Lesson 4 of Estate Planning: Advanced Estate Planning Flashcards

Question

**Alternative to Qualifcation** - A Common Testamentary Trust Arrangement Includes

Answer 1

**A common testamentary trust arrangement includes:** - the transfer of the remaining applicable estate tax exemption to a bypass trust, also known as a B Trust, - the transfer of a certain amount to a General Power of Appointment Trust, also known as an A Trust, and - the transfer of the remaining balance to a QTIP Trust, known as a C Trust. The arrangement is often referred to as an ABC Trust arrangement. **With such an arrangement, a decedent can accomplish several objectives.** - First, the decedent can guarantee the full use of his applicable estate tax exemption with the transfer to the B Trust. - The decedent can also provide the necessary funds to his surviving spouse in several ways. The A Trust allows the spouse to receive income distributions as well as appoint the principal to herself. - The B and C Trusts allows income distributions to the surviving spouse as well as the ability for the surviving spouse to receive principal distributions from the B and C Trusts for health, education, maintenance and support. - In addition, the A Trust and C Trust qualify the transfers for the unlimited marital deduction. A key difference, however, between the A and the C Trust is the selection of the ultimate beneficiaries of the trust property. - Because the surviving spouse will have a GPOA over the trust property of the A Trust, the surviving spouse can choose the ultimate beneficiary of the trust property, whereas the decedent (grantor) will choose the remainder beneficiary of the C Trust.

Answer 2

Answer: D Answer D is incorrect because the ultimate beneficiary of a QTIP Trust is chosen by the grantor of the QTIP Trust. All of the other statements are correct.

Answer 3

**An individual who is uncomfortable placing a large amount of money in a bypass trust could** - leave all of his property to the surviving spouse - but include a provision in the will stating that if the surviving spouse disclaims any or all of the bequest, the disclaimed property will be placed in a bypass trust, - thus giving the surviving spouse an income interest in the trust as noted above.

Answer 4

Provided that a client is comfortable with limiting the amount of property that is transferred outright to a spouse, several planning options emerge. **One of the most powerful to emerge is the use of an Irrevocable Life Insurance Trust (ILIT)** - to provide for the surviving spouse, - prevent property from being included in the gross estate of either spouse, - and protect assets from the claims of the beneficiaries' creditors. **A properly drafted ILIT can accomplish all of these objectives. By allowing the trustee of the ILIT to apply for and purchase a life insurance policy on the life of the insured/grantor of the ILIT, the insured will possess no incidence of ownership in the policy thereby keeping the policy out of his gross estate. The grantor of the ILIT can then name his spouse as the primary beneficiary of the trust, granting the surviving spouse:** - the right to income - the right to receive distributions for health, education, maintenance, and support; and - the right to demand up to $5,000 or five percent of the trust corpus each year without subjecting the principal of the ILIT to estate taxation in the surviving spouse's gross estate

Answer 5

Limited to tentative tax, the net result of Scenario 1 is that Mike and Mary pay no federal estate taxes. Mike and Mary's heirs receive $15,300,000 ($15,500,000 - $200,000 administrative expenses) assuming that there is no additional tax levied by their state of residence. Without portability, the total estate tax liability for Mary would equal $952,000 since she is not allowed Mike's unused applicable estate tax credit.

Answer 6

Answer: In this case, the $1,000,000 death benefit will be excluded from Mike's gross estate because he did not have any incidents of ownership in the life insurance policy at his death (or in the three years immediately preceding his death). Instead, the life insurance policy was owned by the trustee of the ILIT. At Mike's death, the $1,000,000 life insurance proceeds are paid to the ILIT. The trust grants Mary the right to receive the trust income and the right to principal distributions for her health, education, maintenance, and support. Effectively, all of these assets are available for Mary in the event that she needs them during her lifetime. At Mary's death, any amounts remaining in the trust are split equally among Mike and Mary's children. Mike's will directs his executor to create a bypass trust and to fund it with the maximum amount that can be transferred without increasing Mike's estate tax. Since Mike has not made any taxable transfers during his lifetime, the full applicable estate tax exemption of $12,920,000 (2023) is available. Therefore. Mike's executor transfers $12,920,000 (2023) in assets to the bypass trust. During her lifetime, Mary will have the right to receive the trust income and the right to receive distributions of principal for her health, education, maintenance, and support. Similar to the ILIT, the assets of the bypass trust are available to Mary should she need them during her lifetime. At Mary's death, any amounts remaining in the bypass trust are split equally among Mike and Mary's children.

Answer 7

**The general rule with regard to ownership of life insurance is that if the purpose of the life insurance is to provide estate liquidity and benefits to heirs,** - the insured should not own the policies. - If, on the other hand, life insurance (permanent with cash value) is intended to be used during the insured's life for education or retirement, the insured will need to own the policy, thus causing inclusion of any death benefit in the insured's estate at death. **One of the most important issues that an individual faces in the estate planning process is** - ensuring that surviving family members have an adequate income stream to maintain their standard of living. - Several issues should be considered when funding this income-stream-protection goal.

Answer 8

**The amount of life insurance necessary to ** - adequately insure a person may be determined by using a needs analysis, a human value method, or a capitalized income model. - The needs approach and human value approach are well covered - in an insurance course. - The capitalized income approach is fairly straightforward.

Answer 9

**One of the family objectives most frequently cited in the financial planning process** - is a desire to assist children in obtaining a college education. - The extent of desired funding for this goal may differ from client to client, but it is not uncommon for parents to want to provide their children with a college education. **One of the classic reasons for using life insurance in an estate plan is to create** - immediate liquidity at the decedent's estate. - If the decedent was the primary breadwinner of the family, this is particularly important to the survivors. **After the income stream, educational needs of children, and liquidity needs of the estate are provided for,** - there may still be a need for additional income for the surviving spouse. - Life insurance can provide a lump sum dollar amount at death that will satisfy the needed income for the surviving spouse. **Some individuals have estate planning objectives that go beyond providing for their individual needs and the needs of their children.** - Individuals who tend to think of wealth maximization for the family in the long-run - may wish to create pools of capital that can be used by future family members such as grandchildren, great grandchildren, and so on,

Answer 10

**A term insurance policy is a life insurance contract that states** - if the insured dies within the term of the contract, the insurance company will pay the stated death benefit. **Universal life insurance is, in essence,** - a term insurance policy with a cash accumulation account attached to it. **Variable universal life insurance policies are** - universal life insurance policies with one added feature: - the insured can choose how to invest the cash in the cash accumulation account. **Whole life insurance provides** - guarantees from the insurer that are not found in term insurance and universal life insurance contracts. **A second-to-die policy has two insureds and while generally is a permanent (cash value) policy, it could be a second-to-die term policy.** - The advantage of a second-to-die policy is that one of the parties (usually a spouse) can be uninsurable. - A second-to-die policy pays the death benefit at the death of the second spouse. Usually the obiective is to provide estate liquidity to pay estate taxes at the death of the second spouse. - A second-to-die policy may be either - whole life or - universal variable and - is usually owned by an irrevocable life insurance trust (ILIT).

