1. Transfer Taxes and Wealth Planning
Chapter 14
Transfer Taxes and Wealth Planning

2. Learning Objectives Outline the structure of federal transfer taxes
Describe the operation of the federal gift tax
Summarize the operation of the federal estate tax
Explain principles of wealth planning 2 2

3. Federal Transfer Taxes
Common Features:
Common tax rate schedule
Unified credit
Prevents taxation of all but large cumulative transfer
“Exemption equivalent” is taxable amount of credit
Unlimited charitable deduction
Unlimited marital deduction for transfers to a spouse

4. Federal Transfer Tax Rates
Tax base equal or over
Not over
Tentative tax
plus
Of the amount over
10,000
18%
$10,000
$20,000
$1,800
20%
$40,000
$3,800
22%
$60,000
$8,200
24%
$80,000
$13,000
26%
$100,000
$18,200
28%
$150,000
$23,800
30%
$250,000
$38,800
32%
$500,000
$70,800
34%
$750,000
$155,800
37%
$1,000,000
$248,300
39%
$345,800
40%

5. Federal Gift Tax

6. Federal Gift Tax
Levied on individual taxpayers for taxable gifts completed during a calendar year
Transfers subject to gift tax:
Imposed on intervivos gifts, lifetime transfers of property for less than adequate consideration
Imposed once a gift has been completed (occurs when donor relinquishes control of the property and donee accepts the gift)

7. Valuation
Property is included in the taxable gift at its fair market value at the date of the gift
Fair market value
“the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both have reasonable knowledge of the relevant facts”

8. Temporal interests Remainders and life estates
Future interests are valued at present value, calculated by estimating the time until the present interest expires
Present value calculation uses the §7520 interest rate published by the treasury

10. Example of temporal interests
Ben transfers $1M of stock to the Junior Trust and directs it to pay income to Junior for his life and remainder to Georgia. How is the life estate valued if Junior is 5 years-old at the time of the gift and the Section 7520 rate is 5%? Based on Table S, the remainder is valued at $42,580 = ( x $1M). Hence, the life estate is valued at $957,420 = ($1M - $42,580)

11. Federal Gift Tax Gifts specifically excluded from the gift tax
Incomplete and revocable gifts
Payments for support obligations or debts
Contributions to political parties or candidates
Medical and educational expenses paid on behalf of an unrelated individual

12. Federal Gift Tax Annual exclusion
Most gifts are eligible for an annual exclusion of $14,000 (2015) per donee per year
Gifts of present interests qualify for the exclusion
A present interest is a right to own and enjoy the property currently
Certain gifts of future interests placed in trust for a minor can also qualify for the exclusion

13. Federal Gift Tax Calculating taxable gifts Gift-Splitting election
increases the likelihood that gift tax will be reduced:
Better use of the annual exclusions or unified credits
Potential for lower tax rate on a portion of the gift
Spouse must be married at the time of the gift and not divorce or remarry during the year
Both spouses must consent to the election by filing a timely gift tax return
Annual election that applies to all completed gifts

14. Federal Gift Tax
Deductions are limited to the value of the gift after the annual exclusion
Marital deduction
Gifts to a spouse but not gifts of nondeductible terminable interests
An interest that terminates and transfers to another upon an event or after a specified amount of time
Charitable deduction
No percentage limitation but qualifies for an income tax deduction
No gift tax return necessary for gifts of entire interest

15. Federal Gift Tax Computation of the gift tax
Prior taxable gifts + current taxable gifts
Tax on cumulative gifts
Purpose is to increase the tax base and thereby increase the marginal tax rate applying to current gifts
Subtract gift tax on prior taxable gifts
prevent double taxation of prior taxable gifts
Tax is calculated using current rate schedule
Unused unified credit (calculated using current rate schedule

16. Gift tax example
Brian made a $7 million taxable gift this year. Previously he had made a $1 million taxable gift that was offset by the unified credit. What amount of gift tax is due on Brian’s gift?
Tax ($8M of cumulative transfers) $ 3,145,800 Less current tax on prior taxable gifts ,800 Less Unused UC ($5.43M - $1M) - 1,772,000
Tax due on Brian’s taxable gift $ 1,028,000
Note that Brian’s cumulative taxable gifts are $2.57 over the exemption equivalent ($8M - $5.43M). The gift tax is a flat 40% over the exemption equivalent (40% x $2.57 = $1.028M).

