 24-5 24-6 24-7 24-1 24-2 Chapter 24 The Federal Transfer Taxes 24-8 Even though a taxpayer may make a transfer during his or her lifetime which constitutes a taxable gift, such property may still be added back to the gross estate. In other words, in these situations, the law pretends that the taxpayer never made the gift. In effect, these transfers are treated as taking effect at death. In such case, the taxpayer is entitled to a credit for any gift taxes paid that can be used to reduce his or her estate taxes. Examples include gifts made in which the donor retains an income interest in the transferred property (see Example 22, pp. 24-22 through 23-24, and 2036) and gifts made in which the donor retains the right to alter, amend, or revoke the conditions of the gift. (See Example 21, p. 24-24, and 2038.) There are three basic steps in calculating the estate tax. First, the assets included in the decedent's gross estate must be identified and valued. Second, any debts of the decedent, claims against the estate, funeral and administrative expenses, and losses incurred during estate administration may be deducted. Third, any qualifying bequests to charity or to a surviving spouse may be deducted. (See p. 24-15.) The gross estate concept is much broader than the legal probate estate. Many assets not legally owned by the decedent at death may be included in his gross estate for Federal tax purposes (e.g., property held in joint tenancy is not part of the probate estate but is included in the gross estate). However, only assets owned at death and transferred under the terms of a decedent's will are included in his or her probate estate. (See Exhibit 24.5, pp. 24-14 and 24-15.) a. Many individuals see joint tenancy as a substitute for a will without all of the problems associated with wills. By creating a joint tenancy with the desired heir or heirs, property is transferred to the heir(s) just as a will might do but in a very simple and straightforward manner (it's automatic). Joint tenancy avoids all of the problems associated with obtaining and implementing a will (e.g., costs of an attorney, costs and delays of going to court, and other problems associated with probate as discussed below). Indeed, many say the most attractive feature of JTWROS is that it avoids probate altogether. Moreover, there are those that might say there is no need for a will if all of the property is held in joint tenancy with the desired heir(s). While there may be an ounce of truth to this, the stark reality is that the final surviving co-tenant must have a will if he or she wishes to leave the property to a particular beneficiary (unless a new joint tenancy is created with such beneficiary). The problem here is that no one knows who will die first and who will die last. Thus all the joint tenants need wills if they want to ensure that the property passes to the right person. (See p. 24-4.) There are several problems normally associated with joint tenancy. Joint tenancy exposes the property to the creditors of all joint tenants. To illustrate, assume mom retitles all of her assets (e.g., her Schwab brokerage account) so that she and her son share ownership as joint tenants. Her sole objective is to use joint tenancy as a will substitute. But, if her son is subsequently sued, creditors may seek satisfaction of their claims from the son's share of the property! Similarly, if a car is placed in joint tenancy (e.g., between a well-intentioned father and his son), the father increases the chance of being held financially liable for the son's negligence (and vice versa). As a practical matter, nothing should be placed in joint ownership with someone that is at risk of being sued by creditors. Another concern which should not be overlooked is that joint tenancy often produces problems in developing an effective estate plan. First and foremost, if property is held in joint tenancy, the will does not control the disposition of the property. Failure to determine how property is owned can be disastrous. From a nontax point of view, the property may not end up in the hands of the desired beneficiary. From a tax perspective, joint tenancy could result in overfunding the marital deduction. For example, if all of a couple's property is held in joint tenancy, it all passes to the surviving spouse and wastes the decedent's unified credit. Still another issue is the basis of jointly held property which has appreciated. When property is held in joint tenancy, only one-half of the basis is stepped up to the FMV at date of death. 24-9 24-10 24-11 b. 24-12 If 2032A may be used, the agricultural land in question may be valued at $500,000 (the fair market value of $1,500,000 less the maximum reduction from such value of $1,000,000 (2011) available per 2032A(a)(2). [See Example 10, p. 24-18, and 2032A(a).] A power of appointment is a right to dispose of property that the holder does not legally own. A power of appointment would be useful in many situations in which the owner of property wishes to transfer the property currently but postpone the decision as to ultimate ownership of the property. For example, an elderly grandparent might want to create a trust for his or her infant grandchildren. By giving a specific power of appointment to a third party such as a child, the ultimate disposition of trust assets could be made long after the donor grandparent's death. (See p. 24-20.) 