E&G Tax Prof He Flashcards

Terms Definitions
Gain (Income taxation on the transfer of wealth)
The difference between the amount the taxpayer receives and her adjusted basis. §1001. Basis is the taxpayer's cost, or investment, in the asset. §1012.
Ordinary & Capital Gain (Income taxation on the transfer of wealth)
Ordinary: Inventory and depreciable property held for use in business are not capital assets and will therefore produce ordinary income in a sale or exchange. §1221.
Capital: Results from the sale or exchange of a capital asset. The taxpayer's relationship with the property will determine whether or not it is a capital asset. Capital gains must be "long-term capital gain." The taxpayer must own the assets for more than one year. §1222.
Definition of a Gift
§2512(b): Where
(1) property is
(2) transferred
(3) for less than full & adequate consideration
(4) in money or money's worth. Donor's intent is irrelevant.
A gift is complete when the donor has "so parted with dominion and control as to leave in him no power to change its disposition, whether for his own benefit or the benefit of another." Reg. §25.2511-2(b).
Definition of a Gift -- Business Transaction exception, §25.2512-8
Must be
(1) a bona fide purchase,
(2) at arm's length,
(3) free from donative intent.
Reg. §25.2511-1(h)(1): A transfer of property by B to a corporation generally represents gifts by B to the other individual shareholders of the corporation to the extent of their proportionate interests in the corporation.
Gifts are always person(s) to person(s); gifting to a corporation is actually a gift to its shareholders. Exception: charities.
Donor-makes-donee-pay-gift-tax Formula
Revenue Ruling 75-72 provides that the gift tax due is equal to the tentative tax (computed on the full market value of the property transferred) divided by one plus the rate of tax. (GT = TT(FMV)/(1+tax rate)
Discharge of Support Obligations §2516
Excludes from the gift tax transfers made (1) settlement of marital or property rights or (2) to provide a reasonable allowance for child support.
Elements; property in divorce settlements:
(1) written agreement,
(2) divorce within two years of signing, or one year prior to signing,
(3) transfer of marital property or child support.
Examples of Taxable Transfers
I. Sam creates a joint bank account with Tom and transfers $50,000 into it. Sam makes a gift to Tom whenever Tom withdraws funds from the account. Reg. §25.2511-1(h)(4)
II. Max transfers Blackacre, which has a FMV of $100,000, to ABC, Inc., and receives nothing in exchange. Max has made a gift to the shareholders of ABC, Inc. Reg. §25.2511-1(h)(1).
Revocable Trusts and Retained Interests
I. Where the donor reserves power over the disposition of property, the transfer may be wholly incomplete or only partially incomplete.
II. What happens when a grantor creates a trust in one year, retaining the power to revoke it, and then releases the power to revoke in a subsequent year? The trust property will not be in the grantor's gross estate because she has not retained a power over the trust property for her lifetime nor does she have a power over it at the time of her death. §§ 2036(a)(2), 2038(a)(1).
III. There are many situations where a completed gift will be included in the decedent's gross estate. For example, D purchases Blackacre, taking title as joint tenants with the right of survivorship with his daughter, B, and paying the entire purchase price himself. The creation of the joint tenancy is a completed gift. At D's death, however, the full value of Blackacre will be in his gross estate. §2040(a).
Retained Interests in Trusts (Gifts) -- Substantial and Adverse Interest
I. A grantor is deemed to have a power over the trust property even if she can only exercise the power in conjunction with another person. If the person has an interest in the trust that is both substantial and adverse, then the grantor will not be considered as having retained a power. Reg. §25.2511-2(e).
II. A beneficiary can have a substantial and adverse interest if that beneficiary is involved in the power to change the distribution to all of the beneficiaries. As long as the beneficiary involved in any distribution power has an adverse interest to any possible exertion of power by the trustee -- the beneficiary could possibly suffer a detriment. §25.2511-2(e).
