1. Chapter 18: GIFT and ESTATE TAX
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Chapter 18: GIFT and ESTATE TAX
In addition to the income tax, individuals are also subject to the Unified Transfer Tax. text p. 18-2
Unified means tax rules apply from birth through death.
3 components of unified transfer tax:
Gift Tax
During life
Intervivos
Generation Skipping (GST)
Before, during or after death
Estate Tax
Upon death
Testamentary, Intestate

2. GIFT TAX text p. 18-2
Applies to individuals (not “joint”) on lifetime transfers.
- All calculations and filings are computed for a single individual.
- Known as inter vivos, that is “between the living”.
Tax applies to transfers of wealth from taxpayer (donor) to another person. (donee)
- Applies if donor is: US citizen or
Resident of US or
Property transferred is located in the US
Tax Base = Fair Market Value of assets transferred. text p. 18-5
- Several exclusions and exceptions allowed. (see later)
Tax assessed on donor in year transfer is made.
- Donee doesn’t pay tax on receipt of gift.
- IRS can collect from donee only if donor fails to pay.

3. Computing the gift tax
Accounting Period = Cumulative gifts over Lifetime
- Compute and pay gift tax portion annually
- Amount of gifts in prior years affects calculation.
Tax return each year just updates previous calculations.
Progressive tax rates text inside back cover or next page
- Cumulative calculation results in higher rates on subsequent transfers.
“Unified Transfer Tax Credit” allowed against tax. text p 18-4
- No tax owed until unified credit exhausted.
- Amount of credit = $2,141,800 as of 2017, ($2,185,800 in 18)
- Equivalent to gift tax on $5.49 million of value ($5.60 in 18)

4. Unified transfer tax rate schedule
Tax Schedule:
$0 to $10,000, tax = 18%
$10,000 to $20,000, tax = $1, % over $10,000
$20,000 to $40,000, tax = $3, % over $20,000.
$40,000 to $60,000, tax = $8, % over $40,000.
$60,000 to $80,000, tax = $13, % over $60,000.
$80,000 to $100,000, tax = $18, % over $80,000.
$100,000 to $150,000, tax = $23, % over $100,000.
$150,000 to $250,000, tax = $38, % over $150,000.
$250,000 to $500,000, tax = $70, % over $250,000.
$500,000 to $750,000, tax = $155, % over $500,000.
$750,000 to $1 million, tax = $248, % over $750,000
Over $1 million, tax = $345, % over $1 million

5. Example: Gift tax calculation and unified credit
Chuck made taxable gifts (after considering exclusions) of:
$525,000 of cash to his son in 2013
$200,000 of shares of stock to a good buddy in 2014
$2,000,000 of real estate to his girlfriend in 2015
$3,000,000 of artwork to his daughter in 2017
Prepare gift tax calculations for the four years For simplicity, assume unified credit was $2 million in 2013 to 2015
2013: Cumulative lifetime gifts $ 525,000
Gross tax on gifts 155,800+(.37)(25,000) $ ,050
less unified credit -2,000,000
Tax due $
2014: Cumulative lifetime gifts $725,000
Gross tax on gifts 155,800+(.37)(225,000) $ ,050
Tax due $ 5

6. Example: Gift tax calculation and unified credit
Chuck made taxable gifts (after considering exclusions) of:
$525,000 of cash to his son in 2013
$200,000 of shares of stock to a good buddy in 2014
$2,000,000 of real estate to his girlfriend in 2015
$3,000,000 of artwork to his daughter in 2017
Prepare gift tax calculations for the four years For simplicity, assume unified credit was $2 million in 2013 to 2015
2015: Cumulative lifetime gifts $2,725,000
Gross tax on gifts 345,800+(.4)(1,725,000) $ 1,035,800
less unified credit - 2,000,000
Tax due $
2017: Cumulative lifetime gifts $5,725,000
Gross tax on gifts 345,800+(.4)(4,725,000) $2,235,800
less unified credit (use actual 2017) - 2,185,800
Tax due $ 50,000 6

