Estate & Gift Tax

Bogdanski

Fall 2016

Exam Answer Outlines

Question 1

The establishment of Trust A is an incomplete gift, because Dana retains the power to change the remainder beneficiary. When Dana dies, the corpus of the trust is fully includible in Dana’s gross estate, at its date of death value of $5,200,000, because of Dana’s retained income interest and Dana’s retained power to change the remainder beneficiary. Sections 2036 and 2038 of the Code.

The establishment of Trust B is a completed gift of the remainder to Zia. Because Dana’s retained interest is a qualified annuity interest, it escapes the “zero value” rule of section 2702 of the Code, and the gift to Zia is valued using the tables promulgated under section 7520 of the Code.

Because of Zia’s “Crummey power,” Dana’s gift to Zia is eligible for the annual exclusion. Dana is also entitled to the unified credit.

When Zia fails to exercise the Crummey power, the lapse of the power is generally treated as a gift by Zia to the trust; however, given the size of the contribution funding the trust, the lapse is likely to be exempt from such treatment by the “5-or-5” exception in section 2514(e) of the Code.

When Dana dies, section 2036(a) includes some of the corpus of Trust B in Dana’s gross estate. The amount included is the amount necessary to generate a perpetual stream of $50,000 annual payments. (Assuming a 2 percent discount rate under section 7520 of the Code, this would be $2,500,000.)

In computing estate tax, “adjusted taxable gifts” (lifetime gifts) are generally added to the tax base, but not if the gift property is also included in the gross estate. Thus, at least a portion of the gift that occurred when Trust B was established is likely not an “adjusted taxable gift.”

The establishment of Trust C is a completed gift of the entire trust corpus. Dana is entitled, however, to a gift tax charitable contribution deduction, because the charitable remainder interest follows a unitrust interest held by Zia. The amount of the deduction is determined using valuation tables prescribed under section 7520 of the Code. Upon Dana’s death, no part of the charitable trust is included in Dana’s gross estate.

Question 2

Arthur makes completed gifts of XYZ stock to each of the children. Minority (lack-of-control) discounts are available, because each gift is valued separately under Revenue Ruling 93-12 despite the family relationships. A discount for lack of marketability may have already been taken into account in determining that all of the stock of XYZ had a fair market value of $2,000,000. In valuing the stock, the transfer restrictions are likely to be ignored under section 2703 of the Code, because they do not appear to meet the tests of section 2703(b).

Annual exclusions may not be available for the gifts, under Hackl and similar cases. XYZ has never paid a dividend, and Arthur has a veto power that would prevent the children from obtaining funds by selling their stock. Thus, the gifts may not be of present interests. Arthur’s unified credit may be available, however, to eliminate any immediate gift tax liability. Arthur and Basia may elect to split their gifts for the year, in which case all gifts made by either of them will be treated as being made one-half by each.

When Arthur dies, his 25 percent retained block of stock is included in his gross estate, and it is eligible for discounts. Arthur’s extraordinary control over lifetime disposition of the stock by the children could potentially raise issues under section 2036(a)(2) of the Code. Administrative expenses of the estate are deductible under section 2053 of the Code. Because Arthur died less than three years after making the inter vivos gifts of XYZ stock, any gift tax paid on those gifts will be included in his gross estate under section 2035(b) of the Code.

The testamentary trust creates a terminable interest for Basia, and thus no marital deduction is available unless specifically authorized by one of the exceptions in section 2056(b). The exception for a life estate with a general power of appointment under section 2056(b)(5) is not available, because Basia’s invasion power is limited by an ascertainable standard. The phrase “support in reasonable comfort” is an ascertainable standard. See Reg. § 20.2041-1(c)(2).

A QTIP election is available under section 2056(b)(7), because all of the income is payable to Basia for life, with no power in anyone else to divert it from her. The trust’s treatment of the “stub period” income is permissible. The QTIP election, if made by Arthur’s estate, would make the full value of the testamentary trust deductible by Arthur’s estate. This could potentially leave substantial unused unified credit that can be “ported” from Arthur’s estate to Basia under section 2010(c). Basia does not forfeit the “ported” exclusion by remarrying.