Disclaimers §2518
I. A disclaimer occurs when the recipient of property refuses to accept it or relinquishes her right to it.
II. Elements:
(1) Irrevocable;
(2) in writing;
(3) received by holder of property within 9 months of when the property interest was created (exception for minors),
(4) Claimant cannot accept any benefits of the property,
(5) Property must pass to someone without any direction by the disclaimant (exception for surviving spouse).
III. Time limits vary from state to state and if the property is in trust.
IV. Cannot disclaim part of a gift by dividing the gift outside of what the donor intended, i.e., disclaiming a life estate and keeping the remainder.
Examples of Disclaimers §2518
I. Joan died, leaving her household property and art collection to Mary, the family home to Paul, and $1,000,000 to Peter. Mary disclaimed her interest in Joan's furniture and two paintings but not her interest in the rest of the art collection. Peter disclaimed his interest in $400,000 of the $1,000,000 bequest. Assuming that the other requirements of §2518 have been met and that Mary and Peter will not acquire an interest in the disclaimed property pursuant to state law, the disclaimers will be valid. Reg. §25.2518-3(d). The disclaimed property will pass as if Mary and Peter had predeceased Joan.
II. Jack creates an irrevocable trust to pay the income to Martha until she is 40 years old. When Martha is 40, the trust property will be distributed to her of, if she has died, to her issue. Martha disclaims her interest in the remainder of the trust but retains her right to the trust income. Assuming Martha's disclaimer satisfies the other requirements of §2518, the disclaimer of the remainder interest is qualified. Reg. §25.2518-3(d).
Gift Splitting §2513
I. A taxpayer who is married can double the benefit of the annual exclusion. As long as the spouse consents, the taxpayer can treat gifts as if made one-half by the spouse.
II. Section 2513 does not double the amount of the annual exclusion, but it does allow taxpayers to fully utilize the exclusion when only one spouse is making gifts.
III. Requirements:
(1) Both spouses must be citizens or residents of the U.S.,
(2) the donor must not give the spouse a general power of appointment over the property,
(3) the donor must be married to the spouse at the time of the gift and not remarry during the calendar year if they divorce or one dies, and
(4) both spouses must consent to split all gifts made during the calendar year.
IV. If a donor makes a gift of $200,000 and her spouse consents to gift splitting, the spouse has made a $100,000 gift and therefore used up $88,000 of his §2505 applicable exemption amount.
Gifts Generally
I. Deductions have to be factored into tax return; exclusions do not have to be factored into tax return
II. IRS has ruled that gifts of limited partnership interests do qualify as "present interests"; only one ruling to the contrary, where the general partner has complete discretion to distribute income and other special power
I. The value of every item of property is at its fair market value. Look at Regulations for valuation. Reg. §20.2031.
II. For gifts, the date used to determine FMV is the date the gift occurred. §2512
III. For estate tax purposes, the date used to determine FMV is the date of decedent's death. §2031
(a) §2032 allows for an alternate valuation date - 6 months after date of death; two requirements for executor to be able to make election for alternate date:
(1) lowers the value of the gross estate; and
(2) lowers estate tax liability
(b) §2032 applies to entire gross estate, not just those that have been lowered, and overall value of gross estate must have been lowered.
Valuation Tables
A. Applicable federal rate is the 7520 rate
B. Table B: term certain remainder interests
C. Table S: remainder interests following life estates
D. Table J: used for annuities if annuity payable at the beginning of the term (life estates not annuities)
E. Table K: used for annuities if annuity payable at the end of the term
I. Minority Discount: ownership of company without control (MD) is worth less than ordinary ownership of company - i.e., 10% discount on worth of interest
II. (Lack of) Marketability Discounts: an interest that is not readily available in the market and difficult to sell, may be further discounted - i.e., additional 15% discount on worth of interest
III. Absorption (Blockage Discount): the interest is so abundant in the market that if the interest were put out into the market, the value would decrease - another possible discount on worth of interest
Remainder/Retained Interests §§ 2701, 2702
I. §§ 2701, 2702: transferring interests to family members may have a special rule
II. §2702 is trying to stop gamesmanship by valuing unqualified retained interests at $0, and giving the remainder the full value for gift tax purposes.
