Estate & Gift Tax
Bogdanski
Fall 2014

Sample Answers to Question 2

Exam No. 9008

Hu's transfer of $6 million of stock to Winona is included in his gross estate, but not taxed because it is eligible for the marital deduction under § 2056. Although the marital deduction is not allowed for terminable interest in property that passes to the surviving spouse, the conditions that Winona must survive Hu by six months and that they cannot die as a result of a common disaster do not preclude the allowance of the marital deduction because these conditions are specifically allowed under § 2056(b)(3). Hu's transfers to his children are also included in his gross estate and are not eligible for any estate tax deductions. However, because Hu has not made any taxable gifts during his lifetime, his estate can use the full unified credit amount. His estate will therefore no pay tax on the transfers to Kami and Linus, because these transfers only total $4.34 million, which is less than the amount that is effectively exempted from tax by the unified credit. Hu's unused exclusion amount, $1 million, can be used by Winona, his surviving spouse, for any gifts that she makes, under § 2010(c)(4).

Naming Kami and Linus as partners in the partnership is a taxable gift to the extent that the value of the interests that Kami and Linus receive exceed the consideration that each of them paid. Kami and Linus' interests would likely be valued at less than 20% of the fair market value of Flipco's assets because their interest in Flipco lacks marketability and, as minority interest holders, they lack control over the company. The buy-sell agreement would likely be ignored for valuation purposes pursuant to § 2703, which states that agreements restricting the right to sell will be disregarded unless they are bona fide business arrangements. There are no facts presented that suggest that there was a non-tax reason for restricting Kami and Linus from selling their interests in Flipco, and further, it is difficult to show that buy-sell agreements among family members are bona fide business arrangments, see Estate of Lauder. The value of the interest in Flipco that Winona transfers to her children would need to be determined by an expert appraiser. Regardless of the value, Winona can use the $1 million deceased spousal unused exemption, as well as her own $5.34 million exemption amount, and avoid paying gift tax on the transfer.

Winona's investment management services for Flipco are not considered additional gifts to Kami and Linus because performance of services is not a transfer of property subject to gift tax, see Commissioner v. Hogle.

When Ted dies, he leaves all of his estate to Winona, his surviving spouse. This transfer qualifies for the marital deduction under § 2056. It appears from the facts that Ted leaves Winonahis estate outright, so there is no concern that the marital deduction would be disallowed because Ted left Winona a terminable interest. Ted also has not used any of his unified credit because he has made no taxable gifts during his life and he makes no taxable transfers at death. Any of Hu's unusued credit that Winona has not used in making lifetime gifts will expire on Ted's death, and Winona will get Ted's deceased spouse unused exclusion amount.

When Winona dies, her gross estate will include at least the value of her fractional interest in Flipco under § 2033, although the IRS may argue that her gross estate should include the entire value of Flipco because Winona effectively retained the use, enjoyment, and income of Redacre under § 2036(a)(1). The success of this argument will depend on how much Winona treated the limited partnership assets as if they were still her personal assets. Factors that favor the inclusion of the entire value of Flipco in the gross estate include Winona's borrowing of $200,000 from the partnership for a personal expense, when the other two partners, Kami and Linus, did not receive any payments out of the partnership. On the other hand, Winona did not transfer all of her assets into the partnership, and did not have to rely on partnership assets for her support. Additionally, she paid back some, and her estate paid back the rest, of the money borrowed from the partnership, which indicates that she did not intend to treat the partnership assets as her own personal assets. Even if Flipco is brought into Winona's estate under § 2036, only the value of Flipco on the date of Winona's death in excess of the $60,000 that Kami and Linus provided as consideration for their interests will be included in Winona's gross estate, under § 2043.

The other assets, totalling $3.5 million, that are in Winona's probate estate are included in her gross estate under § 2033. Winona's estate can take a deduction for the debts paid and expenses incurred in settling the estate, § 2053. Winona's estate can also use Ted's unused exclusion amount, as well as any of Winona's unified credit exclusion that she has not used in her lifetime transfers to Kami and Linus.

Exam No. 9651

There is no GST tax.

Hu's (H) Estate 2014

Under 2523, there is a unlimited marital deduction for property left to a spouse if the necessary requirements are met. The requirements are that the spouse is a US citizen, it passes from decedent to spouse and it is not a disqualified terminable interest (2056(b)). The trust H leaves to Winona (W) is a terminable interest but there is a delay clause exception under 2056(n)(3) which states that if a bequest is delayed for not more than 6 months, the terminable interest is ok. H's gift to W meets this requirement so the martial deduction applies and H will not have to pay estate tax on this transfer.

