REG 5 - Estate, Trusts & Gift Taxes

Question 1

Trust

Answer 1

An artificial entity, created by a Trustor (Grantor or Settlor), who places property in custody of one party, the Trustee (control-ex:attorney,accountant,advisor), for the benefit of another, the beneficiary.

• Trusts are typically established for the purpose of benefiting specific individuals or charities without giving them current control of the principal (corpus) of the trust.
  
  • Merger Doctrine - the Beneficiary CANNOT be the Trustee at the same time.

Question 2

Trust & Estates (1041)

Answer 2

Two artificial entities that file tax returns, they are Trusts & Estates. Form 1041, the Fiduciary Income Tax Return must be filed on an annual basis for both entities. The beneficiaries must also pay taxes when the income is distributed to them. Due on 4/15, with 5 month extension.

Question 3

Operation of Trusts & Estates

Income Beneficiaries

vs.

Remainder Beneficiaries

Answer 3

Trust are typically established for the purpose of benefiting specific individuals or charities without giving them current control of the principal (Corpus) of the trust. There are two types of beneficiaries:

1. Income Beneficiaries - who gets the income earned by the estate
2. Remainderman Beneficiares - who gets the corpus of the estate

Question 4

Operation of Trusts & Estates

Income Items

vs.

Remainder Items

Answer 4

Income Beneficiaries - Receives earnings of trusts (but NOT net capital gains). Mostly income Statement items.

• Rental Income/Expense
• Interest/Dividend Income
• Cash Dividends
• Mortgage Interest Payments
• Property Taxes
• Insurance Premiums
• Municipial Bond Interests (TESTED)

Remainder Beneficiaries - receives principal (corpus) of trusts (Including capital gains allocable to corpus). Mostly Balance Sheet Items.

• Original Property
• Bonds (plus accrued interests)
• Mortgage Principle Payments
• Proceeds from the Sale of Corpus
• Capital Gains/Losses (related to sale of corpus) (TESTED)
• Stock Dividends/Splits

Question 5

Requirements of a Valid Express Trusts?

(BRATS)

Answer 5

In order to be a Valid “Express” Trust, it must satisfy five conditions (BRATS):

• Beneficiary - the trust must identify who will receive the benefits. (Income & Remainderman)
• Reasonable Intent - there must be a valid purpose for the existance, is usually the separation of control of the assets from benefits.
• Assets - the trust must contain some corpus or property
• Trustee - a trustee must be in place to exercise control over the asets in the trust. (Need not be named in any legal document; may be selected by the courts)
• Specified Life - a trust must have an identifiable termination point expressed in years OR the length of a life in being plus 21 years.
  
  • Private trust = lives until purpose is satisfied
  • Charity Trust = lives forever

Question 6

Trusts are Irrevocable, Unless: (5)

Answer 6

Trusts are generally Irrevocable unlesss:

1. Reserve rights “specifically stated”
2. End of Term
3. Occurence of an Event (death)
4. Purpose Accomplished
5. Consent of Trustor, & ALL beneficiaries, remaindermen & courts.

Question 7

Distribution of Trust Assets

Per Capita

vs.

Per Stirpes

Answer 7

When a trust allocates income/remainder to offspring, the creator must decide if the allocation will be per capita or per stirpes.

• Per Capita - allocation is equal to each person (each beneficiary). Example: If there are 3 children, allocation is a third each. If one dies & has two kids, the new allocation becomes a fourth each.
• Per Stirpes - allocation is equal at the level of the first generation (each group). Example: If there are 3 children, allocation is a third each. If one dies & has three kids, the new allocation for that group is a sixth each.

Question 8

Grantor Trust

Answer 8

Grantor (revocable) Trust - This a trust whose creator (grantor) reserves the right to withdraw assets at any time.

• Tax codes ignores this trusts, NO 1041, as if trust did NOT exist.
• The income is taxed on the Grantor’s Form 1040

Question 9

Simple Trust

Answer 9

Simple Trust - One that makes annual distributions EXACTLY equal to DNI to taxpaying beneficiaries each year.

• Form 1041 is prepared each year
• Taxable income is usually reduced to $0 by distribution
• Distributions may exceed DNI
  
  • Only amount up to DNI is included in beneficiary’s gross income

Question 10

Complex Trusts

Answer 10

Complex Trusts - Any trusts that fails to meet the criteria for a simple trust & satisfies one of these three conditions:

• Distribution less than total DNI, some is retained within the trust
• Amounts are permanently set aside for charity
• Often pays taxes on UNDistributed Income.

