1. ACCT 5315 Estate & Gift Taxation Overview and Gross Estate

2. Estate Tax - An Overview What is the estate tax? The estate tax is neither a tax on property nor a tax on the privilege of an heir to receive the property. Is the estate tax an excise tax? Is the estate tax impacted by the relationship of the beneficiaries to the decedent? What is the taxable estate?

3. Gross Estate Start with the FMV of all ownership interests by the decedent - includes real, personal, tangible, intangible wherever situated Includes dower/courtesy - That portion of the estate that is designed to provide for the surviving spouse after death - established by common law. Certain transfers during life (not double counted as gifts) Retained life estates Testamentary transfers / Reversionary interests Decedent retained powers over property transfers Property affiliated with relinquished powers within 3 years of death

4. Gross estate (continued) Other property interests 50% of qualified joint interests other joint tenancies and tenancies in common certain life insurance proceeds property over which the decedent had a general power of appointment received from another certain annuities qualified terminable interest property.- to be discussed later in the semester How can the government determine what you owned?

5. Decedent’s whose estate are subject to tax. Estate tax applies to: estate of any person who dies leaving property having a taxable situs within the U.S. You must distinguish between U.S. citizens, U.S. residents and Non-residents that own property - real or otherwise in the U.S. Term residence for Federal estate tax purposes means the person’s domicile regardless of citizenship.

6. Valuation - Date and Methods When is the alternative valuation date? If you choose the alternative valuation date, can you value some property at the date of death and other property at the alternative valuation date? Is historical cost used to value the gross estate? What methods are used to value a decedent’s gross estate? Who is responsible for ensuring that the estate is properly valued? Does the IRS have any power in this area?

7. Valuation (continued) How might you value: Real estate stocks and bonds mutual funds business interests notes - secured and unsecured cash / household effects Annuities, life estates, remainders, reversion?

8. Alternate Valuation Method Can only use the AVD if it will reduce the value of the gross estate. Why do you think this rule exists? The AVD must be formally elected on the return. The election is irrevocable If property is sold or distributed during first 6 months and AVD is elected, valued the distributed property at DOD Lapse of time assets - valued at DOD – e.g., patents, life estates, remainders, interests

9. Income Tax Basis of Inherited Property FMV at DOD or AVD whichever is elected. If Property sold, distributed or disposed of within the 6 month period, basis is the FMV at date of sale, distribution or disposition. Special rules apply to gifts being returned to the original donor within one year of the original gift - basis in hands of decedent immediately before dying.

10. Tests for Includibility in Gross Estate 3 tests Type of Property Sufficient Interest to warrant inclusion in GE Did the decedent possess interest at DOD Type of Property General rule - Sec. 2033 - all property includible in GE Powers of a appointment are a special case Lump sum SS benefits excluded - not considered property of decedent Some treaty provisions provide for GE exclusions.

11. Tests for Includibility Continued Sufficient Interest Yield to property law (common law/statutory rights) If decedent held property in trust for someone else, generally not includible. If property in decedents name for convenience only, not includible. Possession at death General rule - if interest came into existence prior to death and is not defeated by death - includible Life interests terminating at death - not includible Accrued benefits required to be paid to estate - include

12. Community Property Community property Only 50% of value of community property is included in gross estate. Applies also to life insurance purchased with community funds.

13. Real Estate Value of all real property owned by a U.S. citizen on DOD is includible in gross estate at highest and best use. Immaterial whether the property came into possession and control of executor or passed directly to heirs What is the essence of this provision? Residency at time of death is irrelevant in determining includibility. Real estate includes mineral rights and royalties. Real estate - reported on Form 706, Schedule A. If real property owned by sole proprietorship - report on Sch. F.

14. Valuation Each valuation must be fixed individually in accordance with the requirements and circumstances of a particular situation. How do you value real property? Generally relying on one valuation factor is typically not sufficient to establish a valuation contrary the IRS’. When is the valuation determined? What attachments, if any, should accompany the Form 706 for purposes of the Real Estate Schedule A? 50% of the value of community property is includible in gross estate of first spouse to die.