7. Requirements for a gift
Complete transfer of gift Loss of control over asset text p 18-7
- Revocable transfers not complete text p 18-15
- Revoke is to keep right to change (take back or amend) gift
- Retaining powers over future use of property not complete
- Donee must accept gift. If disclaimed, no transfer. text p 18-9
Of interest in property Not services
- Could be partial interest in property (see later)
For less than “adequate or full consideration” text p 18-7
- Not a sale (Part sale-part gift possible if sale price < value)
- Must be “disinterested generosity”, that is not compensation, not advertising or other ulterior motive.
- Satisfying a legal obligation is not disinterested, such as parent providing support of a minor child. text p 18-8

8. Exclusions from definitions of Taxable Gifts
Amounts paid directly to educational or medical organization for tuition or medical care on behalf of any donee. text p 18-8
Transfers to political organizations. text p 18-8
Transfers to charities and spouses are NOT excluded however the law allows an unlimited deduction text p 18-11, 20, Has same effect as an exclusion.
Special rule: Marital deduction not allowed for certain terminable interests. text p 18-22
Terminable if gift to spouse ceases at some future point and asset passes to donor or someone else.
Rationale: Without this, Chuck gives all assets to spouse for life and he directs that after spouse dies, assets transferred to children. Spouse’s estate wouldn’t include assets since not owned on death. This would eliminate gift & estate tax for Chuck & spouse.

9. Exclusions from definitions of Taxable Gifts
Annual exclusion allowed of $14,000 of gifts per donee (Same for , $15,000 for 2018) text p 18-10
- Must allow immediate use of gift Called a present interest.
Example: Joe puts $14,000 in a trust account for the benefit of Mary. The account restrictions are that Mary can’t withdraw anything until she is 25 years old. The annual exclusion would not be allowed.
- Exception: Trusts for minors can be set up to restrict access until Age 21 and still qualify for exclusion.
- Special rules for §529 plans: text p 18-11
1 - Annual exclusion applies even though restricted (Actually, not even a completed gift since donor can control.)
2 - Elect to treat single gift to as being made being made over 5 years. (Allows 5 annual exclusions.)

10. Other rules and situations
Gift Split election is allowed between spouses for gifts of “separate” property. text p 18-12
- Effect is to treat gift by one spouse as being made half by each spouse.
- This maximizes use of $14,000 annual exclusions and unified credits of both spouses.
- Elect each year on gift tax form 709.
Each spouse files own form and signs election on other’s form.
- No need to “split” gifts of community property.
By law, gifts are deemed given 50/50 by each spouse.
FYI: 9 states have community property laws which consider married spouses as a single “unit” . Income is considered as earned by the unit and property is owned by the unit. The other 41 sates are called “common law” states where each spouse is considered as an independent legal entity. text p 18-6

11. Other rules and situations
Gifts of partial interests in property possible - For life or for term of years or for remainder after life/term is over
- These are classified as present or future interests
- Value determined at date of gift, so use present values of future amounts. discussed in Ch 20 trusts
Joint bank accounts: No gift until donee withdraws money text p 18-17
Joint tenancy in property: Gift when tenancy created where donor pays for donee’s % in property. text p 18-6
Law typically has “right of survivorship” element (automatic ownership to survivor after other owner dies)

12. Other rules and situations
Naming beneficiary of life insurance is not a gift. (revocable)
- Irrevocably giving up right to change beneficiary and other ownership rights is gift. Text p 18-18
Called “incidents of ownership”.
- Value of gift = policy value at time of gift
If term insurance, value = cost of current policy premium.
This is easiest way to remove millions out of estate taxation. If “incidents” retained, estate value = payout at death. If gifted before death, nothing owned at death.

13. Filing requirements – Gift tax text p 18-12
Donor files return and pays tax. Donee does nothing.
File form 709 only if “taxable gifts” made during year or if an election is made
- Taxable means in excess of exclusions.
- File even if no tax is due to indicate use of the Unified credit.
- Elections made would be gift-split, 5 year spread on 529 plan or QTIP see text p 18-22
Gifts to spouse and charitable gifts don’t require filing.
709 due date is same as date of from 1040

14. Gift tax formula text p 18-4
A bit tricky due to changing rates and credit.
Current “taxable” gifts (Current transfers less exclusions, deductions)
+ “taxable” gifts from previous years
Cumulative lifetime gifts
Tax on Cumulative lifetime gifts
- Tax on total gifts from previous years
Tax on current “taxable” gifts
- (Current unified credit less credit used in prior years*)
TAX DUE for current year
*Called the “deemed paid” credit