Under the lifetime credit for an individual is $5.34 million. H's estate gives $4.34 million to his two children so his estate will not have to pay estate tax on these transfers because he had the rest of his lifetime credit left. Also, under 2505, if a spouse does not use up all of their lifetime credit, then the surviving spouse is able to use it. In this case, W will have an extra 1 million of lifetime credit to use if/when she pays gift or estate tax. Under 2032, H's estate can choose to value the estate at the date of death or 6 months after his DOD.

W's Transfer of Redacre 2015

The creation of the FLL is a completed gift to Kami and Linus. To the extent that Kami (K) and Linus (L) did not contribute equal consideration for their interest in the FLL ($30,000), the difference between the value of their interest and the amount of W's interest will be a gift from W to L and K. Rev. Rul. 93-12 states that an interests are valued without regard to family attribution or other factors similar to that but instead, it is purely valued at what a hypothetical buyer and seller would pay for the property. Therefore, L and K can claim minority discounts because they only own 20%. Additionally, there is an argument for blockage, under the theory that selling off 20% would negatively effect the price. W's value of the company will be increased because she has a majority control over the company.

Under 2703(a) the value of the property is valued without any regard for options, agreements, or right to acquire the property for FMV, unless (b), there is a (1) bonafide business arrangement, (2) not a devise to transfer between family members of decedents for less than full and adequate consideration and (3) the terms are comparable to those similar arrangements into by persons in arms-length transaction. The buy-sell agreements in this case do not meet the exception so they will not change the value of the FLL. Whether W can use the annual exclusion for her gifts to K and L is up for discussion. A present interest is an unrestricted right to immediate use , possession, or enjoyment. This will really depend on the distribution of the FLL. If there are annual distributions and it pays out dividends then it will probably be ok to exclude under Wimmer. On the other hand, if the FLL is not making distributions, which is more likely because it has property in it, then W cannot use the annual exclusion. See Hackl and Price.

W will be able to use up any lifetime credit she has left and can use up H's right now if she wants to.

Ted (T) Dies 2019

Ted has $200,000 in his taxable estate(the RV W bought was not a gift to T because the marital deduction applies). Because T made no lifetime gifts, presumable he still has his lifetime credit he can use. Basically, T will use up 200,000 of his lifetime exclusion and the rest of it, 5.14 million, can be transferred to W. If W still has any of H's lifetime credit, this will go away and be displaced by T's lifetime credit. Hopefully W used up H's lifetime credit in 2015 when she set up the FLL and gave a gift to L and K. Under 2032, T's estate can choose to value the estate at the date of death or 6 months after his DOD.

W's Estate 2020

W's interest in the FLL will be included in her estate. The IRS will come after the FLL under 2036 and try to argue that W is using the company for her own benefit and so the full value of it should be included in her estate. If W acted like she owned the property then it will go back into her gross estate. Considering that W used the company (or at least borrowed against it) to buy an RV goes against her in the analysis. On the other hand, she made payments on the loan during her lifetime (at least $20,000). This is a factual analysis and really depends on whether W treated the company as their own property or not. From the facts that are included, a court would probably decide that the full value of the FLL is not included in W's estate. The value of W's interest in the FLL will be subjected to the same discounts as when it was valued as a gift. W estate will get a deduction for the claim (RV loan) against her estate under 2053(a)(3). Also, W may use any unused lifetime credit that she has not used or from T's estate (but not H's estate). Under 2032, W's estate can choose to value the estate at the date of death or 6 months after his DOD. This may be a good optoin for W. Under 2032, if the estate elects to use it, the entire estate will be valued 6 months after the death of the decedent, instead of the DOD. Note that this would not apply to any property which depreciates merely due to the passage of time but there is no indication of such property in W's estate. The election is all or nothing and the estate must elect to value everything, not just certain assets. This election must lower both the gross estate and the estate tax (no basis games).

If the discounts were not taken into consideration (it is hard to know how much they would receive without being a valuation expert) then the gift of Redacre to L and K would be 2,400,000 (40% of 6,000,000) and so each would receive 1,200,000. W could have used H's credit and so W would have had to use her credit on the remaining 1,400,000 so she would have 3,940,000. W would have T's lifetime credit of 5,140,000 so W would have a total of 9,080,000. W's estate would be 4,200,000 (60% of 7,000,000) and $3,320,000. Total would be 7,520,000 so W would not have any gift tax consequences.