15. Farms and Closely Held Businesses - Overview General rule for valuation of real estate is that it is valued at highest and best use. However, real property used as a family farm or closely held business may be valued on the basis of its current use rather than highest and best use. Sec 2032A provides up to a $1,090,000 reduction in valued from the highest and best use valuation – must elect as this is not the default. If alternate valuation date is used, special use valuation is applied to value determined at alternate valuation date Why do the special use provisions of Sec. 2032A apply?

16. Qualifying Conditions To qualify for Sec 2032A - the following conditions must be satisfied decedent must have been a resident or a citizen of the U.s and property must be located in the U.S. Property must pass to a qualified heir and a requisite agreement must be filed property must be devoted to a qualified use on the date of the decedent’s death.

17. Qualifying Conditions Continued Decedent/family must have owned the property and have materially participated in the operation of the farm or other business for the required period Adjusted value of the real and personal property used in the farm or closely held business must comprise at least 50% of the adjusted value of the gross estate At least 25% of the adjusted value of the gross estate must be qualified real property. For purposes of the 50% and 25% tests, special use value is not use. Full value is used.

18. Qualifying Heirs Member of a decedent’s family who acquired the real property or to whom the property has passed. If a qualified heir disposes of property to a member of the heirs family, the family member is treated as a qualified heir. (Cousins do not count) Family = decedent’s ancestors, spouse, lineal descendants of the of the decedent, individuals spouse, or individuals parents or any of their spouses - includes legally adopted children. All interest in the specially valued property must pass to qualified heirs.

19. What property qualifies for Sec. 2032A? Real property that is located in U.S. and used as a farm - See Code Sec 2032A(e)(4) for description for farming purposes (See Code Sec. 2032A(e)(5) for description) or in a trade or business other than farming. The property must satisfy the qualified use and material participation requirements Qualified property includes - residences, and related improvements on the qualifying real property and occupied on a regular basis by the owner, his lessee or employees for occupational or maintenance purposes. Also included: roads, buildings, other structures functionally related to the use of the property

20. Qualified Use Requirement To qualify for Sec 2032A valuation - property must be devoted to a qualified farm or business use for 5 of the 8 years prior to decedent’s death. Requirement is satisfied if either the decedent or a member of the decedent’s family is utilizing the property for qualified use. Substance - some financial risk associated with an active farm must exist. Cash lease of farm property to decedent’s relatives or heir relatives constitutes a qualified use.

21. Recapture What event or events triggers recapture of tax benefits related to Sec. 2032A. How long is the recapture period? Who is liable for recapture tax? When is the payment due?. Amount of tax subject to recapture Adjusted tax difference = Estate tax w/o Sec. 2032A less Estate tax with Sec. 2032A.- The tax savings Tax will be less than adjusted tax difference on recapture if FMV of property has decreased since original valuation. Qualified use must begin w/in 2 years No recapture tax on involuntary conversions - proceeds must be reinvested in qualified use property.

22. Stocks and Bonds Stocks & Bonds - includible in gross estate. Schedule B - used to report on form 706 Dividends payable to decedent or decedent’s estate - includible in gross estate. What are the 3 important dates relating to dividends? When are dividends technically payable to a SH? If dividend is selling ex-dividend, dividend must be added to the stock price Bond Interest - Includible if accrued at owners date of death.

23. Valuation of Stocks/Bonds Stocks/bonds - valued at FMV at DOD or AVD Dividends payable to decedent or decedent’s estate - includible in gross estate. If a trading market exists - use mean price between high and low for the valuation date. - Large blocks of stock - may use underwriters appraisal. If no sales on valuation date procedure is as follows Obtain mean price for sales on closest day traded before the valuation date and closest day after valuation date Calculate the difference between the two values Pro-rate the difference (i.e. - determine daily difference) Add or subtract daily difference * number of days from sales date before valuation date to valuation date. If weekend death - mean is for values on Friday & Monday

24. Actual Prices Not Available? Use bonafide bid / ask prices Use appraisals for large blocks or stock Inactive/unlisted: use other similar corporations and other appraisals. Closely held Stock: nature or business/history - economic outlook of industry/company Book value or stock, earnings capacity, dividend paying capacity goodwill / intangible assets market price of other corporations similar in size/industry life insurance proceeds Degree of control of the block of stock to be sold.