15. ESTATE TAX Estate is an Entity created upon someone’s death
- Probate Estate (text p.18-14) takes title to property of decedent unless title is automatically transferred to another by means other than the will.
Joint with right of survivorship
Transfer on Death (TOD), Payable on Death (POD)
Living (revocable) trust
These will be discussed more later.
- Temporary life, usually 1 or 2 years.
- Executor(executrix) is specified in will to administer the estate
Pay debts, distribute property to heirs (beneficiaries), etc
- Testamentary transfers: Upon death pursuant to a will
- Intestate means no will exists upon death.
State Common law in then determines beneficiaries.

16. ESTATE TAX Items included in Estate for tax purposes:
- Probate or not, testamentary or not, include in gross taxable estate
Distinction between legal ownership rules and tax rules
- Tax law specifies what is included or excluded.
Valuation of items in taxable estate: text p 18-5
- Fair Market Value at date of death or
- Elect alternate valuation date 6 months later for all assets.
a) Available only if election reduces both estate valuation & tax.
b) Use date of disposal value if asset disposed before 6 months.
c) Value changes due to “mere lapse of time” are ignored.
- Elect Special Use valuation for certain real estate text Ch 19
Applies if decedent used property in business at less than best use. (Example: farm land in Brookfield)
Maximum reduction in value is $1.12 million (in 2017) year holding period required of heir.

17. Situations Where Transferred Property is Included Into Gross Estate:
Decedent kept an interest.
Gift taxes on prop or insurance given away w/in 3 yrs DOD.
Decedent retained economic benefit or enjoyment.
Annuities/life Insurance on decedent’s life.
Decedent kept power to change an interest.
Decedent had reversionary interest.
Joint owned property.
Decedent kept General Power of Appointment.
QTIP trust where spouse had claimed marital deduction.

18. Gross Estate for tax purposes includes:
§ Property owned outright at death. text p 18-14
§ Adjustments for gifts made within 3 years of death
- Add gift tax actually paid on all gifts in 3 year period.
- Add value at death for gifts which would have been in estate under §2036, 2037,2038, text p 18-15
EXAMPLE: Give up right to live in house for life in example below within 3 years of death.
§ Gifts where decedent retained a life interest. not in text
EXAMPLE: Give house to kids, but keep right to live there until death.

19. Gross Estate for tax purposes includes:
§ Reversionary interests where there is > 5% chance of reversion. not in text
EXAMPLE: Son gives house to mother, but get it back if she dies before donor. 5% chance calculated by actuarial tables.
§ Gifts where donor decedent kept power to alter, amend, revoke or terminate gift.
- Includes decedents ability to change who gets what.
- Considered “incomplete” transfers. See slide 7
Revocable (aka) “Living” trusts used to avoid probate, but are ignored for income and estate tax purposes. That is:
- No gift at creation,
- Income taxed to donor,
- Assets included in estate.

20. Gross Estate for tax purposes includes:
§ Value of survivor portion of annuity. text Ch 19
EXAMPLE: Upon death, transfer remaining pension to widow. Use PV factors to value remaining annuity at data of death.
§ Joint Interest portions included in estate: text p 18-16
a) Tenant in common = FMV of % share
No survivorship feature with this.
b) Community Property = 1/2 value.
c) Joint with spouse (aka Tenancy by the Entirety)
= 1/2 FMV
d) Joint with nonspouse = (FMV at death) x (% paid for asset by decedent)

21. Gross Estate for tax purposes includes:
§ General” Power of Appointment given by another.
a) FMV if power allows holder to appoint property to himself or his estate or his creditors. not in text
b) Not general if appoint to self if subject to ascertainable standard.
EXAMPLE - For health, education, maintenance or support. (HEMS). Happiness isn’t ascertainable.
c) Special power allows appointment others but not self.
Property not in estate if special power given by another.
Note: Property in estate per § 2038 if created by decedent.
§ Insurance proceeds if: text p 18-18
1) Proceeds payable to estate or
2) Decedent retained ability to change beneficiary, cancel or assign or borrow against policy. “incidents of ownership”