17. Federal Estate Tax
Designed to tax the value of property owned or controlled by an individual at death
The Gross Estate has two components:
Probate – Process of paying the debts of the decedent, and transferring the ownership of any remaining property to the decedent’s heirs
Probate Estate – Property owned by a decedent (titled in the name of the decedent) at the time of the death

18. Federal Estate Tax

19. Federal Estate Tax The gross estate consists of:
The probate estate plus
Value of certain automatic property transfers that take effect at death
Automatic transfers include joint ownership with right of survivorship.
Property is valued at the fair market value at the date of the decedent’s death.
Executor can elect to value the estate on an alternate valuation date, six months after death, if it reduces the gross estate and estate tax

20. Federal Estate Tax Automatic transfers included in the gross estate:
Property owned by the decedent in joint tenancy with right of survivorship (tenants in common are included in the probate estate)
Proceeds of life insurance paid due to the death of the decedent if either of two conditions is met:
Decedent “owned” the policy
Decedent’s estate or executor is the beneficiary of the insurance policy
Transfers within three years of death
These transfers are “grossed up” for the amount of gift taxes paid (if any)

21. Federal Estate Tax

22. Federal Estate Tax Taxable estate is the gross estate reduced by:
Administrative expenses, debts, losses, and state death taxes
Marital and charitable deductions
Computation of estate tax
Adjusted taxable gifts
Are prior gifts (not already included in the gross estate)
Objective is to allow estate tax base to reflect all transfers

23. Federal Estate Tax Unified credit
Eliminates transfer taxes on a estates with minimal lifetime and testamentary transfers
Measured by current tax on exemption equivalent
Amount of cumulative taxable transfers that can be made without exceeding the unified credit
Credit is applied after reducing the total tax on cumulative transfers for taxes payable on adjusted taxable gifts
A surviving spouse whose deceased spouse died without using their unified credit is entitled to the unused credit (a deceased spousal unused exclusion or DSUE)

24. Applicable Exclusion Amount
Federal Estate Tax
Year of gift/death
Applicable Exclusion Amount
1986
$500,000
1987–1997
600,000
1998
625,000
1999
650,000
2000–2001
675,000
2002–2003
1,000,000
2004–2005*
1,500,000
2006–2008*
2,000,000
2009–2010
3,500,000
2011
5,000,000
2012
5,120,000
2013
5,250,000
2014
5,340,000
2015
5,430,000

25. Estate tax example
Ed died this year with a taxable estate of $10 million. In Ed made a $1 million gift that was offset by the unified credit. What is the amount of estate tax due on Ed’s estate?
Tax ($11M of cumulative transfers) $ 4,345,800
Unified credit (exemption of $5.43M) - 2,117,800
Tax due on Ed’s estate $ 2,228,000
Note that Ed’s estate is $5.57M over the exemption equivalent ($11M - $5.43M). The estate tax is a flat 40% over the exemption equivalent (40% x $5.57 = $2.228M).

26. Wealth Planning Concepts
The generation-skipping tax (GST)
Supplemental tax designed to prevent the avoidance of transfer taxes through transfers that skip a generation of recipients
Not widely applicable as it does not apply to transfers that qualify for an annual gift tax exclusion
Income tax considerations

27. Wealth Planning Concepts
Transfer tax planning techniques
Serial gifts
Strategy saves gift taxes by converting a potentially large taxable transfer into multiple smaller transfers that qualify for the annual exclusion
DSUE
Allows use of unused exemption of deceased spouse
Bypass provisions can accomplish same objective with more control over assets
The Step-up in tax basis