Answer 11

**The owner of the policy** - is the person who has title to the contract. **The insured is the person whose life is covered by the contract.** - When the insured dies, the life insurance company will pay the death benefit to the beneficiary named in the policy. **The beneficiary is the person** - entitled to receive the death benefit once the insured dies.

Answer 12

**As a general rule, the death benefit paid on a life insurance policy will** - escape income taxation in the hands of the beneficiary. - The transfer-for-value rule is the only **exception** to this general rule.

Answer 13

**While the death benefit on a life insurance policy is not generally subject to income taxation,** - the death benefit in excess of the transferee's adjusted basis will be subject to income tax if the life insurance policy is transferred for valuable consideration. **Referred to as the transfer-for-value rule, the condition that subjects the policy death benefit subject to tax is a** - transfer-for-value. - The life insurance policy must be exchanged for valuable consideration for the transfer-for-value rule to apply. **Even if the transfer-for-value rule applies, certain exceptions to the rule will prevent the death benefit in the policy from being subject to income tax.** - Another way of looking at this is that if an exception to the transfer-for-value rule applies, we go back to the general rule that states that the death benefit paid by reason of the insured's death is not subject to income tax. **The IRC states that the transfer-for-value rule will not apply when there is a transfer of a life insurance policy to any of the following individuals:** - the insured, - a partner of the insured, - a partnership in which the insured is a partner, - a corporation in which the insured is a shareholder or officer. - a transferee who takes the transferor's basis in the contract.

Answer 14

**When the insured dies, the beneficiary can choose to receive the policy benefits in one of several different ways, referred to as settlement options, assuming the owner has not previously established an irrevocable settlement option.** - One option, of course, is a lump-sum death benefit. - As an alternative, the beneficiary can choose to keep the life insurance proceeds on deposit at the insurer and receive the interest that accrues on the balance on a regular basis. - Some life insurance policies offer various annuity options as well. **While the death benefit on the policy is generally income tax free,** - any interest accumulated on the death benefit is subject to ordinary income tax. **Surrender Value** - The surrender value is generally the cash value of the contract less a surrender charge which is governed by the contract or by state law. If the owner of the policy surrenders it to the insurance company and receives an amount that is greater than his adjusted basis in the policy, the difference between the amount received and the owner's adjusted basis is considered taxable income. - In this instance, the policy benefit was not paid by reason of the death of the insured, and therefore did not qualify for the income tax exclusion offered in the IRC. Any amount received in excess of the owner's adjusted basis in the policy will be taxed as ordinary income.

Answer 15

**Policy dividends issued on a life insurance policy are not like cash dividends issued on stock.** - A dividend on a life insurance policy is a return of the policy owner's adjusted basis (premiums). **One of the benefits of using a cash value life insurance policy in an estate plan is that the cash value of the policy is available through loans to the policy owner if needed.** - The owner of the policy can borrow from the cash value of the policy at a favorable interest rate specified in the contract. Generally, no income tax consequences result from taking a loan from the policy cash value. - If the life insurance policy lapses, the gain in the policy will include the outstanding loan, and will be subject to ordinary income tax. From a planning perspective, individuals usually do not take policy loans unless - (1) they expect to repay them, or - (2) if the loan will not be repaid, the policy will remain in force until the death of the insured.

Answer 16

**Changing the Beneficiary on the Life Insurance Policy** - If a change of beneficiary is made, a completed gift does not occur for federal gift tax purposes. **Outright Gift of a Life Insurance Policy** - When the owner of a life insurance policy transfers ownership of the policy to another by gift, a gift tax may result. - **If ownership is formally transferred, the gift of the policy will be considered a present interest gift and will qualify for the gift tax annual exclusion.** - If the value of the policy is less than the gift tax annual exclusion, there will be no gift tax consequence and a gift tax return does not need to be filed. - If the value of the policy exceeds the gif tax annual exclusion, a taxable gift does result, requiring the donor to allocate a portion of his applicable git tax credit amount to the transaction of it the applicable gift tax credit has already been used up, pay gift tax on the transfer. - **For gift tax purposes, the value of the policy depends on whether the policy is still in premium-pay status or is already paid up**. - For a policy in pay status, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium. The insurance company that issued the policy will provide this value upon request. When requesting a value from the insurance company, it is important to make sure that the value of the policy is calculated as of the date of the gift. - The gift tax value of a paid-up policy is the replacement cost of the policy, which equals the present cost charged by the insurance company to issue a similar contract.

Answer 17

**When life insurance policies are owned outright by individuals,** - gifts of cash that qualify for the gift tax annual exclusion can be made to the policy owner at the time the premium is due. - If a trust is the owner of the life insurance policy, a gift of the premium to the trust that includes a Crummey provision (a general power of appointment over the contribution to the trust given to the beneficiaries of the trust) will qualify such gift for the gift tax annual exclusion.

