Estate and Gift Taxation

Fall 2014

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 this set of essay questions in the original envelope in which this set came. If you are using a computer, you must submit your answers using SofTest. If you are writing answers by hand, you must write them all in the bluebook(s) you have been provided, and return the bluebook(s) along with this set of questions in the envelope.

 

            No credit will be given for anything written on this set of questions. Only your electronic answer file or bluebook(s) will be graded.

 

            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, unless otherwise instructed, assume that all taxpayers named in the questions are individuals, ­U.S. citizens, and U.S. residents. Any references to “the Code” mean the Internal Revenue Code of 1986, as amended.


 

QUESTION ONE

(One hour)

 

            David was divorced several years ago from his spouse, Xena. The divorce was amicable. David and Xena, now both single, are tenants in common in Blackacre, a parcel of real estate that they originally acquired as community property. Their co-ownership was changed to a tenancy in common when their divorce became final. Under the divorce decree, David or David’s estate must pay $80,000 a year to Xena or Xena’s estate as a property settlement in each of the years 2012 through 2016. Neither David nor Xena remarries.

 

            In 2013, David establishes an irrevocable trust, naming his son Sonny as trustee. David transfers marketable securities with a fair market value of $6,000,000 to the trust. Un­der the terms of the trust, all of the income from the trust corpus is to be accumulated for 10 years. At the end of the 10-year period, the trust is to terminate, and all of the accumulated income and corpus is to be paid to David’s grandniece, Gina, or Gina’s estate. David’s niece, Nancy, was Gina’s mother. Nancy died in 2010.

 

            The documents funding the trust grant Gina the right to withdraw $14,000 from the trust corpus within 15 days of its establishment. In keeping with David’s wishes, Gina does not exercise this right.

 

            Also in the trust documents, David retains the right to require Sonny to distribute income from the trust corpus to David’s granddaughter, Olivia, but only if Olivia successfully earns her business school degree. David may exercise this power only during David’s lifetime, and only with the consent of Gina. At the time the trust is established, Olivia has only one year of study left before she can graduate, but Olivia has taken time off from school to think about her future.

 

            David dies in 2015, survived by Xena, Sonny, Gina, and Olivia. At the time of David’s death, Olivia has not earned her business school degree, and so David’s power over the trust income lapses. At David’s death, the corpus of the trust has a fair market value of $7,200,000, and Blackacre, which is still co-owned by David and Xena immediately before David dies, has a fair market value of $3,000,000.

 

            What are the federal gift, estate, and GST tax consequences to David and David’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 Question 1)

QUESTION TWO

(One hour)

 

            Hu and Winona are childhood sweethearts who marry each other at an early age and remain married to each other until Hu’s death in 2014. Hu’s will leaves a stock portfolio valued at $6,000,000 to Winona, but only on the conditions that (a) Winona survives him by more than six months, and (b) Winona and Hu do not both die as the result of a common disaster. Hu also leaves $2,170,000 to each of the couple’s two children, Kami and Linus. Hu never made a taxable gift in his lifetime.

 

            In 2015, Winona transfers Redacre, a large strip of undeveloped waterfront real estate with a fair market value of $6,000,000, to a newly formed limited liability company ­named Flipco. Winona makes herself the managing member of Flipco; Kami and Linus are named as the non-managing members. Kami and Linus each transfer $30,000 cash to Flipco in its formation. Winona’s membership interest entitles Winona to 60 percent of the capital and profits of Flipco; Kami and Linus are each entitled to 20 percent of Flipco’s capital and profits. Winona, Kami, and Linus sign a “buy-sell” agreement that prohibits any sale of their interests in Flipco. Winona performs substantial investment management services for Flipco, but is not paid any compensation for the services.

 

            In 2016, Winona remarries. Her new husband, Ted, has a net worth of only about $100,000 at the time of the marriage, and he has previously made no taxable gifts. Winona borrows $200,000 from Flipco to help her purchase a recreational vehicle for her and Ted to use on a honeymoon trip and other vacations.

 

            Ted dies in 2019, survived by Winona, Kami, and Linus. Ted leaves his estate, valued at $200,000, to Winona. Ted never made a taxable gift in his lifetime.

 

            Winona dies in 2020. Her will leaves her assets, after payment of debts and expenses, one half to Kami and one half to Linus. At the time of Winona’s death, Redacre, still owned by Flipco, has a fair market value of $7,000,000. In addition to her interest in Flipco, Winona’s probate estate includes other assets with a fair market value on the date of her death of $3,500,000.

 

            At Winona’s death, Winona still owes Flipco $180,000 on the debt she incurred to buy the recreational vehicle. Winona’s estate pays off the debt with cash.

 

            What are the federal gift, estate, and GST tax consequences to Hu’s estate, Ted’s estate, Winona, and Winona’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.

 

            Explain.

 

(End of Question 2)

QUESTION THREE

(One hour)

 

            Sofia has never been married or had any children. Sofia and her younger brother Barry purchase Greenacre, a commercial office building, taking title to the property as joint tenants with right of survivorship. The purchase price is $1,000,000. Sofia contributes $600,000 of the purchase price; Barry contributes the other $400,000. Each is a one-half joint tenant.

 

            Sofia establishes an irrevocable trust, naming her co-worker, Casey, as trustee. Sofia transfers assets with a fair market value of $7,500,000 to the trust. Under the terms of the trust, all of its income is to be paid annually to Barry for the rest of his life; upon Barry’s death, the trust is to terminate, and all of the corpus is to be distributed to Barry’s estate. The trust documents give Casey the power in her complete discretion to appoint any of the income or corpus of the trust to Sofia’s mother, Mai. Casey does not feel com­fortable exercising this power, and she never does so. Two years after the trust is established, Casey and Sofia execute documents that terminate Casey’s power of appointment under local law.

 

            As is her annual custom, Sofia makes year-end gifts to Barry’s daughters, Iris and Jessica. Sofia writes checks for $20,000 to each of Iris and Jessica, and places them in the U.S. mail, addressed to each donee, on December 20.

 

            Sofia dies, survived by Barry, Casey, Iris, Jessica, and Mai. Sofia’s will leaves assets with a fair market value of $5,000,000 to Mai, and the remainder of Sofia’s estate to Barry. At the time of Sofia’s death, Greenacre has a fair market value of $1,500,000. The corpus of the trust has a fair market value at Sofia’s death of $8,000,000.

 

            Sofia’s estate files her final state and federal income tax returns and pays the income taxes owed for Sofia’s final taxable year. The estate is also subject to a state death tax, which the estate pays. As specified in Sofia’s will, all the taxes are paid out of Barry’s residual share. Barry eventually receives assets with a fair market value of $2,000,000 in distributions from Sofia’s estate.

 

            What are the federal gift, estate, and GST tax consequences to Sofia, Casey, and Sofia’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:  21 Jan 15

Expires:  31 Aug 16