III. Example: G creates a trust worth $1,000,000, retains a life estate in the trust, and gives vested remainder to C
(a) LE worth $400,000
(b) Remainder worth $600,000
(c) Applicable interest rate is 5%
(d) G gets sick, realizes may not make it to expected age of death
(e) If LE is an unqualified retained interest, then value is $0 for gift tax purposes, thus remainder is worth $1,000,000.
Remainder/Retained Interests in Trusts: §2702 Requirements
1. Transfer of interest in trust
2. to of for benefit of family member (§§ 2702(e), 2704(c)(2): spouse, lineal descendant, sibling, spouse of any such descendant or sibling)
3. Transferor or applicable family member (different from "family member") retains interest in same trust
4. Then, you value the retained interest at $0 except for a "qualified retained interest." §2702(b)
I. Requirement #2 applies to remainder interests
II. Requirement #3 applies to retained interests
III. Exceptions:
(a) incomplete gifts - §2702(b)(3)(A)
(b) personal residence trust - §2702(b)(3)(B)
Remainder/Retained Interests in Business: §2701 Requirements
1. Transfer of interest in corporation or partnership
2. to family member (§2701(e): spouse, lineal descendant, spouse of descendants)
3. transferor or applicable family member retains an interest in the same corporation or partnership
4. Then:
(a) minimum value - §2701(a)(4)(A) - assigned value of interest must be 10% of overall value (i.e., entire common stock value must have value worth at least 10% of corporate value)
(b) retained interest is zero (with exceptions)
I. Exceptions:
(a) Market stock: market quotations are readily available for that interest,
(b) such interest is of the same class as the transferred interest,
(c) proportional transfers,
(d) such interest is proportionally the same as the transferred interest, and the only difference is voting rights
Power of Appointment
Power that one has that allows one to direct the property to himself or someone else; equivalent of true ownership of a property (covered in §2041)
Gross Estate
I. Definition:
(1) Did decedent have an interest in the property at the moment of death?
(a) No -> not included in §2033, could be included under different section.
(b) Yes -> Did that interest pass from decedent to another as a result of decedent's death?
II. Cemetery lots are included in the gross estate, but if the decedent is the only one being buried in the lot, then the value is zero, because no one else will give value for that occupied lot. Reg. §20.2033-1(b)
III. Bonus checks:
(a) If contractually obligated by employer -> decedent has an interest at death; included in GE
(b) If check is a "death bonus" check -> decedent has no interest at death; not included in GE
IV. Rental income (from apts owned) accruing after death is not included in the GE; rental income accrued/payable before death is included in GE
V. Pain and suffering from a wrongful death suit is included in GE. Revenue Ruling 75-127
1. Decedent has an interest in property at time of death
2. Interest in property passes from decedent to another by reason of decedent's death
§2040: Special Rules
1. Non-spousal joint tenancy acquired by gift, devise or inheritance -- include decedent's fractional interest in GE (§2040(a))
2. All other non-spousal joint tenancies -- presumption to include all in decedent's GE (minus consideration by other joint tenant)(§2040(b))
3. Spousal joint tenancy -- 1/2 included in decedent's GE (§2040(a))
§2040 (Common Interests) Examples
Example 9-1: Mary and Joan are sisters and own Blackacre as equal tenants in common. Joan dies without a will. Under the applicable intestacy statute Joan's interest passes to her two children, Dana and Leslie, in equal shares. Dana and Leslie become tenants in common with Mary; Mary owns a one-half interest, and Dana and Leslie each own a one-quarter interest
Example 9-2: John and Luke are brothers and own Greenacre as joint tenants with the right of survivorship. Luke dies. His will leaves his interest in Greenacre to his daughter, Nancy. After Luke's death, John owns Greenacre in fee simple. Luke's will does not affect the ownership of Greenacre because his interest, terminated at the moment of his death, and he had nothing to devise to Nancy.