Answer 18

**Life insurance is generally considered ordinary income property.** - The deduction for donated ordinary income property is equal to the FMV of the property reduced by any ordinary income that would have resulted from its sale. - The net deduction is usually the adjusted basis of the property. - In the event the FMV is less than the adjusted basis (no ordinary income would result from this sale), the deduction is equal to the FMV of the property itself. - If the policy is "paid up" (i.e., no premiums remain to be paid), the FMV is equal to the policy's replacement value. - If premiums remain unpaid on the policy, the FMV is the policy's interpolated terminal reserve value. - If the donor continues to pay the premiums on any policy donated to a charity, those premium payments are an additional tax-deductible charitable gift. **The income tax charitable deduction for a gift of an existing life insurance policy is limited to 50% of the donor's adjusted gross income if the policy is given to a public charity and 30% of the donor's adjusted gross income if the policy is given to a private charity.** - Simply naming the charity as the beneficiary or making the charity the irrevocable beneficiary of the policy is not sufficient to generate a current income tax deduction. - The ownership of the policy must be transferred to the charity if the donor wishes to qualify the gift for the income tax charitable deduction. **A potential estate tax issue arises when the owner/insured transfers a life insurance policy to a charity and dies within three years of the transfer.** - While the charity is the owner and beneficiary of the policy, the insured had incidents of ownership in the policy within three years of death, requiring an inclusion of the death benefit in the insured's gross estate. - When this occurs, the entire death benefit would qualify for the estate tax unlimited charitable deduction, resulting in no additional estate tax. **If the donor/insured lives for more than three years after the transfer the death benefit proceeds on the policy are removed from his gross estate.** - The gift of the policy to the charity will not be considered an adjusted taxable gift, since the annual exclusion and the gift tax charitable deduction apply to the transfer.

Answer 19

**When an individual dies owning a life insurance policy on the life of another person,** - the value of the life insurance policy will be included in his gross estate (IRC Section 2033). The value of the policy will generally be the interpolated terminal reserve plus any uneared premium.

Answer 20

**The IRC (Section 2042) states that if a decedent owns a life insurance policy on his own life, or possesses any incidents of ownership in the policy on the date of his death, the policy death benefit will be included in his gross estate.** - While the beneficiary will receive the death benefit free of income tax (as set forth in IRC Section 101), the insured will have to include the death benefit proceeds of the policy in his gross estate. **An incident of ownership in a life insurance policy is** - the ability to exercise any economic right in the policy. Incidents of ownership include, but are not limited to, the right to borrow from the cash value in the policy, the right to assign the policy for a loan, and the right to change the beneficiary of the policy.

Answer 21

**The IRC (Section 2035) gives us the three-year rule,** - which states that if an individual gratuitously transfers ownership (or any incident of ownership) of a life insurance policy on his life within three years of death, the death benefit of the policy is included in his federal gross estate. - Note: a new life insurance policy bought within the ILIT would not be subject to the 3 year look back. **Note that the three-year rule applies only to** - gratuitous transfers (gifts) of life insurance policies or incidents of ownership on life insurance policies. - It does not apply to a sale of a life insurance policy. **Life insurance death benefits are exempt** - from income taxes (provided there has been no transfer for value), - but are subject to estate taxes if the policy is owned by the insured.

Answer 22

**An ILIT can get a bit complex when we consider the funding of the life insurance premiums.** - Typically, the insured/grantor of the trust will make annual gifts to the trust so that the trustee can pay the premiums on the life insurance policy. - Generally, all gifts to irrevocable trusts are considered future interest gifts and, therefore, do not qualify for the gift tax annual exclusion. The future interest characterization of the gift, however, can be transformed into a present interest by the inclusion of a Crummey provision in the trust document. **Crummey Powers** - While the Crummey power allows the donor to make a transfer under the annual exclusion rather than use his applicable gift tax credit, a beneficiary who holds a Crummey power may, as a result of that power, be required to include part of the trust assets in his gross estate. - If an individual has a general power of appointment over the annual contribution made to the trust, and the value of the general power of appointment does not exceed the greater of - (1) $5,000, or - (2) 5% of the trust corpus, the general power of appointment is ignored, and the beneficiary will not trigger gift tax if there is more than one party to the trust. - This exception is often referred to as the "5-and-5" rule. - Technically, a general power of appointment lapses to the extent that its value does not exceed $5,000 or 5% of the trust corpus in order to maximize the tax benefits of Crummey trusts; therefore, the contribution made to the trust should not exceed (1) $5,000 per beneficiary, or 5% of the trust corpus times the number of beneficiaries. When this convention is followed, the grantor will qualify gifts made to the trust for the gif tax annual exclusion and the beneficiaries will not have any inclusion in their gross estates by reason of possessing a general power of appointment over the contribution made to the trust, as long as the power lapses before the power holder dies.

Answer 23

**While the primary purpose of an ILIT is to exclude the death benefit of a life insurance policy from an insured's federal gross estate, the trust can be used for other estate planning objectives as well.** - First, the trust document will govern the disposition of the property. Instead of leaving a large death benefit to a family member, the trust will provide for management and conservation of the funds for the benefit of the family members. - Second, the trust provides a degree of asset protection for the insured and the insured's family. **Life Insurance Proceeds Made Available to the Executor of the Insured's Estate** - Since the objective of a life insurance trust is typically to provide liquidity for the estate while keeping the policy death benefit out of the insured's estate, it is important to avoid situations that will trigger inclusion by having incidents of ownership. - Proceeds of the policy are deemed to be made available to the executor of the insured's estate when the proceeds are required to be or may be used by the executor to pay the insured's estate taxes or administration expenses. **Providing Liquidity to the Estate** - Two provisions are commonly found in life insurance trusts that allow the trust to provide the needed liquidity for the insured's estate while, at the same time, preventing the policy death benefit from being subject to estate tax. These provisions include: - (1) giving the trustee of the life insurance trust the right to purchase assets from the estate of the insured and - (2) giving the trustee of the life insurance trust the right to loan money to the estate of the insured..

Answer 24

**Many times closely-held businesses are not marketable and create a large liquidity problem:** - when one of the business partners wishes to terminate or - transfer his/her ownership. - This can occur during the lifetime of the individual or at death. **Some Common Trigger Events Include:** - Lifetime transfer restrictions - Disability - Death of an owner - Estrangement clause - Start-up put and call - Loss of professional license - Guilty of a Felon **Valuation of an owner's interest is an important step in the process of effectively establishing a buy-sell agreement.** - Values may be fixed in price or more fluid, based on an earnings multiplier, discounted cash flows, replacement value, or third-party appraisal. By creating a valid ownership valuation promotes general fairness and can stave off IRS disputes regarding estate valuation. **Funding the purchase of another owner's share can be created with the** - purchase of life or disability insurance, - cash, - borrowing or - through an installment sale. - The exam will focus predominately on buy-sell at the death of an owner funded through the use of life insurance. **The advantages of buy-sell agreements include** - guaranteed market for the deceased's interest, - liquidity to the remaining owners, and - an established value for estate tax purposes.

