Estate and Gift Taxation

Fall 2016

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)

One day, Dana, who has been divorced for many years, establishes three irrevocable inter vivos trusts: Trust A, Trust B, and Trust C. Dana names Dana’s attorney as the trustee of all of the trusts. Dana transfers income-producing assets with a fair market value of $5,000,000 to fund each trust, for total transfers of $15,000,000.

Under Trust A, the trustee is to pay Dana or Dana’s estate all of the income of the trust annually for three years. At the end of the three years, the trust is to terminate and the corpus is to be distributed to Dana’s child, Zia. Dana retains the power, so long as the trust is in existence, to substitute Dana’s mother, Michelle, in place of Zia, as the beneficiary to whom the corpus is to be distributed when the trust terminates. Dana never exercises or releases this power.

Under Trust B, Dana is to receive a distribution of $50,000 a year for the rest of Dana’s life. The trust instrument states that at Dana’s death, the trust is to terminate and the corpus is to be distributed to Zia. Zia is given the right to withdraw up to $14,000 from the corpus of Trust B within 30 days of the establishment of Trust B. Zia receives notice of this withdrawal right, but she does not exercise it.

Under Trust C, Zia is to receive an annual distribution for the rest of Zia’s life, and a tax-exempt nonprofit organization is to receive the trust corpus when Zia dies. The amount that Zia is to receive each year is 5 percent of the fair market value of the trust corpus, such value to be determined each year just before the distribution is made.

Dana dies two years after establishing the trusts. Each trust corpus has a value of $5,200,000 at the time of Dana’s death. Dana’s will leaves her entire estate to Zia, who survives Dana. The trustee administers the three trusts according to their terms.

What are the federal gift, estate, and GST tax consequences to Dana, Dana’s estate, and Zia 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)

Arthur owns all of the stock of a corporation, XYZ. The stock has a fair market value of $2,000,000. XYZ does not pay dividends to its shareholders; instead, it reinvests its profits in growth and expansion. One day, Arthur makes an outright gift of one quarter of the stock to each of his three adult children: Rhea, Simon, and Tara. Arthur retains the other one quarter of the stock.

As part of the gift transactions, Rhea, Simon, and Tara sign a binding agreement that forbids them from transferring the XYZ stock during their lifetimes to anyone without Arthur’s consent. Rhea, Simon, and Tara also agree that at death, they will transfer their shares only to members of their families. (Arthur does not want any of the stock to be held by nonfamily members.)

The following year, Arthur dies, leaving all of his assets, including the one-quarter block of XYZ stock that he retained, to a testamentary trust. After payment of Arthur’s outstanding debts and the estate’s administrative expenses, the assets received by the trust have an aggregate fair market value of $8,000,000.

The testamentary trust’s terms provide that Arthur’s surviving spouse, Basia, is to receive all of the income from the trust for the rest of Basia’s life. Income distributions to Basia are to be made annually on March 1. The trust instrument provides that when Basia dies, any income received by the trust between the immediately preceding March 1 and the time of Basia’s death is to be added to the trust corpus. Upon Basia’s death, the trust is to terminate and the entire corpus is to be distributed in equal shares to Rhea, Simon, and Tara, or their respective estates. During Basia’s lifetime, however, the trust instrument gives Basia the power to withdraw any and all of the corpus to the extent necessary for Basia’s “support in reasonable comfort.” Basia never exercises or releases this invasion power.

Life goes on without Arthur. Three years after his death, Basia remarries, to a man named Evan. One year after Basia and Evan’s wedding, Tara dies, survived by Tara’s child, Gabe. Gabe is Tara’s sole heir.

Eight years after remarrying, Basia dies, survived by Evan, Rhea, Simon, and Gabe. Upon Basia’s death, Arthur’s testamentary trust terminates, and the trustee distributes the trust assets to Rhea, Simon, and Gabe. Basia leaves one third of her own assets outright to Evan, and the other two thirds outright in equal shares to Rhea, Simon, and Gabe. The value of Basia’s probate estate (which does not include the assets remaining in the trust established by Arthur) is about $9,000,000.

What are the federal gift, estate, and GST tax consequences to Arthur, Arthur’s estate, Tara’s estate, Basia’s estate, and Evan 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)

Uma, wealthy and never married, makes a deal with her niece, Nora: The two of them will together buy a joint life annuity from a financial firm, Miraco. Miraco, run by a prominent wealth advisor named Bert, has been paying incredible returns to investors for years.

Miraco sells Uma and Nora an annuity that is to pay $50,000 a year so long as either of them is alive. The entire annual payment is to be made to Uma for the rest of Uma’s life, and upon Uma’s death, if Nora survives Uma, the entire annual payment is to be made to Nora for the rest of Nora’s life. No one has the right to change the terms or beneficiaries of the annuity policy. Uma and Nora each contribute half of the single cash payment that makes up the purchase price of (that is, the “premium” for) the policy. Beginning the following year, Miraco makes the $50,000 annuity payments to Uma, right on time each year.

Pleased with this arrangement, Uma and Nora enter into another contract with each other. Uma agrees to put income-producing assets with a fair market value of $1,000,000 into an irrevocable trust. The trust is to pay all of its income to Uma’s friend Pal every year for the rest of Pal’s life. Upon Pal’s death, the trust is to terminate and the corpus is to be distributed to Nora or Nora’s estate. The trustee of the trust, Jake, is given discretion to choose investments for the trust and allocate stock dividends between income and corpus. Uma retains the rights to remove Jake as trustee at any time and to name a successor trustee, including Uma herself. As part of the agreement with Uma, at the time the trust is established, Nora pays Uma cash in the amount of $616,350. This is the value of Nora’s remainder as calculated using the actuarial tables published in the regulations under section 2031 of the Code.

Years later, Uma’s life is disrupted when an internet “news” organization, Tittle-Tattle.com, publishes several stories that damage Uma’s reputation. Uma sues Tittle-Tattle.com for $5,000,000 compensatory and punitive damages for libel. Based on a cursory investigation, Uma’s attorney in the lawsuit believes that Uma has a strong case.

Uma dies while the lawsuit is still pending. Under applicable state tort law, libel claims survive a claimant’s death. A few weeks after Uma’s death, Miraco makes a scheduled annuity payment to Nora, who survives Uma.

Five months later, the executor of Uma’s estate undertakes an exhaustive search of Uma’s belongings and computer, looking for some lost documents. The search reveals, much to the family’s surprise, that the damaging statements made by Tittle-Tattle.com were in fact true, and therefore Uma’s lawsuit against Tittle-Tattle.com is without merit. Things get even worse two months thereafter, when the public suddenly learns that unbeknownst to all but a few insiders, Bert was a con man operating a “Ponzi” scheme for many years through Miraco. Miraco declares bankruptcy, and Nora is notified that no further payments will be made on the annuity policy. Bert goes to prison. As Bert has no assets that anyone can locate, the victims of his fraud, including Nora, are left without a remedy.

What are the federal gift, estate, and GST tax consequences to Uma and Uma’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: 2 Jan 17

Expires: 31 Aug 18