Question 11

Special Types of Trusts:

Inter Vivos Trust

Testamentary Trust

Resulting Trust

Cy Pres Trust

Totten or Tentative Trust

Answer 11

Inter Vivos Trust - created between living people. Assets transferred into a trust by a living person will not be part of the estate of that person upon death.

Testamentary Trust - created through the execution of a will.

Resulting Trust - created by the courts due to the failure of an express trust & intended to achieve a purpose that the creator of the express trust might have chosen.

• Example: Trust created for daugther to go to school, but dies before finishing. Courts will create a new trust to benefit the daughter’s infant son.

Cy Pres Trust - established due to the fialure of a charitable trust, & designed to achieve a similar goal.

Totten or Tentative Trust - created when settlor opens a bank account in his own name “as trustee” for anohter. May be revoked by the settlor by withdrawing the funds from the account. Once settlor dies, the trust is irrevocable & beneficiary dies before the settlor, the trust is terminated.

Question 12

Fiduciary Income Tax Return (1041) - Filing Requirements

Trusts vs. Estates

(TESTED)

Answer 12

Fiduciary Income Tax Return (1041) - Filled annually by estates & trusts to report income earned by the entity.

Trusts:

• Required to File if:
  
  • Simple Trust has >$300of gross income
  • Complex Trust has >$100of gross income
• Calendar Year
• Due 4/15, with an available 5 month extention
• Quarterly Estimate Payments are Required
• Personal Exemptions:
  
  • Simple - $300
  • Complex - $100

Estates:

• Required to file if Estate has >$600 of gross income
• Calendar OR Fiscal, usually starting on the deceased’s date of death
• Due 3.5 months after the close of the reporting year
• Quarterly Estimate Payments
  
  • NOT required during the first two years, but are required thereafter
• Personal Exemptions - $600

Question 13

Calculation of Income for Fiduciary Income Tax Return (1041)

(for Estates & Trust)

Answer 13

+ Gross Income (same as Individual)

• Interests, Divs, Rental Inc, Cap Gains
• Deductions (same as individuals except 3)
• Trustee Mgmt Fees (on % of taxable income)
  
  • Example: Muni Inc % is not taxable
• Charity (100% deductible)
• Income Distribution Deduction (DNI paid out)
  
  • NOTE: Amount is usually given in prob
• Personal Exemptions (NO Standard Deductions)
• Estates = $600
• Simple Trusts = $300
• Complex Trusts = $100

= Taxable Income

Question 14

Estates

Answer 14

Estates are created at the time of a person’s death to temporary hold the property of the decedent until it can be distributed to their heirs. The executor is responsible for filing the income tax return. Can die with or without a will.

• Intestate - when someone dies without a written will.
• Testate - when someone dies with a will.

Question 15

Distributable Net Income (DNI)

(TESTED)

Answer 15

Distributable Net Income - The maximum amount of distribution that can be taxed to beneficiaries as income. Any amount distributed greater than DNI is considered distribution of principal. (Payoutable profits)

Calculation of DNI:

+ Gross Income (same as indiv except:)

• ADD Muni Bond Interest
• SUBTRACT or REMOVE Capital Gains

- Deductions (same as individual exept:)

• Trustee Mgmt Fees (on % of taxable income only)
  
  • ​”Attributable to Interest/Income”
• Charity (100%)

= DNI (Maximum amount that’s taxable)

Question 16

Gift Tax Return

(Form 709)

Answer 16

A tax return required to be filed by the giver, to report gifts given during the year in excess of the annual exclusion. An individual will not have to pay gifts until gifts amount surpass the Lifetime Exclusion (Information Return only until Lifetime Exclusion is reached).

• Annual Exclusion:
  
  • $14,000 for single
  • $28,000 for MFJ
• Due by April 15
• Lifetime Exclusion = $5,340,00 @ 40% (2015)

NOTE: Gifts & Inheritances are NOT taxable to the beneficiary’s Individual return.

Question 17

Gift Tax Return (709)

Calculation of Taxable Gifts

Answer 17

+ Gross Gifts

• Cash, Property, Loan, Irrevocable Trust
  
  • NOT Gifts:
    
    • _​_Transfers to spouse
    • Charity
    • Political
    • Medical/Tuition paid directly

- Exclusions

• Support to Minors,
• Marital Deductions (marital gifts or transfers)
• Education & Medical (Paid DIRECTLY to school/hospital)
• $14K Gift Exclusion

= Taxable Gifts (Form 709)

Question 18

Gift Exclusions (4)

Answer 18

The following are automatically excluded from the definition of gifts:

1. Transfer to spouses (no limit on amount)
2. Transfers to qualified Charitable Organizations (no limits)
3. Political contributions to organizations
4. Education/Medical payments directly to the organization.

