Estate & Gift
Tax
Bogdanski
Fall 2010
Sample Answers to Question 2
Exam No. 6993
Gift Tax — Family Trust
The trust is a completed gift and will be taxable at the time of creation to D. Although D retained the ability (via directing the trustee) to accumulate income for up to 10 years (until A, the income beneficiary, reaches 35), it would still be paid out to A eventually. Under Reg. 25.2511-2(b), this power to change timing does not render the gift incomplete. This is notably different than § 2036, however, and will affect the calculations at that point.
Because the gift is complete, it will need to be valued. It will probably come to something less than 40% of the $100,000,000 corpus. D will argue vigorously for various discounts. She will begin by noting that Rev. Rul. 93-12 states that interests are valued without regard to family attribution or other factors like that — instead, it is a purely hypothetical buyer and seller. Thus D can claim a minority discount, as B owns a majority 60% share of the trust. Additionally there is an argument for blockage, under the theory that selling off 40% of the trust all at once would negatively affect the price. There may also be an argument for lack of marketability, depending on the type of business Corp. is. The facts note that only that it is a “closely held operating company”, indicating that it should probably go for something less than publicly traded shares of similar companies. There is always a premium paid for the ability to get your investment in and out of a company quickly.
After the valuation battle is over, D will be taxed on the transfer. If D has not used her unified credit (the gift portion), she could and probably should do so now. She will also attempt to take an annual exclusion for the gift. Corp. historically pays annual dividends, which means there should be a present interest for A, unlike in Hackl. However, the IRS will counter that D’s retained power to accumulate A’s income makes it too contingent to be a present interest. They will likely win on this argument, as this appears to fall under the terms of Reg. 25.2503-3(a).
D made no other gifts during her lifetime. Her failure to exercise her power to accumulate income is not an gift (indeed, that gift was already taxed).
Estate Tax — Family Trust
The entire Family Trust will be pulled back into D’s gross estate upon her death due to § 2036(a). Although this section appears to only apply when the decedent retains possession or enjoyment, or the ability to designate who does get possession or enjoyment, the courts have ruled that this includes the right to designate when someone gets possession or enjoyment. Although it may seem counterintuitive, D’s ability to accumulate A’s income (even though it would be paid out in 10 years, at the most), falls under this. Because D retained this power for her entire life, § 2036 will be triggered and will drag the entire trust corpus at the time of her death back into her estate. Once again, the fact that D never exercised this power is irrelevant to the application of § 2036.
The same valuation battle that took place before will need to take place again, with the same arguments being made over the 40% interest, although more is at stake now given the value of the Corp. stock doubling (§ 2036 will value the property at the time of death). An interesting twist here is that the stock value drops immediately after D’s death. The estate may want to consider using the alternate valuation date under § 2032. Under this section, if the estate elects to use it, the entire estate will be valued 6 months after the death of the decedent, instead of at the time of death. Note that this would not apply to any property which depreciates merely due to the passage of time (e.g. annuities or patents), but there is no indication of such property in D’s estate. The election is “all or nothing” — that is, the estate must elect to value everything 6 months after D’s death, including (for reasons stated below) the Charity Trust. Doing so must lower both the gross estate and the estate tax (no basis-only games here). This will be a job for the accountants and the like, as it will have to be determined whether it is beneficial given all the property in the estate. The size of the trust, however, likely will be a deciding factor.
Estate Tax — Charity Trust
The entire $8,000,000 trust will be taxed to D’s estate. D clearly attempted to set up a charitable trust, and did, just not sufficient to merit a deduction under § 2055. That section requires that the donation go to a charitable organization, and churches certainly qualify. However, under § 2055(e), interest split in time (such as this one) between the charity and a non-charitable entity, are only deductible if they fit into the limited exceptions laid out. This is clearly not a pooled income trust, as the charity does not have control over the funds on the facts given (although the trustee actually is not named, the decedent would need to specifically set it up this way). This is an attempted charitable remainder trust, with the remainder spilling out to the non-charitable entity (G) after 20 years. This would only work if it were an annuity (CRAT) which paid out a fixed amount each year, or a unitrust (CRUT) which paid out a fixed percentage each year.
Because this trust pays out an income interest each year, none of it will qualify for the charitable deduction. The policy behind this is to prevent games with income producing assets (or lack thereof) — for example, the trustee here may invest in all growth, non-income producing property, resulting in little or no actual money going to the charity for those 20 years, despite an attempted deduction taken based on actuary tables. To prevent this, Congress created the strict limitations of § 2055(e), none of which D’s trust falls into.
Generation Skipping Transfer Tax
There is
only one possible skip person here:
The gift to G in the initial Family Trust is a future interest, so it cannot be a direct skip. Since it will pay out at the termination of the trust, it will be a taxable termination under § 2512(a). This is taxable to the trustee, not the settlor, so D and D’s estate will not pay GST for this transfer.
The gift in the Charity Trust is likewise a taxable termination, and will also be paid by the trustee at the time of termination.
In both cases D was free to assign her GST exemption to the trusts at creation. It is up to the taxpayer to assign the exemption (although there is a default scheme). If it is done in a trust like this, the excluded amount will be the proportional share, or the “exclusion ratio” under § 2631. This is determined by 1 – (GST exemption allocated / total value of property). The property is valued at the time of creation, which allows for significant savings when the trust property appreciates (such as the Corp. stock, which doubled in value). Although both trusts appear to be too large for D to apply her exemption to cover the entire trust (unless some seriously good arguments are made in valuing the Family Trust Corp. shares), it will still pay off when they terminate. Any amount applied now will effectively mean more money distributed to G, as the trustee will pay the tax out of the trust upon its termination to G.