24-13 Solutions to Problem Materials 24-3 A specific power is one under which the holder of the power may not appoint assets to himself or herself, his or her creditors, his or her estate, or creditors of his or her estate. Under a general power the holder may do so. (See Examples 14, 15 and 16, pp. 24-20 and 24-21, and 2041.) 24-14 ERTA 1981 drastically reduced the scope of the concept of gifts in contemplation of death. Such transfers are (including the payment of any gift taxes) added to the gross estate notwithstanding the fact that the transfers were taxable gifts on which he or she may have paid gift taxes. After unification in 1976, the computation of the estate tax includes any taxable gifts made since 1976 that are not otherwise included in the gross estate. For this reason, it is normally unnecessary to add back gifts to the gross estate. Nevertheless there are a few situations where the rule still applies. For decedents dying after 1981, 2035 only applies to transfers of interests under 2036 (retained life estate that was gifted within three years of death), 2037 (transfer of reversionay interest within three years of death), 2038 (revocable transfer made irrevocable within three years of death), or 2042 (transfer of life insurance within three yeas of death). In addition, any gift tax paid within three years of death must be added back. (See Example 22 and pp. 24-22 through 24-24.) The purpose is to reduce the effect of double taxation of a single estate. (See Example 29, p. 24-31, and 2011, 2012, 2013, and 2014.) Not only can the estate tax liability arise very unexpectedly, it is one type of tax that an individual cannot "prepay." Many times, very large estates are illiquid and require time to convert estate assets into cash with which to pay death taxes. (See p. 24-32 and 6161 and 6166.) No. The mechanics of the estate tax calculation--specifically, the addition of adjusted taxable gifts-- ensure that a decedent's estate benefits from the credit only to the extent it was not used to offset the gift tax. (See Exhibit 24.4 and p. 24-30.) No. Generation skipping transfers must involve at least three generations. (See p. 24-34 and 2613.) 24-15 24-16 24-17 24-18 PROBLEMS
24-19 a. This solution uses the exclusion for 2011 ($13,000). If the couple does not elect to split gifts, the taxable gifts total $22,000 as computed below. Exclusion 2503(b) Mr. Z to M: $30,000 $13,000 $17,000 to N: $ 8,000 $ 8,000 0 Total taxable gifts $17,000 Mrs. Z to M: $ 2,000 to N: $12,000 to O: $18,000 Total taxable gifts $ 2,000 $13,000 $13,000 0 0 5,000 $ 5,000 $ b. If the couple splits their gifts, the calculation is shown below. To M: $32,000=2 $16,000 To N: $20,000=2 $10,000 To O: $18,000=2 $ 9,000 Total taxable gifts by each $13,000 $10,000 $ 9,000 $3,000 0 0 $3,000 Because of gift splitting, Mr. and Mrs. Z's amounts of taxable gifts were reduced from $17,000 to $3,000, and $5,000 to $3,000, respectively. (See Example 6 and p. 24-11.) 24-4 Chapter 24 The Federal Transfer Taxes 24-20 1996 $ 200,000 (10,000) $ 190,000 $ 51,600 (51,600) $ 0 Value of gifts Exclusion Taxable gift 2001 tax on $190,000 gift 2505 credit Tax due in 1996 Value of gifts Two exclusions ($13,000 (2011) 2) Current year taxable gift 1996 taxable gift Cumulative taxable gifts Tax on $1,764,000 cumulative taxable gifts* Tax on 1996 taxable gift of $190,000 at current rates** 2505 credit available in current year*** Tax due in current year Current year $1,600,000 (26,000) $1,574,000 190,000 $1,764,000 $598,200 (51,600) $623,000 (623,000) $ 0 *$155,800 $442,400 [35% (1,764,000 $500,000 = $1,264,000)] ** 38,800 $12,800 [32% ($190,000 $150,000 = $40,000)] ***$1,730,800 $51,600 $1,679,200 available in 2011 2506 credit (2011). (See Example 7 and pp. 24-11 and 24-13.) 24-21 $ 13,000 28,000 21,000 $ 62,000 (26,000) $ 36,000 Cash to donee D Life estate to donee B Remainder to donee N (gift of future interest) Exclusion for D and B only in 2011, per 2503(b) Taxable gifts Note: The charitable contribution is not a taxable gift, per 2522. (See Example 4 and pp. 24-9 through 24-10.) 