Exam No. 9856

The death of Hu in 2014 does not implicate any estate tax payments that would need to be made, although an estate tax return would need to be filed to show (1) partial depletion of Hu's unified credit, and (2) spousal deduction of $6 million. The $6 million dollar transfer to Winona's wife would be eligible for the spousal deduction because it meets the "delay clause" requirements of § 2056(b)(3): the only ways the bequest could "terminate" (i.e. be a terminable interest) are if the spouse does not survive Hu by 6 months (including dying in a common accident). Since the facts show that Winona does in fact survive by 6 months, the interest is not terminable and the full $6 million is eligible for the deduction. Because of this, Hu still has his full $5.34 million dollar unified credit to apply to the $2.17 million dollar transfer to his children. Assuming that Hu uses this credit, he will owe no tax AND the remaining unused amount of the credit ($3.17 million) transfers over to Winona (in addition to whatever unified credit she has of her own). There is no GST because the children are not "skip persons" (they are only one generation below).

Winona's transfer of $6 million to the LLC would likely be considered a gift since it is entirely a family LLC and does not appear to be a traditional, arms-length transaction occurring in the ordinary course of business. The IRS is particularly wary of wholly family owned businesses that might act as a way to make indirect gifts (indirect gifts also being taxable), and in this case it appears that the contribution of Winona relative to the contribution (and lack of services) of Kami and Linus makes this a likely indirect gift. If Winona could not convincingly argue that it was a normal business transaction (like anyone making a capital contribution to a new business), it would be a gift in the same way giving money to a corporation is. As such, it would be taxed as a gift to the individual members in proportion to their ownership rights: in this case, 60% of the 6 million would not be a gift because it would represent Winona's own interest, but the remaining 40% would be gifts. Whether or not a $14K annual exclusion would apply for both children would depend on the likelihood that the LLC actually pays out at least $14K in profits such that it is a present income interest. Being undeveloped waterfront real estate, it is doubtful that this would happen: it would probably just appreciate in value. Lastly, Winona's services to the LLC would not be a gift, even though it is done without consideration: it is analogous to the Hogle case: where a parent is just providing their services in money-management that inures (at least partially) to the benefit of the children, such services are not a "transfer of property" contemplated by the gift tax provisions. Because Winona would have a large amount of unused unified credit (i.e. her own and her deceased husband's) she could escape paying gift tax altogether on this transaction by electing to use it.

The marriage in 2016 has only a potential tax consequence, in that if Winona outlives Ted she will be able to take HIS unused unified credit (which is substantially more than the amount she had from her ex husband). This would occur because he would be the "last such deceased spouse" under the DSUE statute. The $200K "loan" from the LLC could have gift tax consequences depending on if it is (1) bona fide (i.e. an intention to actually pay back) and (2) if there is any interest charged on it. If it is not bona-fide it is a gift from the LLC of 40% of the 200K (can't make a gift to oneself, and Winona is a 60% owner), if it is a loan without an interest agreement, the amount of interest that would be due on a normal commercial loan (actually a loan at the set federal rate) is considered a gift. It should also be noted that the use of the loan for highly personal purposes makes the LLC appear much more like a general bank account of Winona, and less like an actual business.

When Ted dies in 2019 Winona gets something of a windfall: for one, none of the money passing to her ($200K) is taxed since it appears to be given outright (i.e. not a terminable interest) to his spouse, and is therefore eligible for the full spousal deduction. Secondly, having not used any of his unified credit in the past, Winona gets that full $5.34 million (none of it being depleted through the $200K gift since that was a deduction). Therefore Winona would have a unified credit available of $5.34 million plus whatever she had of her own (not including her FIRST husband's), which may or may not be a substantial amount depending primarily on if the transfer of the property to the LLC was seen as a gift and not a business transaction.

When Winona dies in 2020 the exact amount of tax due would depend on if the 2015 transfer was treated as a gift or not. If it was, credit would be given for the amount of gift tax paid at that time. In either event, Winona's 60% ownership interest of a $7 million LLC would pass to Kami and Linus. This may qualify for a lack of marketability discount since LLC ownership interests are often very difficult to sell on an open market -indeed, restraints on alienation were built into the LLC charter. However, since the estate tax looks at the property in the hands of the decedent (not the legatees, unlike the gift tax), there would be no discount for "lack of control" since Winona owned a 60% stake. The remaining $3.5 million in assets would be taxed to the extent that they, in addition to the LLC assets, exceed Winona's unified credit plus Ted's ported unified credit. The estate would most likely be able to take the $180K debt owed to Flipco as a valid and binding "claim against the estate" such that it is deductible from the gross estate. The fact that Winona had paid a portion of it implies that it was bona-fide: whether or not it was for an adequate and full consideration in money or money's worth seems straightforward since she in fact received the full $200K she then owed (thus obviating the concern that she was depleting her estate through a claim that really just paid her legatees).

It seems unlikely that Winona would want to use the alternate date valuation for her property, since you cannot "pick and choose" what property to apply the election to and the property seems to be appreciating, not depreciating.