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 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.

Any references to "the Code" mean the Internal Revenue Code of 1986, as amended. For purposes of this examination, assume that at all times, the interest rate described in section 7520(a) of the Code is 7.0 percent per annum. Unless otherwise expressly instructed, assume that all individuals described in the questions are U.S. citizens and U.S. residents.
 
 

Myra, a 60-year-old widow, establishes two trusts, Trust No. 1 and Trust No. 2, in 1998. To Trust No. 1, which by its terms is irrevocable, Myra contributes her stock market portfolio, with a fair market value on the date of the transfer of $950,000. Under the terms of Trust No. 1, the trustee, a bank, is to pay all of the income of the trust to Myra annually for the rest of her life. Upon her death, the trust is to terminate and the entire corpus is to be distributed to her granddaughter, Gwen, who at the time Trust No. 1 is created is 16 years old. The trustee is given the power, during Myra's life, to invade corpus "for the support or benefit" of Gwen.

To Trust No. 2, Myra contributes her personal residence, with a fair market value at the time of the transfer of $500,000. Under the terms of Trust No. 2, Myra is permitted to live in the residence for 15 years. At the end of the 15 years, the trust is to terminate and the house is to be distributed to Sam, who is Myra's son and Gwen's father. However, the trust instrument provides that Myra has the option following the trust's termination to rent the home from Sam for its fair rental value. Myra also has the right in her complete discretion to change the remainder beneficiary of Trust No. 2 at any time during the 15-year term; otherwise, however, the trust is irrevocable.

In 2001, three years after the trusts are created and funded, Myra renounces her right (which she never exercised) to change the remainder beneficiary of Trust No. 2. At the time, the residence has a fair market value of $550,000; Myra is 63 years old; and Trust No. 2 has 12 years left to run.

In 2003, Myra dies, survived by Gwen and Sam. Pursuant to their terms, the trusts terminate. The stock portfolio, with a fair market value of $1,800,000, is distributed to Gwen. (The trustee of Trust No. 1 never exercised its power to invade corpus.) The house, with a fair market value of $625,000, is distributed to Sam.

What are the federal gift, estate, and generation-skipping-transfer tax consequences -- to Myra, Sam, Gwen, the trustee, and Myra'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.

Hank and Wendy are husband and wife. Hank has two children, Ken and Karen, from a prior marriage.

In 1998, Hank establishes an irrevocable trust, transferring to it shares of stock. Hank's brother, Bob, is named the trustee. The trust provides that all of the income from the trust is to be paid to Wendy every quarter for the rest of her life. Upon her death, if Hank is still alive, the income is to be paid to Hank for the rest of his life, with the remainder to Hank's estate. Upon Wendy's death, if Hank is not still alive, the trust is to terminate and the corpus is to be distributed to Ken and Karen (or their estates) in equal shares. Bob is authorized to invade the corpus of the trust at any time for the "health, education, maintenance, or support" of Wendy. Prior to 1998, Hank and Wendy have already used up their federal wealth transfer tax unified credit.

The shares that Hank transfers to the trust are 1,000,000 shares of Zapco, a high-technology company of which Hank was a founder. At the time the trust is created, Zapco shares are trading at $5 per share in a public market. In a typical month, about 100,000 shares of Zapco change hands.

In 2002, Hank dies, survived by Wendy, Ken and Karen. In 2004, Wendy dies, survived by Ken and Karen; at that point, the trust terminates and the shares are distributed equally to Ken and Karen. Throughout the years 2002 to 2004, Zapco shares trade on the open market at $6 per share.

What are the federal gift, estate, and generation-skipping-transfer tax consequences -- to to Hank, Hank's estate, Wendy, Wendy's estate, Bob, Ken, and Karen -- 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.

Diane, an unmarried woman, dies in 1999 at the age of 70. Her 58-year-old sister, Sarah, owns a policy of whole-life life insurance on Diane's life; Diane had given the policy to Sarah on Sarah's birthday in 1995. The beneficiary of the policy is Diane's estate. Pursuant to Diane's will, the proceeds of the policy on Diane's death, $1,000,000, are paid to Sarah, her sole beneficiary.

Sarah is also the personal representative (i.e., the executrix) of Diane's estate. Among the many expenses that Sarah pays out of the estate's funds is the $100,000 fee that an auctioneer charges to sell off Diane's extensive collection of antique china and glassware. "I hate that musty old stuff," Sarah confides to the auctioneer. Payment of the expense, a reasonable amount under the circumstances, is approved by the local probate court in an uncontested proceeding.

In her will, Diane establishes a testamentary trust, funded by $2,000,000 worth (fair market value) of commercial real estate and marketable securities. By the terms of the trust, Sarah is to receive, each year for the rest of her life, a sum equal to 5 percent of the then-fair market value of the trust corpus, such value to be determined annually by independent expert appraisals. On Sarah's death, the remaining corpus is to be distributed in equal shares to a local community college and a church.

Eleven months after Diane's death, a month before Sarah is scheduled to receive her first payment from the trust, Sarah, now age 59, signs an irrevocable instrument disclaiming her interest in the trust. The disclaimer is effective under local law. As a result, the trust terminates and the corpus is distributed in equal shares to the college and church.

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

Created by: bojack@lclark.edu
Update: 12 Nov 02
Expires: 31 Aug 03