25. Life Insurance Includes - common life insurance, accident insurance, war and risk insurance and national service life insurance, group insurance and double indemnity clause by reason of accidental death or an insured. Insurance taken out on life of another is not taxed under Sec. 2042 Insurance contracts - actuarial risk must exist - premium is based on estimate of insured life expectancy. Insurance is reported on Schedule D of Form 706 Insurance on other than insured - reported on Schedule F

26. Group Insurance Includible in Gross Estate - if incidents of ownership transferred within 3 years. Assignment must be legal under state law and the policy. Careful with controlling interests in closely held companies. Controlling interest stockholders may have rights to modify policies as a corporate officer. Post 1976 assignment of group policy made by employee w/in 3 years of death - includible in employees gross estate. Non-contributory plans - if employee can control how proceeds are to be paid - includible in estate.

27. Insurance on Life of Another Includible on Schedule F Value - cost of replacement not CSV Replacement cost = cost of buying another policy of the same value and same status on the life of the same insured. Cost is obtained by the insurer. If policy is actually surrendered for cash during AVP the amount received should be acceptable if AVD is elected.

28. Life Insurance - Named beneficiaries - continued Transfers within 3 years of death Includible but on Schedule G - transfers during life. Policies purchased within 3 years of death on decedent’s life, but not by the decedent are not includible in income (case law precedent). Courts found that the 3 year provision only applies to transfers during 3 years. Facts and circumstances along with extant case law will determine includibility. Different cases have different findings for community property purchases, joint property purchases and trust purchases. Consider agency relsp

29. Proceeds Payable for Benefit of the Estate / Marital Deduction Life insurance payable to one’s estate, for the benefit of an estate or to executor for other than the benefit of the executor - always includible includible even if purchased by other than decedent for benefit of the estate. If life insurance payable to estate = community property- only half included in gross estate. If spouse owns policy in the clear - marital deduction does not apply Proceed to spouse where owned by decedent - generally qualify for the marital deduction.

30. Business Insurance / Insurance on stockholder What are the common uses of business insurance? Closely helds - careful for attribution of ownership of policy to sole or controlling stockholder if proceeds are not received by corporation for a valid business purpose. Life Insurance proceeds - non-operating asset for purposes of determining stock value. Life insurance - often used to fund purchase buy/sell agreements. If insured has no rights in the insurance policy, only the value of the stock is included in gross estate.

31. Partnership Insurance Partners who purchase life insurance on the lives of each other to fund purchase agreements should make sure they are named as owner-beneficiaries of a policy on the life an an insured partner that policy terms do give an insured partner incidents of ownership over the policy. Partnership agreement should provide that proceeds are to be used to pay for the insured partners interest. Sole proprietor insurance - same as owned by the individual

32. Valuation / Info on Schedule D If proceeds payable to estate - value = amount receivable If proceeds payable to bene - value=amount receivable If proceeds payable in annuity - use the lump sum payment option to determine value If not lump sum amount - use the sum used to determine the amount of the annuity. Every policy on a decedent’s life is reportable on Schedule D regardless of taxability. Amount of policy reported - see above valuation amounts.

33. Jointly Owned Property Property acquired by purchase Portion included based upon percentage contributed to total cost * FMV at DOD or AVD Value of entire property included in gross estate unless the amount contributed by survivor is proven. Piece of joint property received by survivor from decedent cannot be included as survivors contribution. Provision covers joint bank accounts, bonds, stocks or other instruments. Community property - half excluded from first to die.

34. Spousal Joint Tenancies / Valuation of Joint Property 50% of qualified joint interest (tenancy by entirety or JTROS) included in first spouse to dies gross estate. Qualified joint interest = any interest in property held solely by spouses as joint tenants ROS. Valuation = same as those governing other types of property. Schedule E used to report jointly owned property. Must indicate in description whether the whole or only part of the property is included in the gross estate. Tenants in common is not listed on Schedule E.