22. ESTATE Deductions text p 18-19
§ Liabilities, Funeral Expenses, Administrative Expenses
§ Casualty & Theft losses
§ Charitable & Political Contributions
Must be pursuant to will.
Executor can’t just decide to give to charity. If so, not deductible.
§ 2058 – State death taxes
§ Property left to spouse. (marital deduction) text p 18-21
Must not be a terminable interest to spouse unless QTIP election is made. text p (Qualified Terminable Interest Property)
Terminable means ends at some future time or event.
Cost of QTIP election is that estate of spouse is required to include value at their death in their estate.
No marital deduction to a spouse who is not a US citizen. However, large annual exclusion ($149,000 in 2017) text p 18-23

23. Credits against the Estate Tax text p 18-23
§ Unified credit See previous in chapter.
Election available by executor of first to die spouse to transfer unused portion of “exemption equivalent” of unified credit to surviving spouse. not in text
Referred to as portability election.
EXAMPLE – Husband died in 2011 when unified credit allowed $5.0 million value of transfers. His estate utilized $3.5 million. Portability election increases wife’s gift/estate exemption from tax by $1.5 million
Called the Deceased Spousal Unused Exclusion (DSUE).

24. Credits against the Estate Tax text p 18-23
§ Credit on prior transfers
Second to die estate gets credit for estate tax paid on assets included in first to die estate.
Reduced credit over 10 years from 1st to 2nd to die
EXAMPLE:
- Dad dies, leaves $10 million to son. Estate tax paid.
- Son dies shortly thereafter, leaves everything to the grandson.
Is it fair to tax it all again?
100% credit for dad’s tax against son’s estate tax if son’s death with 2 years. % after that.
§ Credit for foreign death taxes text p 18-24
Use lower of foreign tax or US tax on asset (calculation similar to foreign income tax credit in 405 class)

25. Filing requirements – Estate tax text p 18-25
Form 706 required if gross estate + lifetime taxable gifts exceed equivalent exemption amount ($5.49 million in 2017) text p 18-25
Must file in any case if portability election is to be made.
Return and payment due within 9 months after death.
- Special payment schedule can be used if large portion (35%) of estate is a closely held business text Ch 19

26. Estate tax formula text p 18-4 but not exactly correct
Estate tax formula text p 18-4 but not exactly correct. (Text over simplified a bit.)
Gross estate (Value of assets at death)
- Deductions for debts at death, marital & charity, etc
Taxable estate
+ Post 1976 “taxable gifts”
Tax base (Cumulative lifetime/deathtime transfers)
Tentative tax on total transfers
- Tax actually paid on lifetime gifts (recomputed using current rates)
Gross estate tax
- (Current unified credit (full amount), other credits)
NET ESTATE TAX DUE

27. Income Tax Basis in assets received text Ch 19
Gifted property is generally carryover from donor.
If gift tax paid, add allocated tax related to appreciation.
Inherited property is value.
Date of death or Alternate valuation date or Special use value.
Exception: One year rule of §1014(e). No step up of basis if:
- Gift received within 1 year of death
- Donor of gift inherits it back from decedent
Exception: Community property (1/2 automatically in estate)
- Surviving spouse basis = 100% of FMV in estate
Exception: Income in respect of a decedent (IRD)
- Income earned by decedent prior to death but not reportable due to method of accounting.
- Heir’s basis = decedents basis (carry over)
Pension, traditional IRA, installment notes, wages, annuities

28. GENERATION SKIPPING TAX (GST) text p 18-25
Additional tax besides the unified transfer tax.
Applies to lifetime, death time or subsequent transfers (called taxable terminations) where a younger generation is bypassed.
EXAMPLE 1: Grandma makes lifetime gift to grandson.
This would be called a direct skip.
EXAMPLE 2: Grandma’s will lists a bequest to grandson.
Also a direct skip.
EXAMPLE 3: Grandma (or her will) creates a trust with $3 million that gives income from trust to son over his life life. After son dies 40 years later, grandson receives $9 million appreciated value of assets in the trust.
Called Taxable Termination.
- No GST on creation (although this is a gift to son, grandson)
- On death, son’s estate does not include assets.
- Transfer to grandson is taxable termination taxed at GST rate.