When Tara dies, her remainder in the trust is included in her gross estate under section 2033 of the Code. Her XYZ stock is also included, at its value on the date of Tara’s death (taking discounts into account). Because Tara died less than 10 years after Arthur, the section 2013 credit for tax on prior transfers is available.

When Basia dies, if a QTIP election was made, her gross estate includes the entire value of the trust corpus on the date of her death. If no QTIP election was made, the trust corpus is not included in her gross estate because Basia did not have a general power of appointment. Her estate is entitled to a marital deduction for the assets passing to Evan.

The assets passing from Basia’s probate estate to Gabe are not subject to generation-skipping-transfer tax, because when Basia dies, Gabe is not a skip person as to her. This is because of the “orphan” rule in section 2651(e) of the Code. When Tara dies, Gabe moves up a generation with respect to Basia.

In contrast, Gabe is still a skip person as to Arthur. The “orphan” rule of section 2651(e) is applied when the transfer by Arthur was first subject to gift or estate tax, and that was when Arthur died. At that point Gabe’s mother, Tara, was still alive.

Basia could conceivably have some unused unified credit that could be “ported” to Evan, but given the size of her and Arthur’s estates, it is unlikely.

Question 3

The joint purchase of the annuity by Uma and Nora could be in part a gift by Uma to Nora. If at the time of the purchase the actuarially determined value of Nora’s annuity interest is greater than the one-half premium that Nora paid, the difference is a taxable gift by Uma to Nora. Because payments to Nora will not commence for many years, any such gift may not qualify for the annual exclusion. It may, however, be free from tax, depending on how much of Uma’s unified credit is available.

Because Nora is Uma’s niece, section 2702 of the Code does not apply to any gifts by Uma to Nora.

When Uma dies, section 2039 of the Code includes the present value of the remaining annuity payments, to be collected by Nora, in Uma’s gross estate. This amount is reduced by one half, however, because Nora provided half of the consideration furnished to purchase the annuity.

Valuation of the annuity is determined as of the date of Uma’s death. Given Bert’s fraud, one might argue that the fair market value of the annuity was negligible. However, valuation depends on the views of a hypothetical willing buyer and willing seller with reasonable (not perfect) knowledge of relevant facts. Thus, as of Uma’s death, the annuity account may have had a substantial fair market value.

The estate may elect the alternate valuation date under section 2032 of the Code, which would generally value all of the assets in the gross estate as of the date six months after Uma’s death. However, Bert’s fraud was not widely known until a month after the alternate valuation date. A key question would be what a hypothetical willing buyer of the annuity rights would reasonably have known on the applicable valuation date.

The estate may be able to deduct a theft (casualty) loss for Bert’s fraud under section 2054 of the Code.

The establishment of the trust is a completed gift of the income interest by Uma to Pal. The gift is a present interest eligible for the annual exclusion. The fair market value of the gift is the difference between the contribution to the trust and Nora’s remainder interest. The creation of Nora’s remainder is not a gift by Uma to Nora because Nora paid full and adequate consideration to Uma in money. Depending on Pal’s age (in relation to Uma’s age), the trust may be a skip person as to Uma, and the transfer in trust may be a direct skip subject to generation-skipping-transfer tax. Nora is not a skip person as to Uma.

Because Uma can remove the trustee and name herself trustee, she is deemed to have all the powers that the trustee possesses. However, on these facts the trustee’s powers are mere administrative powers that neither prevent completion of the gift nor cause any of the trust assets to be included in Uma’s gross estate.

Uma’s claim against Tittle-Tattle is an asset includible in the gross estate. The fair market value is determined as of the date of death, generally without the benefit of hindsight. Here again, a key question would be what a hypothetical willing buyer of Uma’s claim would reasonably have known on the applicable valuation date. If the alternate valuation date is elected, the claim would likely have a zero value, because by six months after Uma’s death, the claim was revealed to be worthless. Any litigation-related attorney’s fee paid by the estate would likely be deductible under section 2053 of the Code.

Created by: bojack@lclark.edu
Update: 2 Jan 17
Expires: 31 Aug 18