§§2511, 2512, 2523(a): Creation and Termination of Joint Interests During Life
I. The creation of a joint tenancy is a gift to the extent that the joint tenants do not provide any consideration for their interests. §2518(b).
II. The value of the gift depends on whether the joint tenancy can be severed unilaterally, which is a question of state law. If any joint tenant can sever the joint tenancy without the consent of the other joint tenants, then the value of each joint tenant's interest is the same. If a joint tenant must obtain the consent of the other joint tenants to sever the joint tenancy, the value of each tenant's interest will depend on his or her age in relation to the age of the other joint tenants.
§§2033, 2040, 2056(a): Termination of Joint Interests by Death
I. Because the decedent may transfer an interest in property held as a tenant in common by will or intestacy, §2033 brings those interests into the GE. Section 2033 also includes the decedent's share of community property in the GE because each spouse has the right to devise or bequeath his share of such property.
II. Property owned as joint tenants with the right of survivorship or as tenants by the entirety. Such interests are not governed by §2033. Instead, §2040(a) includes in the GE the full value of property owned as joint tenants with the right of survivorship subject to exceptions.
III. If the surviving joint tenant furnished some, or all, of the consideration to acquire the property, that portion of the property attributable to the survivor's contribution is excluded.
IV. Equation: AMOUNT EXCLUDED = value of property X (survivors consideration/total consideration paid)
§2040(a): Termination of Joint Interests by Death, Example
Example 9-3:
Decedent and Survivor acquired Greenacre as joint tenants with the right of survivorship. Decedent paid $80,000 and Survivor $20,000. At the time of Decedent's death Greenacre has a FMV of $200,000. The amount excluded from Decedent's GE is: $200,000 X ($200,000/$100,000)
Thus, $40,000 will be excluded from, and $160,000 will be included in Decedent's GE by §2040(a).
§2040(a): Termination of Joint Interests by Death, Services Provided
I. Services provided in a business context between unrelated parties generally will qualify as adequate consideration. Even services provided by related parties will qualify as consideration if the services are performed in a business context and the survivor provides more than minimal services.
II. If the joint tenants are related, the issue will be whether the services are gratuitous within the context of the marriage will be excluded.
§2040(b): Spousal Joint Interests
I. Section 2040(b) provides that only one-half the value of a "qualified joint tenancy," i.e., joint tenancy property owned only by a husband and wife or property owned by them as tenants by the entirety, will be included in the decedent's GE.
II. It does not matter who provided what portion of the consideration or where the consideration originated. The decedent's estate will also receive a marital deduction for the value of the property included in the GE. §2056.
§2040(b): Spousal Joint Interests, 3 types of joint tenancies
1. Joint tenancy entirety by gift, devise or inheritance
2. Other non-spousal joint tenancies
3. Spousal joint tenancy; only applies if joint tenants are solely the husband and wife
§2036(a)(1): Retained Life Estates
I. If the trustee has discretion to support to children (under 18, or other legal support obligation), then it depends on state law if included in donor's GE
II. If the trustee has wholly discretionary powers, then §2036 does not apply
III. Elements:
1. Decedent makes a transfer of property (exception: transfers made for full and adequate consideration)
2. Decedent retains income interest or use or possession of property,
3. For life, period which does not end before decedent's death, or for period that is not ascertainable without reference to decedent's death,
