Estate & Gift
Tax
Bogdanski
Fall 2002
Sample Answers to Question 3
Exam # 9029
2002
Upon the set up of DLP there is a gift from Don to
Stan. Stan received 10% of the
partnership when he put in less than 1% of the value. It might be considered that Stan is getting some bonus value
for taking the responsibility of general partner, but not much. What Stan got back is clearly in excess
of what he put in and provided consideration for.
The value of Stan’s interest is complicated. Since he has full control over DLP
there could be a premium placed on his interest, increasing the value of
Doris’s gift to Stan. However, the
interest in capital and profits of only 10% is clearly a minority share.
It does not appear there are any unreasonable limitations
placed on the shares. Congress has
guaranteed through 2703 and 2704 that if all kinds of bonuses and restrictions
are added they are not to be part of the valuation Unreasonable permission to w/d would not seem to be outside
of commercially reasonable that you might expect to see elsewhere..
Since the portfolio is commonly traded stock, an appraiser
will not be needed for the value of the partnership but might/is needed for
Stan’s interest to determine the amount of Doris’s gift.
No estate or GST tax issues yet.
2003
There are no gift implications when Don sells some of his
shares. The reduction has not done
anything to the control or majority ownership of DLP.
2004
When Don transfers his shares to Nell there are both GST and
estate tax implications. Nell is a
skip person under 2613 because under 2651 she is assigned two or more
generations below Don and a lineal descendant of Don’s grandparents. The transfer of shares is a direct skip
from Don to Nell.
Don can (and should unless he anticipates more GST transfer) allocate the GST exemption now to lock the value of property for the inclusion ratio under 2642 by allocating the exemption for the full value, you end up with an inclusion ratio fraction of 550,000/550,000 (or assessed value) (the amount of property transferred) the ratio then becomes 1 - fraction and the ratio is 0 so the rate (max fed rate x ratio) (50% x 0) = 0. Since the exemption is 1.1 mil and the property is only 1 mil there is enough for 0.
By doing this Don will not owe any GST tax. If he does not at this time 2632(b)
allocates it in order of payment for direct skips and Don would still be
covered.
Don will however, have gift tax due on this transfer. The shares will need to be valued as
were Stan’s at the set up of the partnership. There is potential control premium for the 55% of shares,
however, also potentially limited by Stan’s total control under the agreement.
Since the interest is technically a present interest Don
should get an annual exclusion.
But because the partnership doesn’t provide any current benefit it could
be claimed the shares are a future interest.
2005
If Don had not allocated the GST exemption before, it must
be done by the filing of his estate return. There still should be enough exemption to cover the 2004 transfer
but it is better to make sure at that point. It will depend what value the 55% LP shares are given of the
$1.2 mil assets. If Doris’s estate
should remain at $2 mil and since he doesn’t have unified credit left be taxed
on that value.
However, 2035(b) will require any gift tax paid on the 2004
transfer to come back into the gross estate. The gift tax from the original transfer will not come back
since it is more than three years ago.
If the IRS decides to challenge the existence of the partnership
as a sham Don could have more problems.
First of all he could be considered as owning a retained interest in all
of the property which mean 2038 requires inclusion of what he had control over,
the entire partnership
Regardless of transferring his shares to Nell 2035 requires
inclusion any way of any interest transferred within three years if it would
have been included under 2038.
Don, Stan and Nell appeared to treat this as a true
partnership and didn’t abuse too many of the perks available. It is likely they will be left alone.
When D & S formed DLP, D contributed almost all of the
assets. Because the contributions
were reflected partially in the capital accounts of the noncontributing
partner, the 10% interest S received is considered an indirect gift from
D. The gift does not qualify for
the annual exclusion, however, because gifts of FLP interests are considered
future interests. Hackl. The gift will be reduced by the
consideration S paid. The value of
the gift will be reduced by a minority discount.
The transfer of D’s interest to N, skip person, in 2006 was
a direct skip for purposes of the GST tax. Because it was a lifetime direct skip, § 2515 applies,
therefore, the GST tax paid by D is considered an additional gift for gift tax
purposes. However, because this is
a direct skip, unless D elects otherwise, the entire GST exemption will be
allocated to the gift. § 2632(b).
The GST exemption is $1.1 mm, therefore, D will not have to pay any GST
tax. However, the transfer was
also a gift of a present interest, therefore, the annual exclusion
applies. D will have to pay gift
tax on the remaining amount because his unified credit has been exhausted. Because the interest transferred was a
control premium, the value of it is increased.
The value of the D’s interest he transferred to N will be
included in his gross estate under section 2035(a) because he made the transfer
within three years of his death and the value of the property would have been
included in his gross estate under 2036 had he not made the transfer. Also, any gift tax he paid on the
transfer will be included under section 2035(b).
