Estate & Gift Tax - Sample Exam Answers to Question 3

Estate & Gift Tax
Bogdanski
Fall 2010

Sample Answers to Question 3

Exam No. 6945

When H and R took the property as equal JTWROS (JT), and H paid ¼ of the purchase price, while R paid ¾, there was a taxable gift by R to the extent that the value of the interest received by H exceeded the amount that she contributed. When H dies, 2040 will presume that the property is included in H’s estate, and it will be up to the estate to show that property really belonged to R and should therefore not be included in H’s GE. Excluded from H’s GE will be the FMV of the property at death multiplied by R’s consideration over the total consideration. Moreover, since the sisters owed the property as JTWROS, there will not be a discount for shared control available to them.

For the several years that H did not exercise her general POA, the poer lapsed. A lapse is treated as a release, and thus an exercise of power, to the extent that the value of the property which could have been appointed exceeds $5k or 5% of the value of the assets over which the power could have been satisfied. Thus, because H had a POA over both income and corpus, she had a POA over the entire amount of the trust to the extent that it exceeded the 5 or 5 exception. She therefore made a gift of this amount to Nell. When H releases the power, she is treated as making a gift to Nell, but the 5 or 5 exception does not apply. H should have disclaimed her POA when she received it due to the gift tax that she is not responsible for. H can take an annual exclusion against these gifts, and she can also use her $1 mil lifetime gift exclusion against them.

There is no GST tax. Even though F, the settlor of the trust, was two generations above N, the distribution to N was actually made from H, who had a POA.

Upon her death, H’s estate is entitled to many deductions under 2053. First, the funeral expenses are deductible to the extent that they are reasonable, and not outlandish. Second, the personal representative fee to R will only be partially deductible. Administrative expenses under 2053 are limited to those expenses that are actually and necessarily incurred for the administration of the estate, and they do not include expenses that not essential to settlement of the estate but that are rather incurred for the benefit of the heirs or beneficiaries. Executor’s fees fall into the latter category, and under Reg. 2053-3(b)(1), executor’s commissions are only deductible if they are paid or fixed by a probate court decree.

Attorney’s fees incurred are deductible to the extent that they are incident to the settlement of the estate. Reg. 2053-3(c)(3). Because neither of H’s lawsuits have to do with the estate, they are not deductible under this provision. However, they may be deductible as claims against the estate. Deductions allowed as claims against the estate are those for the payment of legally enforceable obligations of the decedent existing at the date of death. If H’s attorney in her dispute with Kay is owed money by H, then he has a claim against the estate, and the amount paid to him is deductible. The $100k that H received in the litigation with K will be included in her GE. Damages in lawsuits constitute income, and thus the money would be IRD – which is the worst. Not only is IRD included in the decedent’s income tax, but it is also included in the estate tax. The IRD is first taxed in the estate tax return, and is then taxed in the income tax return. R, as beneficiary, however, will be entitled to an income tax deduction for the estate tax paid on the IRD.

H’s estate will be able to deduct the amount paid to X in damages. While courts are split as to whether the date of death value of the deduction is the correct amount to be deducted, or the actual hindsight value of the deduction, Reg. 2053-4 clarifies this determination. Deductions are limited to: 1) claims that are actually paid by the estate (here, $1,200,000), or 2) if the claim is not contingent, and the amount is ascertainable, the amount deducted on the original estate tax return (not applicable here). While there is a $500k exception, where the estate can make a claim based on the date of death value of the claim has not yet been paid, this also is not applicable since this amount is not large enough to cover the claim involved. If the estate did in fact claim a $2 mil deduction, it must file an amended return. If it did not file its return yet, it must wait until after settlement. If the lawsuit was dragging on past the SOL, the estate should have filed a protective claim for the refund in order to stop the SOL. In sum, the estate will only get a $1,200,000 deduction for X’s claim.

Finally, If H’s father had passed away less than 10 years prior to H, which is not made clear on these facts, any amount that she received from him would qualify for the TPT credit and would avoid taxation.

Exam No. 6776

No implication of GST tax regarding Hannah b/c no “skip person.”

