Estate & Gift Tax
Bogdanski
Fall 2004

Sample Answers to Question 1

Exam No. 6854

Establishment of the Trust: The trust is irrevocable. The gift is a complete gift of both the remainder and income interests because Tom has not retained any rights over the trust valued at the full $3M. However, he gets no annual exclusion for the income interest to Greta, which although it is not a future interest, is subject to be dissipated by Rita’s exercise of her general power of appointment. Therefore, because Greta doesn’t have a present interest in the trust, he gets no annual exclusion. 2503(b). Tom has already used up his unified credit and so has his wife. However, because they are married, they could split this gift if they wanted to (if she consents), under 2513. The gift tax on this would be $1,275,800.

Greta is a skip person. Steve does not have an interest in the trust because he only has a right to the future right to receive the trust corpus. 2652(c)(1))(A). Therefore, the setting up of the trust triggers a GST, direct skip. Tom can allocate his GST exemption to this if he wants, 2632(b) (Life time direct skips take exemption up to full value unless transferor elects otherwise). The GST exemption is $1.5 M, and the GST tax is 48%. Assuming that the there is a full allocation of the $1.5M, then $1.5M would be taxed at the 48% paid by the transferor, 2603(a)(3).

Rita, the trustee, received a general power of appointment, which she let lapse when the trust terminated in 2008. It is a general power of appointment, and is not limited by a state-enforced ascertainable because the language used “needs and sensible desires” are not the magic words of: maintenance, support, health. 2041(b)(1)(A). Nor are they even close. When Rita lets the power lapse, it is treated as a gift for tax purposes of the fair market value of the property, $3.8M. 2514(e) states that it is a gift but only to the extent that the property subject to the power exceeds $5K or 5% of property that could be used to satisfy the exercise. She will get an exemption, as the trust corpus is definitely greater than the de minimis rule. The gift tax will be dragged back into her estate when she dies in 2009 because that occurs w/in 3 years of her death. 2035(b). Note that 2035(a) doesn’t apply to 2041 powers, so full value won’t get dragged back in and the FMV at time of her death is insignificant. She can utilize her $1M gift tax credit against this gift, assuming that she hadn’t aleady used it. She will also get an annual exclusion exemption because she is giving a present interest gift to Steve.

The Crummey withdrawal powers given to Steve and his three siblings are problematic. The powers are utilized so that Tom can take 4 annual exclusions when the trust is set up. A properly executed Crummey withdrawal power allows the grantor to do so. However, there are two reasons that the powers are problematic. First, the siblings and Steve only have eight days to withdrawal their money. The power hold must be given sufficient notice and reasonable time to exercise the power. Fifteen days has been held to be fine, but eight days might be pushing it. The second, and better argument against allowing Tom to take the annual exclusions is that he went beyond the mere “wink” associated with the Crummey power and actually told them not to take the money out. Using the reasoning from Estate of McNichhol, the IRS may look beyond the paper here, and note that there was a direct expression to the holders not to utilize their powers. Since they couldn’t exercise their powers, no annual exclusion should bee allowed.

On the other hand, if the exclusions were allowed, then Tom would get 4 annual exclusions totaling $44K. When the power holders failed to exercise them, that would be treated as a gift, and gift tax would have to be paid. Because Steve is an interest holder in the trust, his portion of tax will be reduced because he can’t make a gift to himself. 2514(e) will exclude $5K of these gifts, and tax would be paid on the full $6K by the three siblings and less for Steve.

Exam No. 6969

Establishing the trust:

Complete Gift? The trust is irrevocable and after setting it up, Tom has no way to affect the distribution so this is a complete gift. Reg §25.2511. Tom will have to pay gift tax because he has already used his gift tax credit. §2505.

Annual Exclusions? §2503c. Tom should get four annual exclusions for the four present interest Crummey powers that Steve and his siblings had. $44,000 excluded. They had the present right to demand $11k. Rita could not take that away from them. I don’t think the emails will matter. The siblings, despite the email, had the legal right to take the $11k each. All Crummey powers are like that – not intended for anyone to take, but it has been accepted by the courts. If the email means they did not have the power to take $11k, Tom would not get these four annual exclusions.

Tom does not get annual exclusions for the interests of Rita, Greta and Steve. Rita could invade for herself and Greta and Steve might not get anything. Their interests are not secure present interests.

Married couples can double their annual exclcusion to $22,000 if they agree to the §2513 split gift election. Tom and Wilma should have done this with the crummy powers.

Lapse of these crummy powers – Not exercising their rights to take $11k, Steve and his siblings are in effect, making a gift back to the trust. These lapses are subject to the $5k or 5% floor of §2514. These should not get annual exclusions - like Tom didn’t get annual exclusions for Rita, Steve or Greta. These siblings are eating into their gift tax exclusion (§2505) or paying gift tax on $6k ($11k - $5k floor). 5% only gets them ($11k*0.05) because that was all they had power over - $11k.