Answer 25

**Cross-purchase agreements consist of:** - each owner owning an insurance policy on each of the other owners. - The estate of each owner then commits to selling the ownership to the surviving owners, typically for a predetermined cost the amount of the insurance proceeds. **Characterisitcs** - Each shareholder owns a policy on all of the other owners, - Premiums are nondeductible. - Life insurance cannot be attached by the company's creditors. - Remaining stockholder's purchase deceased owner's interest. - Tax-free death benefit to the remaining owners. - Step-up in basis of remaining owner's interest. - Allows for an altering of ownership ratios. **Advantages:** - The cross-purchase agreement allows for a step-up in the remaining shareholder's basis and the life insurance cannot be attached by the company's creditors. **Disadvantages:** - The cross-purchase agreement requires that each owner own a policy on each of the other owners, which becomes very inefficient with more than two or three owners. The formula to determine the number of policies is N x (N - 1).

Answer 26

**Stock redemption (or entity purchase) agreements provide** - for the business entity owning the life insurance policies on each owner. - The estate of each owner then commits to selling their ownership back to the company. Once again, it is typical that the cost is predetermined based on a set amount or formula. **Characterisitcs:** - Company owns a policy on each owner. - Premiums are nondeductible. - Life insurance can be attached by the company's creditors. - Company purchases deceased owner's interest. - Tax-free death benefit to the company. - NO step-up in basis of remaining owner's interest. - Does not allow for an altering of ownership ratios. **Advantages:** - The entity purchase requires that the company purchase one policy on each owner which significantly reduces the number of policies required if there are several owners. Entity purchase may also provide relief to younger owners from high premium payments required if on older owners. **Disadvantages:** - The entity purchase agreement's largest disadvantage is that the remaining owners do nor get a step-up in basis on their ownership interest. Also, the life insurance may be atached by the company's creditors.

Answer 27

**Entity insurance is also referred to as - stock redemption if the entity is a corporation. **Entity insurance is an alternative to** - the cross purchase arrangement. **The entity itself purchases the life insurance policies on** - each partner or shareholder. **The advantage of entity insurance is that the** - number of policies is reduced to one policy per partner or shareholder. **The life insurance premiums are not** - tax deductible, and - the proceeds are not includible in the entity's taxable income. **Because the surviving owners are not purchasing the interest from the decedent with entity insurance,** - the surviving owners do not receive a new adjusted taxable basis in the interest purchased.

Answer 28

**Under Chapter 14 of the IRC, the strength of using the buy-sell agreement to establish the purchase price of the business entity** - has been stripped away. **IRC Section 2703, however, provides a safe harbor if certain provisions and guidelines are met, including:** - The agreement must be part of a bona fide business arrangement. - It cannot be a device designed to transfer the property to members of the decedent's family for less than adequate consideration. - Terms of the agreement must be comparable to one that would be entered into by parties who would be involved in an arm's-length transaction.

Answer 29

**Having sufficient liquid resources available to cover estate and inheritance taxes, medical expenses, funeral expenses, administration costs, and the needs of the surviving family members during the estate administration process is paramount.** - Since most individuals do not regularly maintain sufficient cash and liquid assets in their investment and banking portfolios to cover all of these costs and expenses, - life insurance is often used to provide the needed liquidity. - As discussed previously, an ideal way to hold life insurance is in an Irrevocable Life Insurance Trust (LIT) - so that the dollar amount of the death benefit of the policy is not included in the decedent's gross estate.

Answer 30

**Last Medical Costs** - Most of an individual's lifetime medical expenses are incurred within the last three months of life. **Funeral Costs** - Funerals can be expensive, and prices continue to increase. **Transition or Adjustment Period Costs ** - A decedent's surviving family members will need cash to cover their living and other normal expenses, often referred to as transition or adjustment period costs, during the estate administration process. **Administrative Costs** - Administration costs for the estate include - executor's and attorney's fees, - fees for preparation of the estate and inheritance tax returns, - and fees for appraisal reports and the opinions of experts. **Income, Estate, and Generation-Skipping Transfer Taxes** - Having a source of funds to pay these taxes is critical in the estate administration process. - In some special circumstances, it may be possible to defer payment of some of these taxes, but that deferral is not without cost. - Once the taxes are due, interest begins to accrue if the tax is not paid in full by the due date of the tax return.

Answer 31

**Sale of Assets** - One way to generate liquidity to pay estate taxes and administration expenses is to sell some of the decedent's assets. **Life Insurance** - Using life insurance to generate estate liquidity matches the need for funds with the availability of funds. - When an insured decedent dies and incurs estate taxes and administration expenses, the life insurance policy will mature, making a large amount of cash available to cover those expenses. **Tax-Advantaged Accounts** - The Income in Respect of Decedent (IRD) rules state that when an individual has chosen to defer income during his lifetime, the value of those deferrals at death will not qualify for a step-up in basis. - Instead, whoever receives the decedent's income tax deferred accounts must pay income tax on the distributions received from the accounts. - If the IRD causes the estate to be subject to estate tax (because it is included in the decedent's gross estate), however, the beneficiary of the tax-advantaged account will be eligible for a deduction in the form of a miscellaneous itemized deduction not subject to the 2% of AGI floor. - The amount of the deduction is equal to the estate tax attributable to the net IRD - In the event that the executor or administrator of the decedent's estate takes a distribution from a tax-advantaged account to pay the estate taxes and administration expenses, - the distribution is taxable income to the estate, requiring the executor to take a distribution - equal to the amount necessary to pay the estate taxes and the administration expenses plus the income tax liability generated by the distribution.