House

Hannah has a joint tenancy with survivorship rights in the house with Rita. H paid partial consideration for the joint tenancy (1/4) compared to Rita (paid 3/4). As such, upon H’s death, by default the entire value of the house on date of H’s death is dragged into H’s gross estate. Unless: H’s estate will have to prove that Rita paid 3/4 of the purchase price of the house. If it can prove this, then the value included in H’s gross estate will be reduced by 75% (Rita’s 75% ownership deducted). 2040(a). Rita’s purchase money is “clean money,” in that Hannah did not make a gift of the money to Rita then used to buy the house. H’s estate may need to prove that Rita used her own funds (that her father left the full amount of consideration paid to Rita as her property). There is no additional valuation deduction for joint tenancies with survivorship interests.

Trust

Hannah has a general power of appointment over the trust, because she has power to invade the corpus and income of the trust for the benefit of her own creditors, and the power is not limited by an “ascertainable standard” or jointly held with either Fernando or an adverse party. 2041. Having a general power of appointment is akin to owning the property yourself. Each transfer of income to Rita (per the trust terms) is considered a completed / present gift by Hannah to Rita, and gift tax evaluated for each year (Hannah may apply any available $13K / year exclusion plus her available unified credit / $1M lifetime gifts). A release of a general power is also a taxable event. Hannah’s release is another completed “gift” to Rita per 2514, of the remaining income interest to Rita (valued based on federal actuarial tables / present value of the income interest) and a completed gift to Nell as well of Nell’s remainder interests (also valued on actuarial tables on Rita’s life expectancy / the present value of the remainder interest) in the trust, evaluated at the time of the release. Hannah can apply annual $13K exclusion (if available) / unified credit to Rita’s gift upon the release, but because Nell’s remainder interest is a “future interest,” Hannah cannot use annual exclusion and must pay the full gift tax (can still apply available unified credit) for the gift of the remainder interest.

A release of a general power of appointment also triggers inclusion in gross estate. When Hannah dies the next year, per 2041 the full value of the trust will be included in her estate, valued at the date of her death. Hannah’s estate may choose to use Alternate Valuation / 6 mo. per 2032, if her estate is required to file estate tax return and if the result is a reduced value of the gross estate. All gift tax paid on account of gifts made by Hannah in the last 3 years will also be included in her gross estate per 2035.

Estate Tax Deductions

Rita (as executor of Hanna’s estate) will likely be able to deduct the cost Hannah’s funeral expenses, a “reasonable” PR fee for her own services (per 2053, administrative fees deductible when “reasonable and necessary” for the settling of the estate), and the attorneys fees (since they directly relate to claims against the estate). To deduct claims against the estate at the time of filing the estate tax return (required within 9 mo. of death), current Regs require that claims must have consideration: be actually paid, or not contested/contingent and “ascertainable with reasonable certainty” per Reg. 20.2053(1)(d)(1). Contested / contingent claims must wait until the claim is actually paid. Here, the lawsuits with Kay and Xavier are contested at Hannah’s death and not resolved until 18 months later. Rita should file the estate tax return without inclusion of these contested amounts, then file a “Protective Refund” claim within the SOL for refunds. Upon settlement, Rita will need to file an amended estate tax return, now including the additional $100,000 and deducting $1,200,000. Reg. 20.2053(4)(b). This will likely result in a large estate tax refund to Hannah’s estate.

Exam No. 6727

There are no GST consequences to Hannah in this problem.

Creation of the Joint tenancy will be a gift if the joint tenancy is severable by either party’s unilateral act. Value of the gift is the entire value of the property minus the buyer’s portion (gifter’s portion). Because Hannah only paid for a quarter and Rita paid for three quarters when each should have paid for half, Rita is making a gift of one quarter of the purchase price. The gift is complete and Rita can use her annual exclusion and any unified credit she might have to offset the value.

