Estate and Gift Taxation

Fall 2010

Bogdanski

FINAL EXAMINATION

(Three hours)

INSTRUCTIONS

This examination consists of three essay questions, each of which will be given equal weight in determining grades. Three hours will be permitted for this examination. At the end of the three hours, you must turn in both this set of questions and your answers to them in the original envelope in which this set came.

All answers must be entered on an approved type of computer disk or on separate sheets of plain white paper (or for those writing answers by hand, in the bluebooks you have been provided). No credit will be given for anything written on this set of questions.

Pay close attention to the final portion, or “call,” of each question. Failure to respond to the matters called for will result in a low score for the question. On the other hand, discussion of matters outside the scope of the call of the question will not receive credit.

Be sure to explain as thoroughly as possible your answers to the questions posed. Your reasoning, discussion, and analysis are often as important as any particular conclusion you reach.

The suggested time limit for each question is one hour. Experience has shown that failure to budget one's time according to this limit can result in a drastic lowering of one's overall grade on this examination.

For purposes of this examination, assume that:

-- all individuals described in the questions are U.S. citizens and U.S. residents;

-- the federal estate and generation-skipping-transfer taxes did not expire in 2010; and

-- the laws relating to gift, estate, and generation-skipping-transfer taxes for transfers made, and decedents dying, in 2009 were made permanent and remained in effect throughout all of the transactions and events described in these questions.

Any references to “the Code” mean the Internal Revenue Code of 1986, as amended.

QUESTION ONE

(One hour)

Hollis and Wren are husband and wife. In year 1, Hollis sets up an irrevocable trust, transferring to it shares of publicly traded stock that he owns, with a fair market value of $1,500,000. The terms of the trust require that the trustee distribute half of the trust’s income to Wren, and the other half to the couple’s adult child, Sandy, or Sandy’s estate, every year so long as Wren is alive. At Wren’s death, the trust is to terminate and the entire corpus is to be distributed to Sandy or Sandy’s estate. The trust documents give Wren the power, in her sole discretion, to appoint any or all of the corpus of the trust to Sandy or Sandy’s estate.

Also in year 1, Hollis forms a limited liability company, Lilco, transferring to Lilco Hollis’s grand Hawaii vacation home, known as Beachacre. Shortly after Lilco is formed, Hollis transfers a 10 percent non-managing membership interest in Lilco to Sandy. Sandy pays Hollis $10,000 cash for this interest. Under the terms of Lilco’s operating agreement, members are not allowed to sell or assign their interests in Lilco except to family members. After Lilco is formed, Hollis and Wren continue to use Beachacre, which appreciates in value, for recreational purposes. Sandy, who has never liked to travel, does not use the home.

In year 2, Hollis buys a life insurance policy on his own life. The policy is a term life insurance policy with no cash surrender value. The premium is $15,000 a year, and the death benefit is $3,000,000. Hollis makes Sandy the beneficiary of the policy. A few months after the policy is issued to Hollis, and after meeting with his attorney, Hollis assigns the policy to Sandy. Hollis continues to pay the annual premiums on the policy. In year 3, Sandy changes the beneficiary on the policy to Sandy’s cousin, Curt.

Hollis dies in year 4, survived by Wren, Sandy, and Curt. The life insurance company pays the $3,000,000 death benefit to Curt. In his will, Hollis leaves all of his assets to Wren. Ten months after Hollis dies, Wren appoints the entire corpus of the trust that Hollis established, now worth $2,000,000, to Sandy, and the trust terminates.

What are the federal gift, estate, and generation-skipping-transfer tax consequences – to Hollis, Hollis’s estate, Wren, and Sandy – of each of the transactions and events just discussed, with and without all available tax elections? Be sure to discuss the amount and timing of each item.

Explain.

(End of Question 1)

QUESTION TWO

(One hour)

In year 1, Doris, a single woman, establishes an irrevocable trust, transferring to it her shares of stock of Corp, a closely held operating company. The trust is known as the Family Trust. The terms of the trust are that the income from the trust assets is to be distributed annually to Doris’s 25-year-old daughter, Abby, for 15 years; at the end of the 15 years, the trust is to terminate and the trust assets are to be distributed to Abby’s son, Gary, or Gary’s estate. Doris retains the right to direct that the trustee (her sister Shawn) accumulate any or all of the income of the trust until Abby reaches age 35, at which time any income accumulated in the trust is to be paid to Abby.