Answer 32

**Owners of closely held and family C-Corporations have yet another source of funds to cover estate liquidity needs-the corporation itself.** - A corporate redemption of some or all of the decedent's stock at death can transform an illiquid asset (a closely held business interest) into a liquid asset (cash). **IRC Section 303 states that the estate of a deceased shareholder may redeem enough shares to cover the death taxes (federal and state estate, inheritance, and generation-skipping transfer taxes), funeral expenses, and administrative expenses of the decedent; and the shares redeemed for this purpose will qualify for capital gains tax treatment.** - Note that this will usually result in the avoidance of income tax on the redemption, since the redemption occurs after death, and at death, the decedent's estate receives a step-up in the adjusted basis of the shares equal to their FMV at the decedent's date of death. - A Section 303 redemption allows the estate of a deceased shareholder to receive cash from the corporation in a tax-free exchange, and allows the corporation to reduce its earnings and profits (when distributed, earnings and profits of a corporation result in dividend taxation), which also benefits the surviving shareholders. **To qualify for a Section 303 redemption, more than 35% of the decedent's adjusted gross estate must consist of the closely held business interest.** - In the event that the decedent owned interests in several closely held businesses, the fair market value of all of the closely held business interests can be aggregated to meet the 35% test provided that the decedent owned at least 20% of each company's outstanding stock. - In addition, the shareholder redeemed must be responsible for the payment of the estate taxes, administration expenses, and funeral expenses. **To the extent that the estate redeems an amount in excess of the taxes and expenses of the estate,** - the redemption must meet the IRC requirements to achieve capital gains tax treatment (i.e., there must be a complete redemption, or a substantially disproportionate redemption), or the excess amount will be treated as a dividend distribution to the estate subject to dividend income tax.

Answer 33

**In some cases, the executor or administrator of an estate will distribute the estate's assets in lieu of a cash payment to creditors and those providing estate administration services.** - This is not possible for the payment of taxes-both the federal and state governments require a cash payment within nine months of the decedent's date of death.

Answer 34

**If liquidity is needed and all else fails,** - the estate may borrow money to cover the estate taxes ans - administration expenses of the decedent. - If there is not an adequate source of funds available (such as from a life insurance policy), borrowing to cover taxes and expenses may be the most prudent approach.

Answer 35

**After an individual dies, a final income tax return (Form 1040) must be prepared and filed.** - The final return will include all of the decedent's taxable income and deductions until the date of his death. - At the decedent's death, the decedent's estate is created and the estate will pay income tax on the income it receives to the extent that it is not distributed to the decedent's heirs.

Answer 36

**For the year of the decedent's death, if the decedent was married and is survived by a spouse,** - the decedent's final income tax return may be filed as married filing separately or married filing jointly. **The surviving spouse may file as a qualified widow(er) for two years following the decedent's death and enjoy the lower tax rates applicable to joint returns provided that:** - (1) the surviving spouse has not remarried and - (2) the surviving spouse is maintaining a home for one or more dependent children. - (Note that if the surviving spouse remarries, he will be entitled to the married filing jointly lower rates if the new couple files their income tax returns as married filling jointly.)

Answer 37

**To the extent that the decedent had losses from prior tax years that were suspended due to the application of the passive activity loss rules,** - those losses can be claimed on the decedent's final income tax return. **To the extent that the decedent had passive loss carryforwards,** - it may be more advantageous to file the final return as married filing jointly due to the possibility of offsetting not only the decedent's taxable income, - but also the spouse's taxable income with the passive loss carryforwards.

Answer 38

**Certain expenses can be claimed either:** - on the decedent's final income tax return (Form 1040) or - on the estate tax return. **The executor or administrator of the estate may elect to deduct** - unpaid medical expenses as of the date of the decedent's death either on the decedent's final income tax return or - on the estate tax return. - Of course, the executor cannot elect to deduct the same expenses on both returns. **As a general rule, if the decedent's estate is not subject to estate tax** - (either because the taxable estate is less than the applicable estate tax credit amount or estate taxes have been avoided through use of the unlimited marital or unlimited charitable deduction), - the expenses should be deducted from the decedent's final income tax return. **Medical expenses are deductible on the final income tax return** - only to the extent that they exceed 7.5% of the decedent's adjusted gross income in the year of death. - The Taxpayer Certainty and Disaster Relief Act of 2020 has permanently reduced the medical expense floor from 10% - to 7.5%.

Answer 39

**Form 1041 is the** - Estate Fiduciary Income Tax Return **Selection of Tax Year** - Since an estate is not a natural person, it is not required to use a calendar year for tax purposes. - The executor can elect to have the estate's tax year end on the last day of any month during the year. **Expense Elections** - Expenses of administering the decedent's estate and any casualty losses suffered during estate administration may be deducted on either the fiduciary income tax return for the estate (Form 1041), - or the decedent's estate tax return (Form 706), but not both. - The executor may elect to deduct some of the expenses on the income tax return and some of the expenses on the estate tax return if this yields a better overall tax result. **Waiver of Executor's Fees** - Executor's fees are deductible either on the fiduciary income tax return (Form 1041) - or on the estate tax return (Form 706), - but not on both. - Executor's fees are also taxable income to the recipient and will require the recipient to pay income, and potentially, self-employment taxes on the amount received.

Answer 40

**For estate tax purposes, US Savings Bonds are** - income in respect of decedent assets. **IRD assets do not receive a** - step to FMV in basis at the owner's date of death. US Savings - Bonds are treated in this way because usually income tax is not paid on the interest as it accrues-it is paid when the owner redeems the bond. - If the estate redeems the bond, the estate will have to pay income tax on the interest income - or, if circumstances dictate, distribute the income to the heirs and allow them to pay the income tax. **In either case, whoever receives the income may receive** - a corresponding ID deduction (a deduction equal to the estate tax attributable to the value of the IRD asset). **If the decedent has made any charitable bequests in his will,** - it may be wise to satisfy those bequests with any US Savings Bonds or IRD assets held by the estate. - While the charity will recognize income upon the receipt of the asset, no income tax will be paid because charitable organizations are exempt from income tax. **The following list is a partial list of IRD assets:** - Qualified Plans - IRAs - US Savings Bonds - Installment Notes - Annuitized Annuities - Accrued Dividends - Accrued Wages

Answer 41

**By giving away assets during their lifetime,** - not only will the asset be removed from their gross estate (at least the portion that qualifies for the gift tax annual exclusion), - the future appreciation of the asset will be transferred to the donee as well. **The gift-splitting election treats a gift of separate property as being made one-half from each spouse, thus utilizing each spouse's annual exclusion for the gift.** - The election is made on each spouse's annual gift tax return, - requires each spouse to sign the other's gift tax return, and - applies to all gifts made by either spouse during the year. **If a decedent made gifts during the last tax year before his death,** - those gifts must be reported on a timely filed gift tax return. - The decedent will not, however, be available to sign the gift tax return for gift-splitting purposes with his spouse. - The IRC allows a surviving spouse, however, to elect gift-splitting on the gifts made by the decedent in the decedent's final tax year.