The power of appointment that Hannah has over the income of the trust is a general power of appt because it is exercisable in favor of her creditors and is not limited by an ascertainable standard, created before Oct. 1942 or excerisable in conjunction with another. Because it is a general POA, there are tax consequences for any exercise, release or lapse of the power. Hannah does not hold the power at death so it will not be included in her estate. 2035 does not apply to gen. POA’s so it doesn’t matter that she released it within three years of her death. Every time that Hannah fails to exercise her power, it is considered a lapse because she could have taken the income for herself. For each distribution of income to Rita, Hannah will be treated as a lapse and making a gift to Rita. H will have to pay gift tax on the distributions subject to a de minimis exception. The gift will only be the amount in excess of 5K or 5% of the value of the property that could be applied by exercising the power, whichever is greater. The gifts will be present interests and H can use her annual exclusion towards them, and whatever unified credit she has left over. When H releases the power, she will also be making a gift to Rita equal to the value of the income interest in the trust. This will be valued by using the tables. If H can show that income will actually be distributed to Rita she will be able to use the annual exclusion and any Unified Credit.

Hannah’s death:

The joint tenancy with Rita will not be included H’s estate under 2033 because the interest terminated at death. Under 2040 the gross estate includes the value of all property to the extent of the interest held as joint tenants with right of survivorship by D and any other person, except if acquired for adequate and full consideration. Because the surviving tenant, rita, furnished some the consideration, value of the property at death times (consideration furnished by Rita / total consideration paid) will be excluded from H’s estate. IN order to get the exclusion, H’s estate will have to prove that Rita’s portion did not come from H. Because the money came from their father, it will be considered clean money.

The value of all the assets in H’s estate will be their FMV at death or if the estate elects the alternate valuation date. The gross estate will be the FMV of all the assets – any deductions. The estate will get to deduct the funeral expenses incurred by the estate for the burial as allowable under local law. This includes tombstone, transportation of the body and anything for eulogizing and laying to rest H. It will also get to deduct the executor fees to Rita as an administrative expense if they were actually and necessarily incurred. If these are set by a probate decree or actually paid then they will count. Absent a decree, they will be allowed if they are allowable under state law and are the same for similar estates. Hopefully Rita’s fee wasn’t too “sizeable.” Also because the estate is being left to Rita it will be necessary to prove her expenditures were necessary and not just incurred for the benefit of a devisee. Attorney’s fees are deductible if they were incurred to file the return. Here the expenses were incurred in the disputes over the IP property and the Xavier claim. They are not deductible. The battle with Xavier will be a claim against the estate. Transfers because of a divorce decree that happen at death are considered claims against the estate. There is a deduction for legally enforceable obligation of D existing at the time of death. Under the new regs, the deduction is only for money actually paid or an amount that is ascertainable. At the time of H’s death she had not actually paid any claims. The estate should have filed a protective refund claim when the 9 month SOL to file the estate tax return was approaching because the claim wasn’t settled. If H had any counterclaims against Xavier, she could deduct these. The estate could also deduct up to 500K of the claim that has not been paid.

In order for a claim to get a deduction it must have been contracted in a bona fide sale and for an adequate and full consideration in money or money’s worth. The claim from Xavier would be a claim in divorce. Normally love and affection are not money or money’s worth. There are special rules for divorce though depending on when the divorce was finalized and when the property settlement was entered into. If the divorce occurred within the three year window starting one year before the property agreement was entered into and ending 2 years after the property agreement was entered into, any transfer pursuant to the agreement, whether part of a court decree or not, will be considered for full and adequate consideration if made to either spouse in settlement of his or her marital property rights under 2516. The property settlement occurred 18 months after H’s death and they had all ready been divorced several years ago so I would assume they were not within the three year window. However, even though it won’t automatically be considered for full and adequate consideration, if the property agreement is incorporated into the court divorce decree still might be able to argue adequate and full consideration under the Harris case. Under Harris, transfers at divorce pursuant to a court decree are automatically for full and adequate consideration. Therefore, the divorce claim will probable be considered for adequate and full consideration and be allowed as a deduction. Once the actual amount of the claim was settled the estate could file for a refund claim for the actual amount paid of 1.2 million minus the 500K if they took that exception.

The claim against Kay will be included in the estate under 2033. An interest in property for purposes of 2033 occurs when D has something at death that she could transfer to a successor. The claim came into existence during H’s life and was not cut off by death, therefore it is included in the estate.

The gift tax that H paid on the release of her gen poa and the gift tax paid on the lapse of her power over the income in the trust will also be brought back into the estate under 2035.