Estate & Gift Tax - Sample Exam Answers to Question 3

Estate & Gift Tax
Bogdanski
Fall 2008

Sample Answers to Question 3

Exam No. 9082

There are no GST consequences of any of these transactions because no skip persons are involved.

Gift of Interest in Apartment Complex: Frank’s gift of the undivided one-half interest in the apartment complex that Frank owns is a gift for gift tax purposes. Valuation will be calculated as equal to the pro-rata share of the FMV on the date of the gift (here $900k) minus a discount for an undivided fractional interest, because it is unlikely that the one-half interest could be sold for its pro-rata market value. Frank will be able to take a $12k annual exclusion for the gift to Darla, but will not be able to use any of his unified credit since it has been previously used up.

Creation of Family Partnership: To the extent that Darla did not contribute equal consideration for her partnership interest (either through a contribution of assets or services) the difference between the value of her one half partnership interest and the amount of her consideration is a gift from Frank. Frank would normally be able to take an annual exclusion for the amount of the gift, if any, but he is using it up on the apartment complex. Thus, Frank would have a gift tax liability equal to the amount of the tax on the difference between Darla’s interest in the partnership and the consideration she provided for her partnership interest.

Frank Dies: Frank’s death brings up several issues. First, the remaining interest in the apartment complex is included in his gross estate, valued as of the date of his death at the pro-rata portion of the FMV of the complex minus the fractional interest discount (same as when the gift was given). Second, his interest in the family partnership is included in his gross estate. The valuation is an issue. IRC §2703(a) states should value the property w/o regard for any option, agreement, or right to acquire the property for less than FMV, (b) unless: (1) bona fide business arrangement, (2) not device to transfer to members of decedent’s family for less than full & adequate consideration; and (3) terms are comparable to those in similar arrangements entered into by persons in arms-length transactions. This allows buy-sell agreements, like those in this scenario, to potentially be upheld. Here, no information is given as to what similar arrangements provide. Therefore, the family partnership interest may be able to be valued at the price of the buy-sell agreement; though the IRS is highly likely to attack the transaction. A safer method of valuation would be to take the prorate share subtract a minority discount and a lack of marketability discount. Attribution in cases of a family business to establish a control premium or minority discount is not allowed in estate tax scenarios (Bright). Frank also has his unified credit to offset some of the inclusions in his gross estate. In addition, the alternative valuation date is available is the assets lose value in the six months after his death and if his wife died within the last 10 years then he may be eligible for a credit for tax on prior transfers under §2013.

Frank’s Interest in the Retirement Fund: Under IRC §2039, the payments to Darla are included in Frank’s gross estate, because it includes retirement plan benefits is payable to the decedent and a beneficiary can be named. This is true even though Frank never received a payment under the plan and was not a completed gift to Darla when she was named as Frank’s beneficiary b/c Frank could have changed the beneficiary at any time. Therefore, all amounts payable to Darla under the plan are included in Frank’s gross estate and will need to be valued using the annuity table found in the Regs which relates to Darla’s life expectancy and such.

Exam No. 9281

(1) Apartment

In 2008, Frank made a gift of the half of the apartment. Because it is tenant in common, the value of the half of the interest should reflect the shared interest discount. Thus, the value of the gift amount should be less than $900,000 (1/2 of the FMV at the time of the gift) There is no gift for the use of the apartment complex because he owns ½ interest. When he dies in 2011, his ½ interest of the apartment interest is included in his gross estate under §2033. no §2040 joint held property implication which is not so beneficial for tax purposes. Because the value of the estate should be determined on the date of the death, the ½ interest of his interest should reflect the shared interest discount because it is harder to sell than fee simple. For the valuation, we do not consider whether the transferee owned the whole property, which bars the undivided interest discount. Thus, tenancy in common gives the decedent gift tax benefit during life time and estate tax after death because of the shared undivided interest discount. Gift tax for gift made within 3 years of death applies here. Thus, the gift tax paid will be included in his gross estate. No GST here.

(2) Famco

In 2008, when he contributed most of the initial assets, Frank is considered as making a gift to his son of 50% of Famco. They are 50/50 equal partner even though the son has little contributed. Probably, this gift seems subject to minority discount as well. As for 50/50 partners, there should be some stumbling block for the corporate decision and to be a majority shareholder, the partner needs 51%. Thus, the ½ of the property dumped into partnership less minority discount (25%) will be the value of the gift. When he dies in 2011, the partnership interest he owned at the time of death will be included in his gross estate under §2033. The FMV at the time of death is $4,000,000. Under §2703, Buy-sell agreement does not affect the valuation of the partnership and the restriction in the agreement is disregarded unless it is bona fide business arrangement, not a testamentary device and terms comparable to arm’s length transactions. Here, the book value will be disregarded for the valuation purpose if this arrangement doses not meet §2703 exception. Contractual restriction is suspicious all the time. Then the value of the gross estate will be $4M less minority discount(25%). The gross estate will be $3M (4M-1M) I think there is no control premium which is given to majority share. Furthermore, Discounts for lack of marketability would be available for this Family investment partnership. Thus, the value will be less than $3M. If there is comparable partnership, the taxpayer may use the value of the partnership as FMV. Under §2035(b). gift tax paid within 3 years of death will be in his gross estate as well. No GST here.