35. Miscellaneous Property Report on Schedule F Includes property not included in any of the preceding property classifications. Debts due the decedent (not notes/mortgages) interests in business,insurance on life of another claims (including refund claims) rights, royalties, leaseholds, judgments, shares in trusts household goods, personal effects (incl clothing) farm products, livestock, farm machinery, autos, reversionary or remainder interests Code Sec. 2044 prop - property for which the marital deduction was previously allowed.

36. Business Interests Interests other than corporate reported on Sch. F. Rev. Rul. 59-60 used to determine these interests - same as used for closely held stock. Appraisals needed for all assets including goodwill. Value should be what a willing buyer and seller would agree upon if the business were sold including goodwill. Support for valuation should accompany return.

37. Other property interests Debts owed decedent - principal + accrued interest Leaseholds - need renewal value to compute value of leaseholds. Household goods - willing buyer/seller. Room by room itemization is desirable. Items with values of less than $100 may be grouped. Itemized list can be forgone if a sworn statement is made with an appraisal. Appraisals must be filed with return if estate includes art, jewelry, furs, silverware, etc and any one article is valued at more than $3,000 or any collection of articles is worth more than $10,000.

38. Misc. Property Continued Farm Products - Willing buyer seller - not forced sale Deferred compensation - often include payments to named beneficiaries if employee dies before retirement. - These death benefits are not includible in gross estate. FMV=price at which FMV of property includible in a decedent’s estate is the price at which it would change hands between a willing buyer and willing seller, with all reasonable facts known. Absent the willing buyer and seller, retail and auction prices for similar items can be use to value the property.

39. Transfers during life 3 year rule - applies to life insurance transfers and any transfers where decedent retained life estate, transfers taking place at death or revocable transfers. General powers of appointment exercised w/in 3 years does not trigger recapture in gross estate. Note the failure to have to file a gift tax return does not preclude those items mentioned as exceptions to Sec. 2035 from being included in the gross estate. Gift taxes paid on transfers within 3 years of death are includible in decedents gross estate. Transfers for full and adequate consideration are not incl.

40. Transfers with possession or enjoyment retained Included in gross estate if the decedent reserved or retained for life, or for any period not ascertainable without reference to death the use, possession, right to income, or other enjoyment of the transferred property, or the right, either alone or in conjunction with any other person, to designate the person or persons who will possess or enjoy the transferred property or the income therefrom. Value included is the value of all of the property less the value of any outstanding income interest which is not subject to the decedent’s interest or right and which is being enjoyed by another person at DOD.

41. Powers of Appointment Value of all property over which a decedent possessed a general power of appointment at death is includible in GE Power of appointment power given to possessor by another authorizes the possessor to control, with certain limitations, the ultimate disposition of property subject to the power. Recipient of power = donee Only general powers of appointment - taxable State law generally is applied in determining whether a general power of appointment exists. Report property with general power of appointment on Schedule H.

42. General Powers of Appointment Only general powers of appointment can result in tax. General power of appointment (GPOA) a power which is exercisable in favor of the decedent, his estate, his creditors or the creditors of the estate. Remember - if a GPOA exists, more than likely actual ownership interest probably does not. Why? GPOA exclude Power to invade property for purposes of ascertainable standards relating to health, education, support, or maintenance Powers created before 10/21/42 that must be used w another Powers after 10/21/42 exercisable with the creator or with a person having substantial interest in the property, subject to the power where the interest is adverse to the exercise of the power in decedent’s favor.

43. Certain Marital Deduction Property QTIP property for which a marital deduction was allowed is includible in gross estate of spouse receiving the prop. Amount included in GE is fair market value on DOD/AVD QTIP property includible in GE is considered passing from the spouse for estate and GST purposes. May qualify for a marital deduction if it passes to decedents spouse May qualify for a charitable deduction if QTIP passes to charity What is QTIP property?