Answer 42

**As discussed previously, a decedent's assets are included in his gross estate at their FMV** - FMV is the value that would be paid for the property in an arms-length transaction where there is a willing buyer and willing seller, where neither party is acting under compulsion, and where both parties have full knowledge of the facts. **Small estates will be encouraged to overstate the value of its assets, while large estates will tend to understate the value of its assets.** - A small estate (one that does not have to pay estate tax), may benefit by assigning higher values to its assets, since the value of the assets included in the gross estate receive a step-up in basis for the heirs. - Larger estates (estates that have to pay estate taxes) would rather undervalue the assets and save on estate taxes, even if this means that the heirs will have higher capital gains taxes to pay.

Answer 43

**If the executor or administrator elects to value the estate's assets on the alternate valuation date,** - the FMVof the assets six months after the decedent's date of death is included in the gross estate. **In order to elect the alternate valuation date, both of the following conditions must be met:** - (1) the value of the assets included in the gross estate six months after decedent's date of death must be lower than the value of the assets on the date of death and - (2) there must be a reduction in the total estate tax due as a result of the election.

Answer 44

**Owners of closely held businesses often face a severe liquidity problem at death. Their largest and most valuable asset is usually their business interest.** - The inclusion of the value of the business interest in the decedent's gross estate may result in a large estate tax liability that is due nine months after their death, - but it is often difficult to liquidate the business interest in such a short period of time, or - it may be imprudent to liquidate the business interest if, as a result, the owner group or family will lose control. **When the executor of the estate elects to make installment payments of estate tax under Section 6166, it is possible to extend the payment of estate taxes attributable to the closely held business over a 14-year period.** - The first four years of payments are of interest only, followed by 10 payments that amortize the estate tax liability over the payment period (although may be paid over a shorter period). **To qualify for a Section 6166 deferral of estate tax, three requirements must be met:** - (1) the value of the business interest must exceed 35% of the value of the decedent's adjusted gross estate, - (2) the business interest must be a closely held business (i.e., a sole proprietorship; a partnership if at least 20% of the total capital interest is included in the decedent's gross estate; a partnership with 45 or fewer partners; a corporation if at least 20% of the voting stock is included in the decedent's gross estate; a corporation with 45 or fewer shareholders), and - (3) the entity must have been actively engaged in the conduct of a trade or a business at the date of the decedent's death.

Answer 45

**For estate tax purposes, the FMV (i.e., the highest and best use value) of the property** - must be included in the gross estate; the value of the land in its current use does not matter. **If an individual is using a piece of real property as a farm or in another trade or business that is not employing the property at its highest and best use,** - the value of the property may be higher than the value of the property in its current use. - This may create an estate tax that could be much larger than an estate tax based on the value of the property utilizing its current use value. **To help provide relief in cases such as this, Congress enacted the Special Use Valuation provisions under Section 2032A of the IRC.** - If special use valuation is elected, the value included in the decedent's gross estate will be the current use value of the property, subject to a limitation that the highest and best use value cannot be reduced by more than $1,310,000 (2023). **In order to qualify for special use valuation, the following conditions must be met:** - (1) the decedent was at the time of his death a citizen or resident of the US, - (2) the property must be used in a farming operation or trade or business that was actively managed by the decedent or the decedent's family for five out of the eight years immediately preceding the decedent's death, - (3) the value of the real and personal property used in a qualifying manner must equal or exceed 50% of the decedent's gross estate (as adjusted only for secured mortgages for property included in the gross estate), - (4) the value of the real property used in a qualifying manner must equal or exceed 25% of the value of the gross estate (as adjusted only for secured mortgages for property included in the gross estate), - (5) the qualifying property must be located in the US and must pass to qualifying heirs (a member of the decedent's family who acquires the property from the decedent) who must actively participate in the farming activity or trade or business, and - (6) the executor must file the election with the estate tax return, complete with a recapture agreement. **Subsequent to the transfer of the property to the qualifying heirs,** - the qualifying heirs must continue to use the property in its qualified use, as stated in the election included with the estate tax return, for a period of at least 10 years following the decedent's death. - If the heirs stop using the property in a qualifying manner, or the property is sold during the 10-year period following the decedent's death, an additional tax is imposed. - The amount that is imposed is the lesser of - (1) the estate tax savings from special use valuation, or - (2) an amount equal to the proceeds from the sale of the property less the special use valuation amount.

Answer 46

**Recall that a disclaimer is an irrevocable and unqualified refusal to accept a gift or bequest. To be considered qualified for estate tax purposes, the disclaimer must meet the following requirements:** - (1) the disclaimer must be in writing, - (2) the disclaimer must be made within nine months of the date on which the transfer creating the interest was made or the day on which the disclaiming party reaches the age of 21, - (3) the disclaimant cannot specify the party to whom the property will be transferred as a result of the disclaimer, and - (4) the disclaimant cannot accept any interest or benefit in the property prior to disclaiming.

Answer 47

**Disclaimer By the Surviving Spouse** - A special rule exists for surviving spouses. A surviving spouse may disclaim a bequest yet still receive benefits in the disclaimed property. - Use of this provision adds flexibility to an estate plan by allowing the surviving spouse to make determinations regarding the size of the deceased spouse's taxable estate after the decedent has died. **Disclaimer In Favor of Surviving Spouse** - In some situations, disclaimers are used to transfer property to the surviving spouse. - This situation occurs when the property passing to the surviving spouse is insufficient, and the other heirs of the estate (usually the children) want to ensure that their surviving parent is well provided for. - To the extent that a disclaimer is executed and, as a result, property passes to the surviving spouse, the property passing as a result of the disclaimer will qualify for the estate tax marital deduction and will not be construed as a gift from the disclaimant to the spouse. **Disclaimer In Favor of Charities** - If a disclaimer is executed and, as a result, the property is transferred to a charity under the terms of the decedent's will, - the charitable transfer will qualify for the unlimited charitable deduction in the transferor's estate. **Disclaimer By Others Ignoring the Marital Deduction** - In the event that an individual disclaims property and the property does not pass to the surviving spouse or a qualified charity, - no estate tax savings will result in the transferor's estate. - Overall family transfer tax savings may result, however, by preventing the inclusion of that property in the gross estate of a family member who does not need to receive it. **Powers of Appointment** - If the disclaimant has the authority to designate the recipient of the property as occurs with a general power of appointment, - a qualified disclaimer of the bequest cannot be made.

