1. © 2007 ME™ (Your Money Education Resource™) Estate Planning for Financial Planners Chapter 6: Estate Tax

2. 2 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Introduction  See Estate Tax Formula

3. 3 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 The Gross Estate (1 of 2)  2033 – Property owned at death.  2034 – Dower & curtesy interests.  2035 – Gift tax paid within 3 years of death and gifts made within 3 years of death under 2036, 2037, 2038, and 2042.  2036 – Transfers with a retained life interest.  2037 – Transfers with a reversionary interest.

4. 4 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 The Gross Estate (2 of 2)  2038 – Revocable transfers.  2039 – Annuities.  2040 – Jointly owned property.  2041 – Powers of appointment.  2042 – Proceeds of life insurance.  2044 – QTIP Property.

5. 5 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2033 – Property Owned at Death  All property in which the decedent had an interest at death  Examples: cash, stocks, bonds, retirement accounts, autos, clothes, etc.  Rental income accrued before death.  Cash surrender value of a life insurance policy owned on the life of another.  State income tax refunds.  Medical insurance reimbursements.  Awards for pain and suffering (but not wrongful death).

6. 6 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2034 – Dower & Curtesy  Replaced by right of spouse to take against will No impact today on taxable estate

7. 7 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2035 – Three-Year Lookback  Any gift tax paid within three years. Not the actual gifts  Gifts given within the last three years if the gift was a: 2036 – transfer with a life estate. 2037 – transfer taking effect at death. 2038 – revocable transfer. 2042 – transfer of life insurance on the life of the decedent. Premiums paid on a policy not owned are not included.

8. 8 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2036 – Transfers with a Retained Interest  Property transferred where the decedent retained an interest. Express or implied understanding. Retained interest for life.  Transfer home to kids but retain life estate Retained interest for period not ascertainable without reference to death. Reserved for period that does not end before death.

9. 9 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2037 – Transfers Taking Effect at Death  Property transferred where: Possession of enjoyment requires the beneficiary to survive the decedent. Decedent has retained a reversionary interest.  Income to spouse, then back to you at spouse’s death Value of reversionary interest is > 5%. Moment immediately before death…no alternate valuation available. Back to you at grandkid’s death, value probably less than 5% so not included in estate

10. 10 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2038 – Revocable Transfers (1 of 2)  Interest subject to the power of the decedent to alter, amend, revoke or terminate. Get income from trust for life if don’t wear a Cubs hat  Also applies to affecting the time or manner of enjoyment of property or income, even if the identity of the beneficiary is not affected.

11. 11 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2038 – Revocable Transfers (2 of 2)  Does not apply if: Transfer was for full and adequate consideration, Power can only be exercised with the consent of all parties in the transferred property, or Power held solely by another person.

12. 12 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2039 – Annuities  Straight life annuity – Not included.  Survivorship annuity – Included. For portion of annuity value attributable to decedent’s contributions

13. 13 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2040 – Jointly Owned Property  JTWROS  Tenancy by the entirety Contribution rule  Spouses: each owns 50%  Others: 100% in estate unless show contributions by other joint owner

14. 14 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2041 – Powers of Appointment  General power of appointment Can appoint assets to yourself, creditors of your estate so included in estate  Except if the power is subject to an ascertainable standard. Health Education Maintenance Support Or exercise of power requires approval of an adverse party Or power limited to > 5% or $5,000 not included in estate

15. 15 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2042 – Proceeds of Life Insurance  Proceeds receivable by the decedent’s executor. Note: if beneficiary receives the proceeds but is required to remit money to the estate to pay taxes, debts, etc. then value of proceeds is included.  Decedent possessed an incidence of ownership in the policy. Own it or right to: change beneficiary, surrender or cancel policy, assign policy, revoke an assignment, pledge the policy for a loan.

16. 16 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 2044 – QTIP Property  Property for which a QTIP election was made in the gross estate of the first-to-die spouse. QTIP: generally income for life to spouse, then assets to kids  Normally wouldn’t qualify for marital deduction as surviving spouse doesn’t control disposition of assets at death  Since not taxed in estate of first to die; IRS wants inclusion in second to die estate

17. 17 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Valuation of Assets (1 of 3)  Fair market value at date of death or alternate valuation date (6 months from death)  Real estate Appraisals  Closely held business Valuation discounts Minority discount Lack of marketability discount Blockage discount Key person discount

18. 18 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Valuation of Assets (2 of 3)  Financial Securities Average of the High and Low FMV on the trading day Accrued Interest – Included in value Accrued Dividends – Included in value Stock that is not actively traded

19. 19 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Valuation of Assets (3 of 3)  Life insurance Cash surrender value – gifts and policies on others. Death proceeds – policies owned on the decedent’s life.

20. 20 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Alternate Valuation Date  6 months after date of death.  Executor must make the election by the filing date of the estate tax return.  Election must lower the gross estate and estate tax due.  Election applies to all assets in gross estate.  Exceptions Wasting assets  Installment sales, annuities Assets disposed of between death and alternate valuation date.

21. 21 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Deductions from the Gross Estate  Funeral expenses  Last medical expenses  Administration expenses  Debts  Losses during administration

22. 22 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Funeral Costs  Reasonable expenditures Funeral Burial plot Grave markers Transportation of body Future care of burial site

23. 23 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Last Medical  Costs related to last illness.  Cannot have been deducted on decedent’s final income tax return.

24. 24 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Administration Expenses  Expenses actually and necessarily incurred in administering the estate.  Examples are expenses related to Collection of assets Payment of debts Distribution of property Attorney and accounting fees Appraisal and valuation

25. 25 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Debts  Debts the decedent was obligated to pay.  Examples include: Outstanding mortgages Income Tax due Gift Tax due Credit Card Debts Monthly service providers (gas, electric, phone bills)

26. 26 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Losses During Administration  Casualty and theft losses if not compensated for the loss by insurance.  Must be incurred during the administration of the estate.

27. 27 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Estate Formula  Adjusted Gross Estate  Less Marital deduction – discussed in Chapter 10  Less Charitable deduction – discussed in Chapter 9  Equals Taxable Estate  Plus Post ‘76 gifts – added back to gross up  Equals Tentative Tax Base

28. 28 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Tentative Tax  See tax rate schedule

29. 29 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Credits  Applicable estate tax credit Covers $5,340,000 estate in 2014 Spouse’s unused estate tax credit covering up to an additional $5,340,000 estate can be used by surviving spouse Tax rate: 2013:40%  State death tax credit Repealed after 2005  Prior transfer credit Credit for estate taxes paid within the last 10 years See credit schedule on page 190  Foreign death taxes credit – tax paid on property outside the U.S.

30. 30 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Estate Tax Liability  Paid by executor or administrator.  If no executor or administrator, then person in receipt of the property must pay.  If the executor distributes to heirs before paying tax, then the executor may be personally liable.

31. 31 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Paying and Reporting Taxes (1 of 2)  Return Form 706 is due 9 months after death Extension to file (but not to pay) can be granted for an additional 6 months  Penalties Failure to file - 5% per month up to 25% Failure to pay - 0.5% per month up to 25% Failure to file is reduced by failure to pay

32. 32 © 2007 ME™ (Your Money Education Resource™) Updated on 12/12/06 Adjusted Taxable Basis to Heirs  Basis = FMV at death or alternate valuation date  Except: Gifts that revert back to the original owner that were transferred one year before death JTWROS Community property IRD  Holding period = long term