(3) Retirement Account

When Frank dies, the annuity does not terminate. This is joint survivor annuity. Up to the point when he dies, there is no gift tax. Under §2033, there no interest he owns at the time of death because the annuity interest dies with him. However, under §2039, because it is payable, he possesses the right to receive payment. It is just like retained life estate for the decedent. The amount included in his gross estate will be the value of the survivor’s benefit that is proportionate to contributions made by the decedent or his employer. here, Darla does not contribute anything. Thus, the whole benefit will be included.

Exam No. 9510

1/2 undivided interest to D

Under Reg 25.2511 the creation of concurrent interests inherently requires a transfer of property from one to another and if adequate consideration is not paid then a gift has been made. D has not paid F for her interest and thus a gift has been made. Since the donee-tenant (D) can dispose of her share at will, without control or permission of F, the interest is severable. This is a present interest in property and F will get at $12K annual exclusion. The value of the gift is 1/2 the value of the property minus a minority discount due to the cotenancy. So F has made a gift to D of $900,000 minus a minority discount (sum of the part do not add up to the whole). Since he has used all of his gift tax credit, he will have to pay gift tax.

Famco set up

When Famco was set up most of the initial assets were contributed by F. Since F and D are equal partners a gift has been made by F. There would be no gift by F if his partnership account was credited with his contributions. The gift is the value of D’s interest over what she has contributed (i.e. what her partnership account should be). In valuing the gift there would be a discount for a lack of marketability (partnership interest not bought and sold on open market). The discount can be upwards of 30% but the valuation can be tricky.

F dies

F’s estate will include the value of his 50% ownership of the partnership under 2033. 2036 may grab some of D’s share if they weren’t careful and a bunch of income comes out of partnership to pay for F’s expenses without corresponding withdraws on D. However, once the partnership has been set up, if the account balances are respected from then on out, 2036 will not grab any more than F’s share. If 2036 were to grab D’s share as well, it appears that she has furnished some consideration by contributing assets to the partnership which 2043 would allow for a reduction for the actual consideration received at the time of the gift when the partnership was set up. 2036 will hinge on whether F continued to enjoy income from the portion of the assets he “gifted” to D when the partnership was set up.

The buy-sell arrangement may impact the underlying value to the estate. 2703 provides the value of the property is determined without regard to any option, agreement, right to acquire or use the property at less than FMV, or any restriction on the right to sell or use such property unless an exception applies. There is an exception if the option, agreement, right or restriction is a bona fide business arrangement, not a devide to transfer such property to member of the family for less than full and adequate consideration, and the terms of the option are comparable to those obtained in a similar transaction at arm’s length. This is a very hard test to pass especially in a family owned business. In general, buy-sell agreements will be ignored if they would not have been entered into by unrelated parties at arm’s length. Since D has an option to purchase the other 50% of the partnership at book value instead of FMV, the IRS probably won’t respect the buy-sell arrangement and there will be no discount for it.

The partnership interest attributable to F’s estate will get a discount for lack of marketability much like the one that was given when the partnership was formed and a gift occurred. If the partnership is indeed split 50/50, there will be no control premium. There may still be a minority discount because the 50% block cannot make unilateral decisions without the consent of the other 50% block. Also there is no family attribution so for valuation it does not matter that D owns the other 50%. The value of the partnership (before discounts) will be based on the net fair market value of the assets and not the book value since a willing buyer / willing seller scenario would not operate on book value but rather fair market value.

Retirement fund

Under 2039 the gross estate shall include the value of any payment receivable by any beneficiary by reason of surviving the decedent under any form of contract or agreement, if under such contract or agreement, the payment was payable to the decedent, or the decedent possessed the right to receive such payment, either alone or in conjunction with another for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death. Basically, if you were ever going to get paid under any scenario and you die and someone else gets it, then it goes into the gross estate. Here F’s retirement plan requires inclusion in the gross estate under 2039. The plan is valued at F’s death, not as the payments come in. The amount included in the gross estate includes any contribution by the decedent and also any contribution by the decedent’s employer is considered to be contributed by the decedent if made by reason of employment.