Section 2036 includes in the gross estate the value of
property decedent transferred during his lifetime if he retained the use,
possession, right to income, or other enjoyment of the transferred
property. An interest or right is
treated as having been retained or reserved if at the time of the transfer
there was an understanding, express or implied, that the interest or right
would be later conferred. Although
D transferred all of his interest in DLP to N and S, if there was an implied
agreement that he would retain possession or enjoyment of the property, or the
right to income from it, 2036 will include the FMV of the transferred property
on the date of D’s death in his gross estate. DLP’s assets were contributed almost entirely by D; neither
S nor N requested or received any distributions from DLP while D was alive;
and, the only distribution DLP made was to D – this is enough to trigger
2036. The FMV of DLP – $1.2mm –
will be included in D’s gross estate.
For purposes of determining D’s estate tax liability, D’s gross estate will include the $2mm of his own assets, under § 2033, and the $1.2mm FMV of DLP, under § 2036.
Exam # 9922
D's a widower; no split-gifts.
On setting up DLP, D has contributed $500K; S has contributed $50. Yet, S got 10% of the interest. This may be a gift of $50K (OK, $49,950. Happy?) from D to S. If so, it will get a minority discount, so the gift amt will be around 35K. An annual excl of 11K may apply, making the taxable gift 24K. Wh the exclusion applies depends on wh this is a gift of a present interest. On one hand, GP has complete control over ptnshp operations, on the other hand, he can't get a distribution w/o D's consent. Prob no ann excl, b/c no present use or enjoymt. And they don't want to argue too hard about it, b/c they'll have to argue later that D did NOT have the right to current use/enjmt.
D's used up uni credit, so it's taxed at close to 50%. Don pays the tax. On the other hand, it could ba argued that S's agreement to serve as GP is adequate compensation for the extra %age. In an arm's length transaction, this would often be the case. Here, or course, there is nothing for the GP to do; this isn't a real estate development GP. So it's a sham argument.
The distribution may be a partial gift from S to D. No, I take it back. S's %age increased, so he didn't give anything up, I don't think.
D's gift of 55%, his entire DLP interest, to Nell. The value of this gift would normally be increased b/c it's a majority holding, but b/c under state law the LP has no powers at all, it really shouldn't get a majority premium in value. It will get a lack-of-control discount though. And I guess a lack of markatability discount as well. Although the underlying stocks are marketable, the 55% LP is not. So the value will be reduced from 550K to, say, 400K, conservatively. That amt is a gift and subject to gift tax immediately, or around 200K.
It is also subject to GST tax, as a direct skip, under 2623 & 2651. The taxable amt of a direct skip is the value rec'd, which is 400K. GST tax on this is 200K, payable by D. But then the 200K GST tax is gift-taxed under 2515! That's another 10K. Pay up Donny! Pay up. He owes 500K in taxes total, for this transfer of 550K of stock, valued at 400K. Alternatively, D may choose to allocate 400K of his GST exemption and pay no GST tax, and also thereby escape the gift tax on the GST tax, leaving his total at 200K, but with only 700K of GST exemption remaining. Assuming he's used none so far.
The fact that it doesn't seem to be much of a real partnership doesn't matter much. IRS has tried an failed to get courts to look at FLPs as shams.
2005 - Don dies.
The 2M to S in probate is obviously in D's GE and taxed at around 50%, which the estate pays.
Gift tax on gifts made in the last 3 yrs comes back into D's GE. That's 200K or 300K, depending on how the GST worked out. 2035.
What about the DLP though? 2036 may bring this back into D's GE. If it does, his estate will be taxed on the full current value of the stocks, which is 1.2M, but will get a deduction for gift taxes paid on it, which is 200K or 300K (depending on wh he paid GST or allocated exemption) for nell's and maybe 12K for S's.
2036 would bring DLP back into D's GE under 2036a, if it could be shown that Don retained an interest in the property. The argument is that the minute he wanted the property for another investment, he got it! The fact that he did not have the legal right under state law to get it w/o his son's permission is an argument against 2036a applying. Byrum argues in favor of recognizing those state rights, rather than the reality that S is never going to say no to D's requests for cash from the DLP. Nonetheless, despite Byrum, he certainly did, in fact, enjoy possess and use at lease the %age of the property he in fact withdrew, and I would argue he retained an interest in the whole thing! In that case, an extra 1.2M would be in his GE. He'd get credit though for gift taxes paid on 424K of that, so the excess on which new tax would be paid would be 776K.
What's more, he gave away his 55% to Nell w/in 3 yrs of death, so 2035 will bring that back into his estate anyway. So even if the 2036 argument fails, 55% still comes back. If 2036 fails though, that 55% will continue to get the lack of marketability and control discounts. That would make the 55% worth about 480K (70% of 55% of 1.2M. About.) He'd get credit though for the gift taxes already paid on 400K worth, so only the appreciation of 80K would really be getting taxed in his estate.
Would this cause an additional GST tax on
the appreciation as well? I don't think so. If the GE includes it under 2036,
b/c a string was kept, but a skip person has it, is there additional GST tax?
Don't know.