When Steve lets his crummy power lapse he is giving back to a trust that may ultimately pay out to himself. But his interest cannot be valued because Rita can grab everything. A gift to yourself has no gift tax consequences, but if you can’t value the interest you are retaining it is assumed to be zero.

No GST consequences with the lapse of the crummy powers because possible recipients are no more than one generation away from Steve and his siblings.

The trust drafter could have done some cool cascading lapsing with the crummy powers to prevent this mess for Steve and his siblings.

Establishing the trust and the lapse of the crummy powers has no tax consequences of any flavor to Greta or Rita.

Rita has a general power of appointment because she can appoint the money to herself. §2041 says GPA(general power of appointment) means you can appoint to your self, creditors, creditors of your estate or your estate. Her supposed limitations are not reasonably ascertainable so as to be enforceable by a court. Reg §25.2511g2. “Ongoing needs” is an ascertainable standard – like accustomed standard of living, but “sensible desires” is not enforceable to some limit. It is like happiness or desire or pleasure. The sensible thing to do with $3 million dollars would be to have a lot of fun. Rita has a general power of appointment. When you have a general power of appointment it is like you own the property. Having this power has consequences when you let it lapse, exercise it, release it or die with it, but not when you get it.

Income distributions to Greta: Because Rita had GPA and could have taken this money for herself it is like a gift from Rita to Greta. Because it is what the trust calls for, it is a lapse instead of an exercise. Gift tax is due from the distribution of the income. Rita is responsible for the gift tax. This lapse is subject to the §2514 $5k or 5% floor and the $11k annual exclusion because the income Greta is receiving is a present interest. Depending on the amount of income paid to Greta, Rita is eating into her gift tax exemption amount or paying gift tax (most likely out of the trust). If Rita is married she might be able to do a split gift election (§2513) to double that annual exclusion.

GST: Greta is Tom’s granddaughter and Rita’s grandniece and the intermediate generation is alive (no orphan rule) so Greta is a skip person §2613 and §2651. GST tax will be paid upon the distributions. The trust itself was not a skip person because Rita had a permissible interest – she could receive current corpus §2613. The recipient of a taxable distribution is responsible for the GST tax. §2612. If the trustee pays the GST tax, this is considered another taxable distribution and more taxes are due. GST allocation can be made explicitly or it will follow the default of §2632. I believe this would eat into Rita’s GST exemption, not Tom’s because we are treating this like a GPA where Rita is giving Greta money.

Distribution to Steve when Greta is 25:

No GST consequences because Steve is only one generation away from Tom and Rita. Gift tax is due on the $3,800,000 transfer to Steve. Greta, having the general power of appointment, could have taken all of that money just before Greta’s 25^th birthday. She let that power lapse and this is effectively a gift from her to Steve of $3.8 million. Rita must pay the gift tax. She gets the §2514 5% or $5k floor and a §2503c annual exclusion because Steve has a present interest in the $3.8 million.

Rita’s death 2009:

This trust is gone and §2033 does not capture it Rita’s gross estate because Rita did not have an interest in it at the time of her death.

Per §2035 all the gift tax that Rita paid in the last three years goes back into her gross estate. This will be a lot because of the distributions to Greta and the big distribution to Steve was within one year.

Does §2035 act with 2036, 37, 38 or 42 to pull any property back into Rita’s gross estate? No. 2042 has to do with life insurance. 2036-8 require that the decedent transferred property but kept a string of some sort. §2035 steps in if that string was cut within 3 years of death. §§2036-8 don’t apply to Rita because she didn’t transfer property, she was appointed trustee with GPA. In the last three years she did not relinquish a power that would have caused §§2036-8 inclusion. Had she died before Greta was 25 with GPA over the property it would have been included in her gross estate per §2041 and estate tax would have been paid. Instead, she gave the property away / let her GPA lapse during her life and gift tax was paid. This is, I think, why §2041 isn’t on the §2035 list. There are no sneaky advantages to getting rid of the property you have GPA over or getting rid of the GPA once you are terminally ill.

Rita gets an estate tax credit per exemption amounts listed in §2010c. Basically, the first $3.5 million pass tax free.

Valuation could be done on the date of Rita’s death or 6 months later with a §2032 election if that alternate date would save estate tax.

There are no tax consequences to anyone else when Rita dies.

Rita, perhaps, should have disclaimed the GPA or had Tom put in some ascertainable standards. Had he used ascertainable standards, Rita would just have a fiduciary duty, not GPA. Tom would have received an annual exclusion for Greta’s interest as would Steve and his siblings when they let their crummy powers lapse. Rita wouldn’t be paying gift tax upon distribution to Greta because just following the trust document is not a gift. GST tax would still be paid, but Tom could allocate some of his GST exemption. This family seems to have paid way too much tax. Estate tax, gift tax and GST tax are meant to tax the transfer of wealth at each generation. Here, tax was paid 1) from Tom to Rita 2) from Rita to Steve instead of just once from Tom to Steve. Also, the money ultimately going from Tom to Greta got taxed 1) from Tom to Rita, 2) from Rita to Greta gift and GST.

Exam No. 6223 -- See .pdf file here.