24-22 a. Mr. C has made two gifts: (1) an income interest to his daughter, D; and (2) a remainder interest to his grandson, R. The value of each of these gifts is determined below. First, using Table B in Appendix at the back of this text, find the factor for valuing a term certain remainder interest. In this case, the applicable interest rate is 4.8 percent, and the factor for a remainder interest for a 20-year period is 0.391538. Next, by subtracting this factor from 1, the factor for valuing the income interest is determined to be 0.608462. Finally, the value of D's income interest for 20 years is calculated by multiplying the value of the trust property by this factor. In this case, the value is $30,423 ($50,000 0.608462). The value of the remainder interest is determined by multiplying the value of the trust property by the remainder factor determined from Table B. In this case, the value is $19,577 ($50,000 0.391538). Note: There is no exclusion for a remainder interest since it is not a present but a future interest. b. When the income interest is for the life of the beneficiary, valuation of the remainder interest requires a factor for the life expectancy of the income beneficiary. Table A in Appendix A of this text contains single life remainder factors, and at 4.8 percent and D's age of 40, the factor is 0.19707. The remainder interest is valued at $9,853.50 ($50,000 0.19707). The value of the income interest is $40,147 [$50,000 (1 0.19707 0.80293)]. (See Examples 3 and 4 and pp. 24-9 and 24-10.) Solutions to Problem Materials 24-5 24-23 $ 9,000 (9,000) $ 0 New automobile to donee N Exclusion per 2503(b) in 2011 Taxable gift Note: Under 2503(e)(2)(A), the tuition payment is not a taxable gift (see p. 24-7.) Under 2501(a)(5), the political contribution is not a gift. (See p. 24-10.) (See pp. 24-5 through 24-6.) 24-24 $500,000 120,000 $620,000 (26,000) $594,000 Real estate to J Municipal bonds to K Two exclusions ($13,000 2) per 2503(b) (2011) Taxable gifts Note that the payment of medical expenses for M is not a taxable gift, per 2503(e). Also that the unlimited exclusion applies only if the payment is made directly to the provider. (See pp. 24-6 through 24-7.) 24-25 a. L's basis in the land for purposes of computing a gain on sale is $118,900, calculated as follows: FMV of land at date of gift Basis of land to donor Appreciation at date of gift $ 250,000 (100,000) $ 150,000 Gift Exclusion Taxable gift $250,000 (13,000) $237,000 ($150,000 appreciation=$237,000 taxable gift) $30,000 gift tax $18,900 Gift tax attributable to appreciation Donor's carryover basis Donee's basis $ 18,900 100,000 $118,900 b. Therefore, if the land is sold by L for $300,000, his gain is $181,800 ($300,000 $118,900 basis). [See p. 24-9 and 1015(d)(6).] Because L sold the land at a price that is greater than the fair market value at date of gift ($250,000) but less than the donor's basis ($325,000), no gain or loss is recognized on the sale. [See p. 24-9 and 1015(a).] No effect because the gross estate is not diminished by a spouse's legally enforceable claim per 2034. (See p. 24-17.) The $1 million payment qualifies for the marital deduction; thus, the taxable estate equals $4 million. [See p. 24-28 and 2056(a).] Q's gross estate should include the date-of-death fair market value of the bonds ($54,000) and the dateof-death value of accrued interest ($3,950). (See p. 24-16.) Q's gross estate should include the alternate valuation date fair market value of the bonds ($51,500) and the value of the date-of-death accrued interest six months later, which is still $3,950. (See p. 24-16 and 2032.) 24-26 a. b. 24-27 a. b. 24-28 There is no inclusion in M's gross estate attributable to M's interest in Trust A because M's income interest expired on M's death. However, on his death, M owned the remainder interest in Trust B, which is includible in his probate estate. Therefore, the fair market value of the remainder interest must be included in M's gross estate. The value of a remainder interest is $1,501,059 ($2,100,000 property value 0.71479 24-6 Chapter 24 The Federal Transfer Taxes table factor for a remainder interest found at http://www.irs.gov/retirement/article/0,id=206601,00.html) when the life income beneficiary is 82 years old and the interest rate is 5.0 percent. (See Examples 3 and 9, Table A in Appendix A, and pp. 24-8 and 24-16.) 24-29 $ 750,000 15,000,000 $15,750,000 Probate estate 2041 inclusion because A's general power of Appointment (See Example 15 and p. 24-23.) Gross estate Note: The life insurance proceeds are not includible because A did not have any incident of ownership in the policy at her death. [See pp. 24-19 through 24-21 and 2042(2).] 24-30 $5,350,000 20,000 1,000,000 $6,370,000 Probate estate 2039 inclusion of the annuity 2038 inclusion because G held the power to Revoke the trust at death Gross estate Note: The value of social security payments to G's widow is not includible in G's gross estate because G had no right to such payments at death. (See pp. 24-20 through 24-24.) 