At the time the Family Trust is established, Doris’s holdings in Corp (all of which she transfers to the Family Trust) consist of 40 percent of the outstanding stock of Corp. The other 60 percent is held by Doris’s brother, Bart. Valued in the aggregate, all of the outstanding stock of Corp has a fair market value throughout year 1 of $100,000,000. Corp pays a dividend to its shareholders every year.

Doris dies in year 5, survived by Abby, Bart, Shawn, and Gary. Prior to her death, Doris does not exercise her power to have the income of the Family Trust accumulated; all of the income is in fact paid to Abby every year. Valued in the aggregate, all of the outstanding stock of Corp has a fair market value on the date of Doris’s death of $200,000,000. Shortly after Doris dies, Corp encounters a temporary run of bad fortune, and the value of its stock drops precipitously for several months.

In Doris’s will, she establishes a trust (the Charity Trust) for the benefit of the church that she attends, named Chapel. Under the terms of the Charity Trust, $8,000,000 in cash and liquid assets is contributed to the trust, with all of the income from the trust to be distributed to Chapel annually for 20 years. At the end of the 20 years, the corpus of the Charity Trust is to be distributed to Gary or Gary’s estate.

In year 16, when Abby and Gary are still alive, the Family Trust terminates in accordance with its terms, and the 40 percent block of Corp stock is distributed to Gary. Valued in the aggregate, all of the outstanding stock of Corp has a fair market value on the date that the Family Trust terminates of $300,000,000. Bart continues to own 60 percent of the outstanding stock of Corp.

What are the federal gift, estate, and generation-skipping-transfer tax consequences to Doris, Doris’s estate, Abby, Gary, and Shawn of each of the transactions and events just discussed, with and without all available tax elections? Be sure to discuss the amount and timing of each item.

Discuss.

(End of Question 2)

QUESTION THREE

(One hour)

Hannah and her younger sister, Rita, live together in a residence that they own as equal joint tenants with right of survivorship. Hannah and Rita purchased the house together from an unrelated third party several years ago, shortly after Hannah was divorced from her husband, Xavier, and Rita’s husband died. Neither sister has remarried. Hannah paid one quarter of the purchase price for the house, and Rita paid the other three quarters; both women had gotten the purchase money as bequests under the will of their late father, Fernando. Both sisters have substantial assets.

Hannah has a power of appointment over the corpus and income of a trust that had been created by Fernando. Hannah’s power gives her the right to cause income or corpus from the trust to be distributed to Hannah’s creditors. In default of any exercise of Hannah’s power, the income from the stock is paid annually to Rita for life, with the remainder to go to Rita’s daughter, Nell. Hannah never exercises her power, and after several years of trust operations, with the income from the trust being distributed to Rita, Hannah releases the power.

Hannah has been battling a competitor, Kay, in her business. Hannah is the plaintiff in a pending lawsuit against Kay, in which Hannah is seeking $1,000,000 in monetary damages for trademark infringement, unfair competition, and other alleged wrongs. Hannah is also involved in a protracted dispute with Xavier, in which Xavier claims that Hannah defrauded him in the negotiations surrounding their divorce settlement. Xavier is seeking $2,000,000 in monetary damages from Hannah.

About a year after she releases the power of appointment, Hannah unexpectedly dies, survived by Rita. Rita is named the personal representative (executor) of Hannah’s estate. Hannah leaves her entire estate to Rita. The estate pays Hannah’s funeral expenses, a sizable personal representative’s fee to Rita, and attorney’s fees that Hannah and the estate incurred in the disputes with Kay and Xavier. Eighteen months after Hannah’s death, the estate settles its case against Kay by accepting from Kay $100,000 in damages; shortly thereafter, the estate settles its case with Xavier by paying Xavier $1,200,000 in damages.

What are the federal gift, estate, and generation-skipping-transfer tax consequences to Hannah and Hannah’s estate of each of the transactions and events just discussed, with and without all available tax elections? Be sure to discuss the amount and timing of each item.

Discuss.

(End of examination)

Created by: bojack@lclark.edu

Update: 13 Jan 11

Expires: 31 Aug 11