Abby
There are no transfer tax consequences for A due to the Family Trust or the income paid out of it. She had no power or control over any of the interests contained in it. Likewise, she is not even involved in the Charity Trust.
Shawn
Shawn will be liable for the GST tax when the Family Trust terminates. The GST will be determined as noted above.
I am unsure who the trustee of the Charity Trust is, but if it’s S, she is liable there as well for the taxable termination to G.
Exam No. 6727
Year 1
When D sets
up the trust, there is no GST consequences because the
trust is not a skip person because not all interests are held by skip people or
no one holds an interest and at no time may a distribution be made to a
non-skip person. The income gift to her
daughter will be complete at the time the trust is set up. A gift is not considered incomplete just
because the donor reserves the power to change the manner or time of the
enjoyment of the gift. D can direct the
trustee to retain all or part of the income but Abby will still get it
eventually. SO the income gift will be
complete and the gift will be value at the time the trust is set up using the
actuarial tables. Because the trustee
has the power under the direction of D to hold back income this makes the gift
a future interest so there will be no annual exclusion. Because the gift is an income interest, D
will have show that income is actually distributed. There is evidence that the Corp has issued
dividends so this shouldn’t be problem.
Year 5
D dies in year 5. Any gift tax paid by her in the last three years will be brought back into her estate. Because D retained the right to retain income in the trust it will be considered a string for 2036 and as a retained power to alter the interest under 2038. 2036 would include the whole value of the trust in the gross estate whereas 2038 will only include the income interest. Because 2036 is the larger inclusion that code section will apply. It does not matter that D never actually exercised the power. 2036 will apply even if the power is never exercised, there only needs to be a possibility that it could have bee. The value of the trust is 200 million when D dies, the date of death value is the default value for the value of assets. However, because the value of the stock drops shortly after D’s death, the estate should elect to use the alternate valuation date. This can only be used if it lowers the gross estate and the estate tax. Because the whole value of trust is included in the estate, this will most likely be the case.
Normally
charitable bequests are allowed an unlimited deduction. The transfer must be directly to the charity
or in trust for the charity. The charity
must be an eligible one under 2055 and 2522.
The IRS is fairly lenient so I am sure that Chapel will qualify. The charity trust in the will is a split
interest transfer, meaning that one interest is charitable and the other is
not. Under 2055, if a charitable
interest is also subject to an interest that is not charitable, there is no
deduction unless the remainder interest is a charitable remainder annuity
trust, charitable unitrust, or a pooled income
fund. To be an annuity trust one
beneficiary must get a fixed amount or fixed percentage of the FMV of the trust
corpus at the time it was created, not less than 5% annually. It can be either a lead or remainder
trust. This trust is not one of
these. To be a unitrust,
the income beneficiary is entitled to receive an annual payment equal to a
specified percentage of the trust corpus valued annually and not less than
5%. It can be a lead or remainder
trust. This trust is not one of
these. To be a pooled income fund
usually a trust or fund is maintained by a charitable organization to which
donors transfer property. This is not
one of these. There is no way for the
IRS to guarantee that Chapel will ever actually get any income. So D will not get a charitable deduction for
the trust. The estate will have to pay
estate tax on the full value of the trust.
When the trust terminates in 20 years and is distributed to
D’s estate will be able to use any deductions for administration expenses, funeral expenses, unpaid mortgages or claims against the estate. It will also be able to use any unified credit that is left over. When calculating the estate tax the taxable gift that was paid at the time the property was gifted will not go into the adjusted taxable gifts because the property was included in the estate. This prevents D from being taxed twice.
Year 16
When the
family trust terminates the distribution of stock to
Exam No. 6776
Year
1
D
sets up irrevocable trust, income to daughter Abby for 15 years, remainder to
D’s grandson Gary. Trustee is Shawn- who has the power to accumulate
income but must eventually distribute accumulated income to Abby upon Abby
reaching age 40.
Shawn
does not have a general power of appointment since she can only accumulate
income for a limited time, this is not exercised in
favor of herself/her estate / her creditors/ her estate’s creditors. This
is a specific power of appointment. The power to accumulate income (turning the
hose on / off) by itself does not defeat the completeness of a gift.
Doris’ power to compel Shawn to do this also does not defeat the
completeness of the gifts to Abby (income interest) and
D.
will have to pay gift tax immediately on the value of the first 10 years of
Abby’s income interest (using the present value of future earning
projections of the corpus) and may not allocate any annual gift exclusion to
that amount (but D. can use her available unified credit / $1M so may avoid
paying actual tax but must still file). D. CAN allocate annual gift exclusion
(+ any unified credit remaining) to the remaining 5 years of income interest,
since upon Shawn’s termination of withholding powers Abby’s income
interest becomes a “present” interest.
Doris
has made a completed gift to
The
trust is funded with 40% of stock in Corp. Since the Corp. pays
a dividend each year, it is “productive property” and Abby’s
present interest to the income won’t be scrutinized (possibly knocking it
into a “future interest” category per
No
GST tax in Year 1.
Year
5
Because
the Charity trust is a time-divided interest (income to Chapel for 20 years,
remainder to grandson Gary), the testamentary trust set up for benefit of
Chapel will only qualify as a charitable donation (and thus be exempt from
inclusion in D’s gross estate) if it is a proper charitable remainder
annuity trust, unitrust, or pooled income trust. It
does not meet such requirements here;
Year
16
Termination
of the trust triggers a “taxable termination” for GST Tax purposes
on top of a gift to