4. Then the value of the property is included in the decedent's GE.
§2036(a)(2): Retained Life Estates
I. Same as §2036(a)(1), except for 2nd element;
1. Decedent makes a transfer of property
2. Decedent retained a right to designate who will possess or enjoy property
3. For life, period not ascertainable without reference to decedent's death or a period which in fact did not end before decedent's death
§2038: Powers to Alter, Terminate, or Revoke
I. Incomplete gift of trust if decedent retained power to affect (1) who gets trust benefits and (2) how much the beneficiaries get
II. "Welfare" by itself is not an ascertainable standard; "welfare" in conjunction with "health, education, and support" is an ascertainable standard
III. If decedent denies himself the power to appoint himself as trustee, but can appoint someone "related or subordinate" to him, then the decedent will be treated as still retaining power to alter, amend, or revoke
IV. Elements:
1. There was a transfer of property by decedent by deed
2. Power to alter, amend, revoke or terminate held by decedent
3. At time of decedent's death
§2037: Retained Reversions; Transfers at Death
1. The decedent made a transfer in trust or otherwise,
2. The possession or enjoyment of the property can be obtained only by surviving the decedent, and
3. The decedent retains a reversionary interest and the value of that reversionary interest immediately before the decedent's death exceeds 5% of the value of that property
Exception: bona fide sales for adequate and full consideration in money or money's worth
§2035: Gifts Made in Contemplation of Death
I. Certain gifts made within the last three years of life will be included in decedent's GE
II. §2035(a) -- if property would have been included under §§2036, 2038, 2037, and 2042, then it is included in GE
III. §2035(b) -- gift tax paid on gifts made within 3 years of death will be included in decedent's GE
§2039: Value of Annuities and Employee Death Benefits
1. Must be a contract or agreement, but NOT life insurace (the payments to the decedent, or the decedent's right to such payments, must arise from the same contract or agreement),
2. Someone receives benefits under contract after decedent's death,
3. Decedent has right to receive payments under contract prior to death.
If §2039 is met, then the value of beneficiary's benefits under contract are included in decedent's GE.
§§2041, 2514: Powers of Appointment
I. A power of appointment is the right to designate who will enjoy property. No special words are needed to create a power of appointment; the right to appoint property, to demand property, to designate beneficiaries, to withdraw property, or to consume property are all powers of appointment. The persons appointed to receive property are called "objects."
II. Powers of appointment created before Oct. 1, 1942 are not taxed
§2041(a)(2): Powers of Appointment
1. Power held at death
2. Exercise (limited to transfers that would have been included under §§2035-2038.
3. Release lapses
§2041: Powers of Appointment, General Power of Appointment
I. §2041 Elements, General Power of Appointment:
1. A power exercisable,
2. In favor of the powerholder or powerholder's estate or creditors of powerholder or creditors of the powerholder's estate
II. If general power of appointment is limited by an ascertainable standard, then it is no longer a general power of appointment
III. No general power of appointment if power held in conjunction with (1) creator or (2) someone with a substantially adverse interest
§2041: Powers of Appointment, Special/Limited Power of Appointment
I. A power exercisable in favor of anyone but the groups of people listed in general power of appointment.
II. Not subject to estate tax or gift tax under §§2041 or 2514; still subject to §§2036(a)(2) and 2038
§2041: Powers of Appointment, Examples
Example 12-3: Dan creates an irrevocable trust with FN Bank to accumulate trust income or to distribute it to Bruno as, and when, he requests it. At Bruno's death, the trustee is to distribute the trust property to Bruno's children in equal shares. Because Bruno can withdraw trust income for his own benefit or to pay his creditors, he has a general power of appointment.
Example 12-4: Dan creates an irrevocable trust with FN Bank as trustee to pay the income to Celia for her life and to distribute the trust property to those of Celia's children as she designates in her will. Because Celia can only appoint the trust property among her children, she does not have a general power of appointment.
§§2041, 2514: Exercise, Release, and Lapse
I. Section 2041 not only includes in the GE property over which the decedent had a general power of appointment, but the decedent released or exercised that power in a transfer that, had the decedent owned the property outright, would have been included in her GE under §§2035-2038.
II. In addition, §2514(b) treats the exercise or release of a general power as a transfer of property by the powerholder (donee). As a result, the exercise or release of a general power of appointment will usually be taxed either as a gift or in the donee's GE.
III. Lapse occurs when the donee has a limited amount of time to exercise a power of appointment and fails to do.
IV. The lapse of a power is considered to be a release of that power and, therefore, a transfer of property by the donee, but only to the extent that property that could have been appointed exceeds the greater of $5,000 or 5% of the trust assets out of which the exercise of the power could have been satisfied. §§2041(b)(2), 2514(e).