Answer 48

**One form of marital deduction transfer involves the use of the qualified terminable interest property (QTIP) election.** - While an individual can express a desire that his executor elect to qualify certain transfers for the unlimited estate tax marital deduction by making a QTIP election, - the ultimate decision of whether to make the election, and, if the election is made, how much property should be qualified for the election, - rests with the executor or administrator of the estate. - As such, the QTIP election is a postmortem planning device, since the decisions are made after the decedent's death.

Answer 49

**In the case of a non-citizen surviving spouse, a Qualified Domestic Trust (QDOT)** - can be created to qualify the estate for the marital deduction properly passing to the non-citizen spouse. - Election must be made by a US citizen spouse or - US Citizen executor.

Answer 50

**The executor will also elect any allocation of the generation-skipping transfer tax (GSTT) exemption and if appropriate,** - a Reverse QTIP election so that the decedent remains the transferor of this QTIP property for GSTT purposes after the death of the surviving spouse, even though the property is included in the surviving spouse's gross estate for estate tax purposes.

Answer 51

**The GSTT is an** - excise tax, - in addition to any gift or estate tax, imposed on the transfer of property to a donee - (other than a spouse) who is two or more generations younger than the donor. **Like the estate and gift tax systems,** - the GSTT system has an annual exclusion ($17,000 in 2023), a lifetime exemption ($12,920,000 in 2023), and an exemption for qualified transfers. **The following exhibit identifies the similarities and differences among the** - GSTT, - estate tax, and - gift tax regimes that are covered throughout this section.

Answer 52

**Whether or not a transfer is subject to GSTT** - depends on whether the transferor is two or more generations older than the transferee. **When property is transferred during life and is subject to gift tax,** - the transferor is the donor. **When the property is transferred at death and is subject to estate tax.** - the transferor is the decedent.

Answer 53

The transferee is the individual who receives the property. **For GSTT purposes, individuals are categorized into two groups:** - (1) nonskip persons and - (2) skip persons **Skip Person:** - A skip person, or the person to who a transfer may result in a generation-skipping transfer tax, is broadly defined as any lineal descendant of the transferor's grandparent (or the transferor's spouse's grandparent) - who is two or more generations younger than the transferor and any person who is not a lineal descendant, - is not the spouse of the transferor, and - is two or more generations younger than the transferor based on age (37½ years). - For the purpose of applying these rules, - any spouse or former spouse of a transferor and all charitable organizations are always considered to be in the same generation as the transferor. - Also, adopted relatives are considered the same as blood relatives.

Answer 54

**Unrelated individuals are those individuals** - who are not related to the transferor. **Non-lineal descendants, for GSTT purposes, are relatives who are more distant than the lineal descendants of the transferor's grandparents.** - To determine whether unrelated individuals or non-lineal descendants are skip persons, the individual's age is the only relevant factor; where the individual falls in relation to the transferor's family tree is irrelevant. **The following chart shows non-lineal descendants.** **A generation is defined as a** - 25-year period. - Therefore, an individual's generation includes all individuals 12½ years older than him and 12½ years younger than him

Answer 55

**A trust may also be considered a skip person** - (1) if all interests in the trust are held by skip persons, or - (2) if the trust distributions can only be made to skip persons. **For purposes of the first definition,** - a person is deemed to have an interest in a trust if he has the present right to receive income or principal distributions from the trust. **Charitable organizations are considered to be in the same generation as the transferor.** - If a charitable organization holds an interest in a trust, then the trust cannot be a skip person. - For this purpose, a charitable organization is deemed to have an interest in a trust - (1) if it has a present, non-discretionary right to receive income or principal, or - (2) if the organization is the remainder beneficiary of a qualified charitable remainder trust or pooled income fund.

Answer 56

**If a child of the transferor is deceased at the time of a transfer,** - then that child's descendants are moved up one generation for purposes of determining whether any transfer constitutes a generation-skipping transfer (GST). **The predeceased ancestor exception may also apply to transfers made to the transferor's grandniece(s) and/or grandnephew(s) if,** - at the time of the transfer, the transferor has no living lineal descendants.

Answer 57

**A nonskip person is** - any person or trust that is not a skip person. - A transferor's spouse, or former spouse, is always considered a nonskip person because they are considered to be in the same generation as the spouse. **A trust is a non-skip person if** - any non-skip person holds an interest in the trust. - Also, if no person has an interest in the trust, but a distribution may be made to a non-skip person, the trust is a non-skip person.

Answer 58

**GSTT applies to three types of taxable transfers:** - (1) a direct skip; - (2) a taxable distribution; and - (3) a taxable termination. **A direct skip is** - an outright transfer of property to a skip person that is subject to estate or gift tax. - An outright gift to a grandchild or a trust that is a skip person during life or at death is a direct skip. - The GSTT on a direct skip is imposed on the value received by the transferee. - The transferor is liable for the GSTT on a direct skip, unless - the direct skip is made from a trust. - In the trust instance, the trustee is liable for the GSTT. **A taxable termination is any termination of a trust interest unless at the termination of the trust, the trust property transferred is subject to** - (1) federal estate or gift tax, - (2) a non-skip person receives an interest in the property transferred out of the trust, or - (3) the distribution from the trust will never be made to a skip person. - The taxable amount of a taxable termination equals - the value of the trust property transferred - less any expenses, indebtedness, and taxes attributable to the taxable termination. - The trustee is liable for the GSTT on a taxable termination. **A taxable distribution is any distribution from a trust to a skip person that is not a taxable termination or a direct skip.** - The amount received by the transferee in a taxable distribution, reduced by any expenses incurred by the transferee in connection with the GSTT, - is the taxable amount of the distribution. - Unlike direct skips and taxable terminations, - the transferee is liable for the GSTT on a taxable distribution.

