Estate & Gift Tax
Bogdanski
Fall 2008

Sample Answers to Question 2

Exam No. 9091

The first taxable event is the creation of the trust. The trust is irrevocable, and H is given income for the rest of his life, and the power to appoint to anyone. Essentially, that is everything. However, there is usually a marital deduction available under § 2523 because W and H are husband and wife, so there would be no tax. Because H has a life estate and the power to appoint there is not terminable interest problem, except for the fact that S can invade the corpus or income of the trust, so H is not guaranteed to get the money. Therefore this is a taxable event, and there is no QTIP election available, because S could invade. W will get an annual exclusion, but will not be able to use the marital deduction.

S has the power to invade the income or corpus for B’s support or G’s education and medical expenses. This is not a gift to S, because it is not general power of appointment, because S cannot give the money to herself, her estate, her creditors, or the creditors of her estate.

In year 3, S uses her power to give $120,000 to G for medical bills. Under 2503(e) there is an unlimited exclusion for education or medical bills, however the payment must be made directly to the institution. Because S paid the money out to G, and then P as custodian paid the medical bills, this exclusion will not work, which is unfortunate. When you exercise a power of appointment, you are making a taxable gift. However, G will be liable for the gift and GST tax, because S exercised the power in her favor. G is a skip person, because she is the grandchild of W, and S and W are in this same generation. § 2613. This means Generation Skipping Transfer Tax will apply. The facts do not suggest that S has used up her unified credit for GST or gift tax, so hopefully she can use both of these. If S has used up her unified credit, S will also have to pay gift tax on the amount of the GST tax. The GST tax is computed by taking the highest estate tax rate (45%) times the inclusion ratio. The inclusion ratio is the amount of exclusion over the amount of the transfer. § 2602. For 2008, the exclusion amount is $2 million. § 2631. Once allocated, the exclusion is irrevocable.

Under 2503(c) S can use her annual exclusion for this pay out, even though it goes into trust, because the transfer was made according to the Uniform Transfers to Minor’s Act, but she will still be liable for the GST and gift tax for the other $108,000. If S is married, she can use gift splitting to use her husband’s unified credit as well. If S had paid the money directly to the medical institution though, it would have all been a non-taxable event.

W did not keep any strings on this trust, so when she dies it will not go into her estate. W does have a $2 million dollar unified credit, so at least that much should be passed down to her kids, so that it does not all end up in H’s estate when he dies. If her will leaves everything to H, it will be tax-free because of the marital deduction. H should disclaim the amount of the unified credit, if he doesn’t need it for his own support. Because it was 4 years later that W died, the gift tax paid in year 1 will not go back into her estate.

At the time of H’s death, the trust does into his gross estate, because he had the income interest, and he has the power to appoint the remainder-holder. When you let a power of appointment lapse, it is like making a gift to whoever would get the money if you do not exercise the power. Under 2055 (b) this is a charitable bequest so there will be a deduction available for the full value of the trust.

Regardless of who got the money, distributing it at H’s death would not be a taxable event for S, because she was just doing her duty as the trustee.

Exam No. 9607

Creation of irrev trust in YR 1 –

Wendy made a completed gift of $3.5 million when she created the trust. A gift to an irrevocable trust is complete – Reg § 25.2511-2. She can offset her gift tax liability using her some or all of her $1 unified gift tax credit, and also using an annual exclusion of $12K b/c her husband Henry has a present interest as income beneficiary in the trust (she also could have named some contingent beneficiaries and given them Crummey powers, so that she could take more annual exclusions – but she didn’t. No splits gifts here b/c H as an income beneficiary has an interest in the gift. W retained no interest in the trust for herself.

Distribution to Gwen in YR 3 –

Gwen is a skip person, so the GST tax takes effect. Here we have a taxable distribution of $120K from the trust - § 2612(b). When a trustee invades corpus for a skip person, it’s a taxable distribution of corpus. Transferee G is liable for payment of the GST tax - § 2631(a)(1). Base of tax is $120K minus deduction for expense of figuring out the tax. Tax rate is 45%. Gwen is 2 y/o and probably doesn’t have the money to pay the GST tax – if the trust pays the tax, the amount equal to the portion paid will be treated as a taxable distribution. Here’s an additional GST tax on the tax paid for her. All this is in addition to the gift tax W paid in YR 1. Part of the $2 million GST exemption can be allocated to the tax payable - § 2631

Grandparents should have considered providing for Gwen’s education and medical needs by taking advantage of the § 2503(e) exclusion for “qualified interest.” Those interests include educational and medical expenses. The whole $120K could have been covered as a tax-free gift. This arrangement is especially good for grandparents, since their transfers to grandchildren are otherwise subject to double taxation. No tax consequences when Peggy, acting under authority by the UTMA, pays the hospital bill

Wendy’s death –

When W dies, tax on most of the $4.25 FMV of the trust assets will be offset by the § 2056 marital deduction and unified estate tax credit amount under § 2010(c). But first, there’s a terminable interest problem to address. § 2056(b)(1) says if an interest has a chance of terminating or failing (e.g., b/c of death) and someone else might get the property, there’s a terminable interest and thus no marital deduction. Terminable interest rule was designed to prevent avoiding the estate tax. To get around this, Wendy’s estate can make a QTIP election - § 2056(b)(7) to get a marital deduction. The language of the trust meets the (b)(7) requirements (i.e., property passes from decedent, surviving spouse is entitled to all income for life, distributed annually, etc). While W’s estate could take an unlimited deduction, it wouldn’t want to b/c it would be wasting her unified estate tax credit of $2 million. The estate wants to max out that amount by creating a bypass trust, distributions to be made by the trustee under ascertainable standards, remainder payable to whomever. This leaves $2.25 mil ($4.25 mil minus $2 mil) in her gross estate – all of which the estate can QTIP. After any deductions for §§ 2053-2056 are taken, she’ll have a relatively small amount of tax due on her taxable estate

Elections – W’s estate can value her estate and the trust assets as of 6 months after W’s death - § 2032. But, it probably couldn’t do that b/c the stocks are appreciating rapidly.