Section 2042: Life Insurance
I. Elements:
1. Life insurance paid to beneficiary other than estate
2. Decedent retained at least one incident of ownership
II. Section 2033 covers life insurance policies of other owned by decedent
Section 2053: Expenses/Claims/Debts/Taxes/Losses
I. Elements:
1. If the expense/debt/tax/loss is founded on a promise or agreement, then it must be for adequate and full consideration in money or money's worth; §2053(c)(1)(a)
2. Amount allowable under local law
3. Value of all expenses/debts/taxes/losses must be less than the value of the probate estate
4. Amount of expenses/debts/taxes/losses necessarily incurred in preserving and distributing the estate (expenses made in convenience not deductible)
II. Class Example: Uncle tells nephew he will give him $25,000 if nephew graduates from law school. Uncle dies one month before nephew graduates. Nephew has enforceable contract with uncle's estate, but because nephew did not give adequate and full consideration in money or money's worth, the estate will pay the nephew but not be able to deduct the value from uncle's GE
III. Administrative fees can be deducted on either estate tax return or estate income tax return, but not both
IV. Funeral expenses are deductible if reasonable; dependent on relative wealth of decedent, i.e., Michael Jackson (§20.2053-2)
Section 2053: Expenses/Claims/Debts/Taxes/Losses, Examples
I. Example 14-1: State has a nonclaim statute that requires all claims against Decedent's estate to be presented for payment within six months of Decedent's death. Decedent owes Debtor $25,000 but fails to present the claim within six months. The claim is unenforceable as a result. Decedent's estate cannot deduct the $25,000, even if it pays Debtor, because the claim was not allowable under state law.
§2055: Transfers to Charity
I. Section 2055 allows the decedent's estate to deduct the value of certain transfers to charity
II. The decedent must designate a qualifying organization. Only donations to the organizations enumerated in §2055(a) will qualify and then only if the donation is for the purposes specified in the statute. Bequests to the U.S., any State, or a political subdivision are deductible as long as the property must be used exclusively for public purposes. §2055(a)(1). Property that escheats to the state when the decedent dies intestate does not qualify because the decedent did not transfer the property to the state; it passed by operation of law.
III. Bequests to corporations that are organized and operated exclusively for religious, scientific, literary, educational, or charitable purposes or to trusts or fraternal associations if the gift is to be used exclusively for religious, scientific, literary, educational, or charitable purposes are also deductible. §2055(a)(2), (a)(3).
IV. State law must
1. Uphold the validity of the charitable donation and
2. restrict the distribution of property to organizations that are charitable within the meaning of §2055.
V. If a beneficiary makes a qualified disclaimer under §2518, that beneficiary is treated as predeceasing the decedent. This may qualify as a bequest that would otherwise fail to meet the requirements of §2055.
VI. A deduction will be allowed for a conditional bequest, but only if the possibility that the charitable transfer will not become effective is so remote as to be negligible. §20.2055-2(b)(1). If the probability that the condition will defeat the charitable interest does not exceed 5%, then it will be considered so remote as to be negligible. Revenue Ruling 70-452.
§2056: Marital Deduction
1. Available to any decedent who is subject to the federal estate tax even if he is not a citizen or resident of the U.S. Deduction available to noncitizen or nonresident only if the property is included in his GE property and the other requirements of §2056 are met
2. Property must be given to a spouse
a. Only a final divorce decree terminating marriage is sufficient to change marital status; legal separation or initiation of divorce proceedings is insufficient.
b. If the spouse is not a citizen, the property must be left to a qualified domestic trust as defined in §2056A.
3. The spouse must survive the decedent
a. If order of death between spouses cannot be determined, state law will create a presumption that each spouse survived with respect to his or her own property.
4. The property must be in the decedent's GE as determined by §§2033 and 2044. If the property is not in the decedent's GE, allowing a marital deduction would create a double benefit.