29. GENERATION SKIPPING TAX (GST)
Flat rate = maximum estate rate (40%)
Separate GST Exemption is same as exclusion amount as the current estate/gift. $5.49 million in 2017.
GST tax actually paid on intervivos gifts is also considered a taxable gift.
Example: Grandma makes a $100,000 taxable gift (after annual exclusion) to grandson in Assume grandma has made millions of dollars of gifts in previous years and has used up her gift and GST exclusions.
GST = $100,000 x 40% = $40,000.
Gift tax = $140,000 x 40% = $56,000.
Total tax = $96,000

30. In all of the following, assume taxpayer died in 2017.
Taxpayer died with one asset, a mutual fund worth $6 million which cost $7 million. How much will be included for estate tax calculations? What will be the beneficiary’s basis? Slides 16, 27
Assume that the day after death, the mutual fund is worth $5.5 million. Does that change your answer? Slide 16 30

31. Taxpayer died with a farm in Brookfield
Taxpayer died with a farm in Brookfield. As a farm, it is worth $1 million. For development, it would be worth $2 million. Son wants to be a farmer. What is the value to be used for estate tax? Slide 16 31

32. Taxpayer is sickly and decided to gift a majority of her $14 million of assets and pay gift tax. In 2016 she made gifts of $10 million and paid $1.9 million in gift tax. Taxpayer died in with $2.1 million of assets. What will be effects of these transactions on the estate tax. Slide 18 32

33. Taxpayer had a $1 million term life insurance policy which named his son as beneficiary. Taxpayer can change the designated beneficiary at any time. How much will be included in calculating the estate tax on death. Slide 21
Assume that taxpayer above relinquished the right to change the beneficiary and other ownership rights 5 years ago. Effects then and now in year of death? Slide 21 33

34. What if taxpayer above relinquished the rights 2 years ago? Slide 18
In 2010, taxpayer transferred $1 million house to kids but retained the right to live in it for life. Value of life interest was $600,000. What are the effects in year of gift and year of death? The house was worth $1.5 million in Slide 18 34

35. Taxpayer gifted a house to mother valued at $1 million but required that he will get it back if she dies before him. Taxpayer died this year (Mom still lives.) Tax effects in year of gift and death? Slide 19
Taxpayer put $1 million cash in trust naming son as beneficiary. Taxpayer has right to change beneficiary. Taxpayer dies. Effects in year of gift and year of death? Slide 19 35

36. Taxpayer has pension which pays $2,000 per month for as long as she or her husband is living. Estate consequences on her death (He still lives.)? Slide 20
Taxpayer bought land with brother. The cost was $200,000. Taxpayer paid $150,000, brother paid $50,000. It was titled as joint ownership with right of survivorship. Taxpayer died when property was worth $600,000. Amount in estate? Slide 20 36

37. modified Taxpayer bought land with spouse. The cost was $200,000
modified Taxpayer bought land with spouse. The cost was $200,000. Taxpayer paid $150,000, spouse paid $50,000. It was titled as joint ownership with right of survivorship. Taxpayer died when property was worth $600,000. Amount in estate? Slide 20 37

38. Trust was set up by father. Son gets income for life. Son dies
Trust was set up by father. Son gets income for life. Son dies. A) What if son has the right to change remainder beneficiary to anyone he chooses? B) What if right excludes change to himself or his estate? C) What if right allows change to himself only if he needs more than the income to live? Slide 21 38

39. Executor decided to give all of decedent’s personal effects valued at $500 to charity. Effect on taxable estate? Slide 22
Husband died. Per an estate plan, his $2 million of assets were put in trust. Wife has a life interest and upon her death, the assets went to his children. Effect on his taxable estate? Slide 22 39

40. Mother and son were in a car accident
Mother and son were in a car accident. Mother’s $10 million estate had son as sole beneficiary. Mother died at scene. Son’s sole beneficiary was grandson. Son went into a coma and died 3 years later in the hospital. Is there any relief from double estate tax? Slide 24
Son gifted land valued at $1 million with a basis of $10,000 to father. Father died 6 months later and son inherited the land. What are the gift, estate and income tax effects? Slide 27 40