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, these questions and your answers to them will be collected. All answers must be entered in the bluebooks you have been provided (or, for those typing or operating computers, on separate sheets of plain white paper). 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.

References to "the Code" mean the Internal Revenue Code of 1986, as amended.
 
 

Donna owns 100 percent of the outstanding common stock of XYZ, a corporation that operates a highly successful business. It is the only class of XYZ stock outstanding. The value of all of the XYZ stock throughout 1994 is $10,000,000. Unlike many closely held corporations, XYZ pays substantial dividends.

In 1994, Donna establishes an irrevocable inter vivos trust and transfers 20 percent of the XYZ stock to it. Donna's attorney, Leo, is named the trustee. The terms of the trust are that any and all income from the trust is to be paid to Donna's child, Celia, for life. Upon the death of Celia, if Donna has survived Celia, all of the trust income is to be paid to Donna for the rest of her life, with the trust to terminate upon Donna's death and the trust corpus then to be distributed to Celia's child, Gretchen, or to Gretchen's estate. If Donna is already dead when Celia dies, the trust is to terminate upon Celia's death, with the corpus to be distributed to Gretchen or to Gretchen's estate.

The trust instrument gives the trustee the power to accumulate income from the trust, rather than to pay it out currently, in the trustee's absolute discretion; such accumulations are to be paid to Gretchen or her estate, along with rest of the trust corpus, when the trust terminates.

At the same time as she funds the trust, Donna makes an outright gift of 20 percent of the XYZ stock to each of her other two children, Victor and Walt.

As originally drafted, the trust gives Donna the power to remove the trustee for any reason and name a successor trustee, including herself. In late 1995, however, Donna voluntarily relinquishes the power of trustee removal, which she never exercised. (Leo is still the trustee.) The release is effective under applicable local law.

In 1997, Donna dies. She leaves the 40 percent of the XYZ stock that she held in her own name (outside the trust) to Walt. In the year 2000, Celia dies, survived by Gretchen; the trust terminates and Leo distributes the 20 percent block of stock from the trust to Gretchen.

The fortunes of XYZ continue to rise after the trust is set up. If one owned 100 percent of the stock, its value would be $12,000,000 in 1995; $15,000,000 in 1997; and $20,000,000 in the year 2000.

What are the federal estate, gift and generation-skipping-transfer tax consequences -- to Donna, Donna's estate, the trust, Celia's estate, and Gretchen -- 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.

Greg has a nephew, Ned. In 1994, Greg establishes an irrevocable inter vivos trust, Trust No. 1, transferring to it a sizeable stock portfolio. Under the terms of the trust, income is to be paid to Greg annually for life; on Greg's death, the trust is to terminate, and the trust corpus is to be distributed to Ned. In consideration for the establishment of the trust, Ned pays Greg the actuarial value of Ned's remainder interest, based on Greg's life expectancy and the applicable rate then in effect under section 7520 of the Code.

Greg is the owner and beneficiary of a whole-life life insurance policy; Ned is the insured. The policy, issued some years ago, has a substantial cash surrender value.

In 1999, Greg dies, survived by Ned. The trustee distributes the corpus of Trust No. 1 to Ned.

In Greg's will, he establishes another trust, Trust No. 2, to which all of his probate estate is distributed. The trust names as beneficiaries Greg's widow, Wendy, and his daughter, Della. The trust instrument provides that, during Wendy's life, the trustee, a bank, must pay one half of the income from the trust to Wendy and the other half of the income to Della (or, if Della predeceases Wendy, the second half to Della's estate). Upon the death of Wendy, the trust is to terminate and the entire corpus is to be immediately distributed to Della or her estate.

Payments of income are to be made to the beneficiaries quarterly. Trust No. 2 also provides that any undistributed income present in the trust at Wendy's death is to be paid to Della or Della's estate.

Della is named the personal representative (executrix) of Greg's estate. To raise funds to pay death taxes and to provide Trust No. 2 with some liquidity for investments, Della has the estate sell some of Greg's art collection at auction. The auction is run by an art dealer, Zeke, who takes a 40 percent commission on all sales. Zeke pays 60 percent of the auction proceeds to the estate, keeping the other 40 percent.

What are the federal estate, gift and generation-skipping-transfer tax consequences to Greg and to Greg'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.

In 1991, Jackie, a wealthy widow, is diagnosed with a serious illness. After consulting with her lawyer, she decides to take steps to minimize the taxes that will be due upon her death. Prior to this time, Jackie had made no gifts to any individual in any year in excess of $10,000.

In 1992, Jackie makes gifts of rapidly appreciating real estate to each of her four grandchildren (whose parents are alive at the time). The gifts have a fair market value of $300,000 per grandchild.

In 1994, Jackie dies. Among the assets in her substantial estate is a promissory note from her butler, Sergio. The promissory note has an unpaid balance of $50,000 on the date of Jackie's death. Even ignoring his obligation to Jackie, Sergio is insolvent by a large margin immediately before Jackie dies; however, Jackie leaves him a great deal of money in her will (along with his promissory note), so that after the distribution of her estate, he has a positive net worth well in excess of $50,000.

Jackie was the sole life income beneficiary of a trust established by her father, who died in 1980. The trust instrument gave Jackie the power to invade the corpus of the trust during her lifetime for the "support, comfort and well-being" of herself or her brother, Brett. The power could be exercised, however, only if Jackie had first withdrawn all of the corpus from another trust, previously established by her late mother, by exercising an unrestricted, life-long general power of appointment that Jackie had over the mother's trust. Jackie never exercised her power over either trust. Upon her death, the two trusts terminate, and their corpora are distributed, as the terms of the two trusts expressly provide, to Brett.

What are the federal estate, gift and generation-skipping-transfer tax consequences to Jackie and to Jackie'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.