24-31 24-32 $2.5 million per 2036. This is a transfer with a retained life estate. (See Example 18 and p. 24-22.) The gift tax of $14,250 attributable to the gift of marketable securities and the gift tax of $5,000 attributable to the gift of the income interest must both be included in S's gross estate. In addition, the fair market value of the trust property of $972,000 must also be included in the gross estate. Because S's retention of the income interest until death would have triggered 2036, 2035(d)(2) treats the transfer of the income interest as a gift in contemplation of death. (See Example 22 and p. 24-24.) Under 2038, a decedent's gross estate includes the value of any property interest transferred by the decedent during his or her lifetime if the decedent possessed a power to alter, amend or revoke the enjoyment of the property interest at his or her death. At his death, F had a power to alter the enjoyment of the remainder interest in property worth $3,900,000. The value of this remainder interest is $1,531,118 ($3,900,000 0.39261 table factor) when the life income beneficiary is 60 years old and the interest rate is 5 percent. (See p. 24-23, Table A in Appendix A, and 2038.) The full date-of-death value of the corpus of $3.2 million is included in P's gross estate, per 2036(a)(2). P retained the right until his death to designate the persons who could possess or enjoy the income from the transferred property. (See Example 19 and p. 24-22.) Because S could not appoint any amount of the trust corpus to herself, her creditors, her estate, or the creditors of her estate, S held only a specific power of appointment over the corpus. Therefore, none of the value of the corpus is includible in S's gross estate. [See Example 14, p. 24-21, and 2041(b).] $8,077,000. The insurance proceeds and the gift tax paid by R are included because of 2035 and 2042. Even though R tried to give away his ownership of the policy, such a gift is in contemplation of death and, therefore, is ineffective for estate tax purposes. (See Example 22, pp. 24-19 and 24-24.) a. $250,000 (11,000) $239,000 2002 gift from Q to R (50% value of asset) Exclusion for 2002 2002 taxable gift [See Reg. 25.2511-1(h)(5).] 24-33 24-34 24-35 24-36 24-37 b. c. 100 percent ($1.2 million), per 2040(a). (See Example 13 and p. 24-20.) $0 per 2040(a). Because R made no initial contribution to the asset purchase, none of the asset value would be in his estate. (See Example 13 and p. 24-20.) Solutions to Problem Materials 24-7 24-38 $8,000,000 (60,000) (12,000) (35,000) (100,000) $7,793,000 (See pp. 24-25 through 24-27.) Gross estate 2053 claims against the estate 2053 funeral expenses 2053 legal and accounting fees (administration expenses) 2055 charitable contribution Taxable estate 24-39 a. b. The $85,000 date-of-death value will be included in D's gross estate. (See 2033.) However, the executor may deduct the $85,000 loss under 2054 for purposes of computing D's taxable estate. If such a deduction is claimed, the executor may not also deduct the loss for income tax purposes on the estate's Form 1041. [See p. 24-27 and 642(g).] The $2,200 storage fee may be deducted for estate tax purposes as an administrative expense. [See 2053(a)(2).] If the deduction is taken on the Federal estate tax return, no deduction is allowed for income tax purposes. [See p. 24-25, 642(g), and Reg. 20.2053-4(d)(1).] 24-40 Both transfers qualify for the unlimited marital deduction. Although both the annuity and the patent are terminable interests that will lapse after a period of time, no other person has received any interest in either asset from J. [See p. 24-28 and 2056(b)(1).] a. b. This is qualified terminable interest property. Thus, the full $10 million value of the property is deductible, per 2056(b)(7). (See Example 26, p. 24-29.) 100 percent, per 2044. (See p. 24-29.) $8,800,000 qualifying interest (sole proprietorship) $10.2 million gross estate $800,000 2053 and 2054 deductions = $9,400,000 93:6% $3,000,000 estate tax liability $2,808,000 deferred liability, per 6166: (See Example 30 and p. 24-32.) b. August 2016 (five years and nine months after date of death in 2011). (See p. 24-33.) 1995: $ 900,000 (10,000) $ 890,000 $ 302,900 (192,800) $ 110,100 1997: $ 600,000 (10,000) $ 590,000 890,000 $ 1,480,000 $ 547,200 (302,900) $ 244,300 (0) $ 244,300 1999: To donee S Exclusion Taxable gift to son 2001 tax on $890,000 2505 credit available Tax due To donee D Exclusion Taxable gift to daughter 1995 taxable gift Cumulative taxable transfers 2001 tax on $1,480,000 Tax on $890,000 Gross tax on 1995 gift 2505 credit available Tax due 24-41 24-42 a. 24-43 Gift to wife in 1999 is not a taxable gift because of 2523 marital deduction. 24-8 Chapter 24 The Federal Transfer Taxes 2011: $10,000,000 1,480,000 $11,480,000 $ 3,998,800 (354,400) (1,730,800) $ 1,913,600 Taxable estate Adjusted taxable gifts Total taxable transfers Tax on $11,480,000 ($155,800 [.435 ($11,480,000 $500,000 = $10,980,000) )] Gift tax paid 2010 credit (2011) Tax due (See Comprehensive Example on p. 24-32.) 24-44 No; his credit will not be wasted. If all of the property is held in joint tenancy, it will pass to his surviving spouse and none of his credit is used. However, under the portability rules, his unused credit can be assigned to his wife who will be able to use it. (See Example 27 and p. 24-10.) TAX RESEARCH PROBLEMS
Solutions to the Tax Research Problems (24-4524-46) are contained in the Instructor's Resource Guide and Test Bank for 2012. ...
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This note was uploaded on 02/05/2012 for the course ACCT 110 taught by Professor Smith during the Spring '11 term at Adrian College.
- Spring '11