Answer 59

**Like the gift and estate tax systems, the GSTT system also has** - exceptions, - exclusions and - exemptions | Exam Tip: Exclusions and Exemptions most likely to be tested

Answer 60

**The original GSTT system was retroactively repealed in 1986 and replaced with a new GSTT system.** - Therefore, the current GSTT generally only applies to transfers made after the date of enactment, October 22, 1986, but certain transfers between September 25, 1985 and October 23, 1986 are subject to GSTT. **Transfers between these dates will not be subject to GSTT if:** - The transfer was to an irrevocable trust that was in existence on or before September 25, 1985, to the extent no additions were made to the trust after September 25, 1985. - The transfer was pursuant to certain wills and revocable trusts executed before October 22, 1986, and the decedent died before January 1, 1987. - The transfer was from a person who was under a mental disability to change the disposition of his property continuously from October 22, 1986 until the date of his death.

Answer 61

The GSTT system has both an exclusion available for qualified transfers and an annual exclusion of **$17,000.** **Medical and Educational Payments - Qualified Transfers** - The direct payment of tuition to a qualified educational institution or the direct payment of qualified medical expenses to a medical care provider on behalf of a skip person is - not subject to GSTT. - The exclusion from GSTT also applies if the payments are made from a trust.

Answer 62

**Similar to the gift tax system,** - an annual exclusion of $17,000 per donee per donor for present interest gifts is available for GSTs. **For transfers that constitute direct skips,** - the application of the annual exclusion is applied in the same manner as the annual exclusion for gift tax. - Thus, a direct skip is a nontaxable gift for GSTT purposes to the extent the transfer is excluded from taxable gifts under the annual gift tax exclusion. **Transfers to a trust deemed a skip person are only considered nontaxable gifts for GSTT purposes to the extent the transfer is equal to or less than the annual exclusion and if:** - The beneficiaries are given a Crummey power over the contribution to the trust; and - The trust assets can only be distributed for the benefit of the beneficiary during the beneficiary's lifetime; and - If the trust does not terminate before the beneficiary's death, the assets must be included in the beneficiary's gross estate.

Answer 63

**Gift splitting also applies to** - transfers subject to GSTT. **When an individual elects on the gift tax return (Form 709) to split gifts for gift tax purposes,** any GSTs are also deemed split gifts.

Answer 64

Every individual is allowed a GST exemption equal to the applicable estate tax exemption, currently **$12,920,000 (2023).** Unlike the gift and estate tax system, the same exemption applies to assets transferred during life or at death. **Allocation Rules** - The GST exemption is allocable to inter vivos transfers and testamentary transfers giving the transferor or the transferor's executor the ability to select which GST will benefit from the exemption. The allocation of the GST exemption to a transfer is irrevocable. - If a direct skip occurs during a transferor's lifetime, the transferor's GST exemption that has not been used is automatically allocated to the direct skip. - If the transferor does not want to utilize his GST exemption, the transferor must - (1) describe on a timely filed federal gift and GSTT retum (Form 709) the transfer and the extent to which the automatic allocation does not apply, or - (2) timely file the federal gift and GSTT return (Form 709) with the payment of the GSTT due without the automatic allocation. - If any GST exemption remains after the allocation to any direct skips, the exemption is allocated pro-rata to any taxable terminations or taxable distributions from the decedent. The allocation, included on the transferor's gift tax return, must detail the name of the trust, the amount of the allocation, the value of the trust's assets at the date of the allocation, and the inclusion ratio (discussed below) of the trust after the allocation. - When an individual allocates the a GST exemption to a trust in excess of the amount necessary to create a zero inclusion ratio (discussed below), the allocation of the exemption is void and available for subsequent allocation. - When an individual dies with unused GST exemption, the executor of his estate allocates the GST exemption on the decedent's federal estate tax return (Form 706). This allocation may be for à testamentary GST or a late allocation to a lifetime transfer.

Answer 65

**After it has been determined that a GST has occurred (whether a direct skip, taxable termination, or taxable distribution)** - the value of the GST is then multiplied by the applicable rate. **The applicable rate** - is the maximum estate tax rate in effect at the time of the GST (40% for 2023) - times the inclusion ratio, which is the difference between the applicable fraction (defined below) and one. **The applicable fraction is calculated by:** - dividing the applicable GST exemption allocated to the transfer by the value of the transfer - reduced by any federal estate tax or state death tax incurred by reason of the GST that is - chargeable to the trust and is actually recovered from the trust, the amount of any charitable deduction allowed, and - the value of the transfer that is a nontaxable gift (i.e., annual exclusion and qualified transfers). **The inclusion ratio is then determined by** - subtracting the applicable fraction from one. - The inclusion ratio is then multiplied by the maximum transfer rate (40% for 2023) to - calculate the applicable rate which is - multiplied by the value of the GST to determine - the GSTT due.

Answer 66

**A Reverse QTIP election is a QTIP election that is** - made for estate tax purposes but not for GSTT purposes. - Thus, the assets would qualify for the unlimited marital deduction for estate tax purposes and utilize the GST exemption for GSTT purposes at the death of the first spouse. **Since a partial Reverse QTIP election is not permitted, an executor may wish to create two QTIP Trusts for the same spouse and make a Reverse QTIP election for one of them so as to accomplish two goals:** - (1) the elimination of estate tax at the death of the first spouse, and - (2) the full utilization of the decedent's GST exemption.

Answer 67

**As discussed previously, qualified disclaimers allow property to pass to someone** - other than the primary beneficiary named in the decedent's will or under the state's intestacy laws. **A qualified disclaimer by a parent cannot be used to avoid GSTT.** - The predeceased-parent exception to the generation-skipping transfer tax applies only - when the parent actually dies; thus, "presumed death" for estate tax purposes will not suffice.

Answer 68

- Property transferred to a member of the next generation, and then later transferred to that person's heirs, is generally taxed twice, once each time the property is transferred. - The generation-skipping trust has been used in estate planning to pass property ultimately to a generation at least two levels younger than the grantor of the trust while allowing the intervening generation some income benefits from the property on an estate-tax-free basis. - Use of a generation-skipping trust allows the planner to split legal ownership of assets (ownership is held by the trust) from the use of assets the beneficiaries of the trust may use the trust assets). - If the beneficiaries do not have legal title to the trust assets when they die, the beneficiary cannot transfer anything in the trust at his death; and, therefore, no part of the trust will be included in the beneficiary's gross estate.

Lesson 4 of Estate Planning: Advanced Estate Planning Flashcards

(102 cards)