Henry’s death –

§ 2044 includes in his estate the amount that W’s estate allocated by QTIP election (i.e., $2.25 million). H also died with a GPOA b/c he had the power to appoint by will the entire trust corpus to his estate or his creditors. The entire value of trust assets – FMV $5.5 million – is dragged into his estate - § 2041. There’s no ascertainable standard language that would’ve prevent § 2041 from latching on – Vissering. The assets go to their church as an outright devise, so H’s estate will get a charitable contribution deduction for the entire amount - $5.5 million – under § 2055. No estate tax consequences

Sarah –

She had a power of appointment limited by an ascertainable standard. Therefore, none of the assets go into her estate. Nor was she liable for gift tax when she, as trustee, made a taxable distribution to Gwen

Exam No. 9904

GST: trust not skip person, but distribution to Gwen is a taxable distribution. Taxed under gift tax and gst tax.

Gift Tax:

Upon formation of the trust, Wendy makes a taxable gift of only the remainder interest of the trust to Henry. Henry is given a general power of appointment over the remainder interest, and since no one else can change that, he has a completed gift. The trustee does have the power to invade corpus for medical care and education of Gwen, but that is probably not enough to make the gift incomplete because the trustee is limited by an ascertainable standard. So, to determine the gift tax Wendy will pay, the value of the remainder must be determined by using the actuarial tables.

The gift to Henry of the income interest is incomplete because the trustee Sarah has the power to invade the corpus and pay income from the corpus for the education and medical care of Gwen. The requirement that Sarah pay income for the support of Henry and Wendy’s minor son, Brent, does not influence Henry’s interest because he has a legal obligation to support Brent. So, if Sarah was only allowed to pay income for support of Brent, then the income interest gift to Henry would be complete. However, the right to invade the corpus for Gwen makes Henry’s income interest gift incomplete. He will however have taxable gifts from Wendy (taxable to Wendy) annually as he is paid income from the trust. And she will be allowed a marital deduction under § 2523 for each of those gifts.

The distribution of trust corpus to Gwen constitutes a taxable gift by Wendy. Wendy will be entitled to an annual exclusion of $12,000 and may use any available/remaining gift tax unified credit. Wendy will not be allowed a medical expenses exclusion under § 2503(e) because the medical expenses were not paid directly to whom they were owed. The money for the expenses was first paid to Gwen, or her guardian, and Gwen and her guardian subsequently paid the medical expenses. In order for the exclusion to apply, the trustee must have paid the medical expenses directly.

There is no gift by Wendy to Sarah, Sarah is not given a general power of appointment because she cannot invade the corpus for herself or her creditors and she is limited by ascertainable standards in relation to her rights to invade the corpus for others.

Therefore, Sarah also makes no gifts when she makes distributions from the trust as she is merely a trustee with no general power of appointment.

Henry makes no taxable gifts.

Estate Tax:

Upon creation of the trust, it appears that Wendy parted with dominion and control of the trust, however, the trustee is required to pay out income of the trust for the support of Wendy’s minor child, and support of a minor child is a legal obligation of Wendy’s. Therefore, Wendy retained some legal interest in the trust. Upon her death, the entire corpus of the trust will be dragged into Wendy’s gross estate under § 1036 because her interest in the trust did not terminate before her death, Brent was still a minor at the time of her death and therefore she still had a legal obligation to support him and therefore an interest in the trust. The entire value of the trust will be included.

Wendy’s estate will get a marital deduction, but valuation could be problematic, as Henry’s interest is difficult to value due to the trustee’s power to invade corpus and use income for the education and medical care of Gwen.

Under § 2035 the gift tax paid by Wendy for the gift to Gwen in year three will be dragged back into Wendy’s gross estate because it was paid within three years of her death.

Wendy’s estate will be able to use her estate tax unified credit, minus any that was used for taxable gifts.

When Henry died, he died holding a general power of appointment as to the remainder of the trust because he could have appointed the entire corpus to his estate or his creditors. Since he did not exercise his general power of appointment and the entire corpus of the trust was paid to a charitable organization, his estate can deduct the full value of the corpus under § 2055.

Absent a charitable deduction, Henry would have been eligible for a Tax on Prior Transfers Credit (§ 2013) because the trust also went through Wendy’s gross estate. Henry died within ten years of Wendy, six years after, so according to the scale back provisions of the credit he would get to take a credit of 60% of estate taxes paid by Wendy on the full value of the trust at the time of her death.

GST:

The trust created by Wendy is not a skip-person because there are non-skip people with interest in the trust as well as one skip-person, Gwen, with an interest.

The distribution from the trust to Gwen constitutes a gift to a skip person by Wendy, so she paid gift tax, but will also pay GST tax on that distribution under § 260.