5. The property must "pass" from the decedent to the surviving spouse.
a. If the property is in the decedent's GE and if the survivor acquires the property as a result of the decedent's death, this requirement will be met.
b. A surviving spouse's interest in pension plans, employer death benefits, and similar arrangements are also considered to "pass."
c. If the surviving spouse disclaims an interest in property left by the decedent, that property will not be considered as passing to the surviving spouse.
6. The spouse's interest is not a "nondeductible terminable interest."
a. A terminable interest is simply an interest in property that will terminate or fail on the lapse of time or the occurrence or nonoccurrence of an event or contingency. The classic terminable interest is a life estate because the life tenant's interest will terminate at his death.
b. If the decedent transferred an additional interest in the property to someone other than the surviving spouse and that person will enjoy the property after the surviving spouse, the interest is nondeductible.
c. Exceptions:
1. When the third person pays the decedent full and adequate consideration in money or money's worth for his interest.
2. "Estate trust." A trust to pay the income to the surviving spouse for life and the remainder to the surviving spouse's estate. In this situation, the property will pass from the decedent to the survivor's estate. Because the survivor can then transfer the property to anyone by his will, it will be included in his GE pursuant to §2033.
§2056: Marital Deduction, Examples
I. Example 16-7: Decedent leaves a patent to Spouse. The patent will expire in 10 years. The property interest is a terminable interest because of the limited protection granted by statute, but Decedent has not transferred an interest in the patent to anyone other than Spouse. As a result, the value of the patent qualifies for the marital deduction.
II. Example 16-8: Wife owns Whiteacre and transfers a life estate to Husband. At the same time, Wife sells the remainder interest in Whiteacre to Children. Although the life estate is a terminable interest, it will qualify for the marital deduction because the Children pay adequate and full consideration for their remainder interest. Because this payment is made directly to the decedent, it will be in her GE pursuant to §2033.
Exceptions to the Terminable Interest Rule
I. Electing against the will means the surviving spouse wants to take her statutory share in a common-law state (not in a community property state), instead of taking the share left to him/her in the will.
II. Terminable Interest §2056(b)
1. Interest which fails upon occurrence of a contingency or lapse of time
2. Decedent created an interest in another
3. Interest passes to another upon occurrence of contingency or lapse of time
III. Exceptions to terminable interest exception:
1. Life Estate with Power of Appointment §2056(b)(5)
2. Life Insurance Settlement Options §2056(b)(6)
3. QTIP trust §2056(b)(7)
4. Estate trust
Exceptions to the Terminable Interest Rule, Life Estate with Power of Appointment (LEPA) §2056(b)(5)
I. Section 2056(b)(5) provides that the decedent's estate will be entitled to a marital deduction for property left to a surviving spouse in trust if:
1. the spouse is entitled to all of the income (or a specific portion of it) for life,
2. the income is paid annually or at more frequent intervals,
3. the spouse has the power to appoint the entire interest (or a specific portion of it) to herself or to her estate, and
4. no person has the power to appoint to anyone other than the surviving spouse.
II. Right to Income
a. The trustee cannot be given discretion to accumulate income, payment of income must be mandatory. It also means that the trust property must either produce income or be personal use property, such as a residence.
III. Power of Appointment
a. The spouse must be treated as the unqualified owner of her right to appoints the property. The surviving spouse cannot contract with the decedent only to exercise the power in favor of their children or someone else.
b. The surviving spouse must have the ability to exercise her power without the consent of anyone else, including the trustee. The surviving spouse must also have the power to appoint to herself or her estate. The power of the surviving spouse to appoint to herself or her estate is a general power of appointment and will bring the property into her GE at her death under §2041.
c. Someone other than the surviving spouse may also have a power to appoint the trust property as long as this power is not in opposition to that of the surviving spouse.
IV. Specific Portion
a. A provision giving the surviving spouse one-half of the income or 30% of the income will qualify as a specific portion. A provision giving the spouse $5,000 of income per month or $50,000 income per year will not qualify.
b. The surviving spouse's right to income or her power to appoint or both can be limited to a specific portion. The marital deduction will be allowed, however, only for the smaller portion.