Question 19

Gift Tax

Three Types of Transfers

Answer 19

Present Interest Gift - a gift of property that is immediately available to the gift beneficiary.

• $14K Exclusion - “Start Enjoyment NOW”

Future Interest Gift - a gift that must be reported regardless of size at present value of the future interest. Does NOT qualify for the $14K exclusion.

• Any gift in which amount is not immediately available to gift beneficiary.

No Interest Gift - a future interest that is revocable by the donor at any time until the property transfers. This gift is NOT reported, & wealth is still considered a party of the taxpayer’s estate as long as they have the right to revoke the transfer.

Question 20

Lifetime Exclusion

Answer 20

A credit that reduces gift & estate taxes that, in its entirely, is equal to 40% of a certain amount ($5.34M in 2014) applied to gifts & the estate such that the specified amount is essentially nontaxable.

Question 21

Alternate Valuation Date (AVD)

Answer 21

A date six months after a decedent’s death that assets can be valued at, if they are not yet distributed & if selecting the AVD, as opposed to valuing assets as of the date of death. The AVD can be used if it will reduce the value of the estate & the amount of estate tax due.

Question 22

Income in Respect of Decedent (IRD)

Answer 22

Collections of amounts earned by & due to the decedent as of the date of death, such as unpaid salary, that is treated as income to the estate & to the recipient (the beneficiary), who will declare it as IRD.

Question 23

Estate Tax

(Form 706)

Answer 23

An estate tax return (Form 706) must be filed on behalf of anyone who, at the time of death, had a gross estate exceeding the lifetime exclusion ($5.340M). The due date of the return is exactly 9 months after the date of death.

• Filing within 9 months of date of death
• Filing required when Gross Estate exceeds Lifetime Exclusion.
  
  • But actual tax only owed if TAXABLE estate exceeds exclusion of $5.430M

Question 24

Estate Tax (706)

Tax Due Calculation

Answer 24

+ Taxable Gifts over the years (Form 709)

+ Taxable Estate (Form 706) (Gross Estate - Deductions)

= Total Taxable Transfer

x Tax Rate

= Tentative Tax Liability

• Unified Credit (Lifetime Exclusion * 40%)
• Other Credits (Foreign, State Death tax)
• Prepayments

= Tax Due (706 due 9 mo’s after death of decedent)

Question 25

Estate Tax (706)

Gross Estate

Answer 25

+ All Assets (Cash & Property)

+ All gifts reported gift tax returns (709)

+ IRD (receivables/money coming at a later time)

+ Life Insurance Proceeds

+ Revocable Trust

+ 1/2 of property w/ spouse

= Gross Estate ( Value @ Death or AVD-6 mo’s)

Due 9 months after the decenden’s death.

Question 26

Estate Tax

Allowable Deductions (7)

Answer 26

1. State Death Tax Deduction - includes taxes actually paid & claimed as a deduction.
2. Marital Deduction - Anything transferred to the decedent’s surviving spouse.
3. Charitable Deduction - All contributions authorized by the decedent in their will.
4. Funeral Expenses
5. Casualty & Theft Loss - Losses during the estate administration.
6. Administrative Expenses - Costs incurred in settlement of the estate.
7. Liabilities of the Estate - All debts existing at the time of death with exception of the estate tax liability itself.

Question 27

Estate Tax

Credits (3)

Answer 27

Once the taxable estate is determined, the tentative tax is computed based on the appropriate tax atables. This tentative tax is then reduced by various credits:

• Foreign Tax Credit - Taxes paid on property in other countries to the extent the property has been taxed twice.
• Unified Credit - A credit that is large enough to eliminate tax on an estate equal to lifetime exclusion.
• State Death Tax Credit - Payments for State estate, inheritance, legacy, or succession taxes.

Question 28

Portability

Answer 28

Allows for a surviving spouse to apply the decedent’s unused liftime exclusion, in addition to the remainder of the surviving spouse’s lifetime exclusion to future gifts & to the estate upon death.

Question 29

Generation-Skipping Tax

Answer 29

A tax imposed when gifts are given to unrelated individuals more than 37.5 years younger than the donor or related individuals who are more than one generation younger than the donor, such as a grandchildren/great grandchildren to preven avoidance of gift tax.

Example: If a person gifts an excessive amount to grandchild, it will be taxed twice. Taxed as if it went to the paren, then to grandchild.