Exceptions to the Terminable Interest Rule, Life Insurance Settlement Options §2056(b)(6)
The installments or interest payments must be made annually or at more frequent intervals, commencing no later than 13 months after the decedent's death.
Exceptions to the Terminable Interest Rule, Qualified Terminable Interest Property (QTIP) §2056(b)(7)
I. Any QTIP proprety at death will be included in the surviving spouse's GE under §2044. Section 2056(b)(7) extends far beyond this and allows a decedent to control the ultimate disposition of the property without depriving him of the benefits of the marital deduction, thus recognizing the issues arising in second (or subsequent) marriages.
II. Elements:
1. The surviving spouse must be entitled to all of the income (or a specific portion of it) from the property, payable annually or at more frequent intervals;
2. No person may have the power to appoint trust property to anyone other than the surviving spouse during that spouse's life and
3. the executor must elect QTIP treatment.
III. Right to Income:
a. Same as §2056(b)(5) with one exception, income earned by the trust between the last distribution date and the date of the surviving spouse's death, i.e., the stub income, need not be distributed to the surviving spouse nor need it be subject to a power of appointment in the surviving spouse.
IV. No Power to Appoint to Other than the Surviving Spouse
a. The trustee, the spouse, or anyone else can have the power to appoint the surviving spouse during her life.
b. If the surviving spouse has the ability to withdraw trust property for her own benefit, she will have a general power of appointment. This power may convert the trust from a QTIP trust to a power-of-appointment trust.
c. Although no one can appoint trust property to anyone other than the surviving spouse during her lifetime, the surviving spouse can give away or sell her income interest. If she does so, §2519 treats the transaction as a transfer of the underlying trust assets minus her income interest.
V. Election: the executor must make the appropriate election on the decedent's estate tax return.
Exceptions to the Terminable Interest Rule, QTIP Examples
I. Example 16-14: Decedent's will leaves $5,000,000 in trust with FN Bank as trustee, to pay the income quarterly to Spouse. At Spouse's death, the trustee is to distribute the trust property to those of Decedent's children as Spouse appoints in his will and, in default of appointment, to Decedent's children equally. If the executor elects, the trust will qualify under §2056(b)(7) even though Spouse has a limited power to appoint among Decedent's children because that power does not arise until Spouse's death. The trust property will be included in Spouse's GE by §2044.
II. Example 16-15: Decedent's will leaves $5,000,000 in trust with FN Bank as trustee, to pay the income quarterly to Spouse. After Spouse's death, the trustee is to distribute income to Decedent's children equally and has discretion to distribute trust property to Decedent's children for their health, education, support, or in an emergency. If the executor elects, the trust will qualify under §2056(b)(7) because the trustee's power does not arise until after Spouse's death and the trust property will be in Spouse's GE under §2044.
Planning, The Annual Exclusion and the Unified Credit §§2010, 2503(b), 2505, 2513
I. Credit Shelter Trust/Bypass Trust: The purpose is to take advantage of the unified credit in the estate of the first spouse to die. This trust should qualify for the marital deduction, i.e., the surviving spouse cannot be given a general power of appointment over the trust assets and that the executor should not elect QTIP treatment for this trust. She might even have the power to withdraw trust corpus for her own health, education, support, and maintenance since such a power is not a general power of appointment and thus would not bring the corpus of the trust into her gross estate. If the trust is limited to the applicable exemption amount, the decedent's estate will pay no tax because of the unified credit in §2010.
II. Example 16-18: H and W are married. H owns $4,000,000 of property and W owns nothing. H dies in 2006 and leaves all of his property outright to W. H's estate will pay no tax because the $4,000,000 will qualify for the marital deduction. If W dies in 2008, her estate will pay a tax of $900,000. If H had left half of his property in a credit shelter trust for the benefit of W, she would have paid no estate tax on her death because the taxable estate of each would be only $2,000,000 -- the amount that is sheltered by the unified credit.
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