ACC 551: Chapter 14-Transfer Taxes and Wealth Planning

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Chapter 14 Transfer Taxes and Wealth Planning

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Learning Objectives Outline the basic structure of federal transfer taxes Describe the federal estate tax and the valuation of transfers, and compute taxable transfers at death and the federal estate tax Summarize the operation of the federal gift tax and the calculation of the federal gift tax Apply fundamental principles of wealth planning and explain how income and transfer taxation interact to affect wealth planning

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Federal Transfer Taxes Introduction Federal transfer taxes Estate tax Gift tax Generation Skipping Tax (GST) Definitions Intervivos transfers Testamentary transfers

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Federal Transfer Taxes Common Features Common tax rate schedule Applied to cumulative lifetime transfers Unified credit Prevent taxation of all but the largest cumulative transfers “Exemption equivalent” of $5 million is taxable amount of credit Unlimited charitable deduction Unlimited marital deduction for transfers to spouse

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Federal Estate Tax Designed to tax the value of property owned or controlled by an individual at death The Gross Estate 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

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Federal Estate Tax

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Federal Estate Tax The probate estate includes: Property in possession and control of the decedent at the time of death including: Cash Stocks Jewelry Clothing Property owned by or titled in the name of the deceased at the time of death The probate estate does not include property transferred automatically at the time of death (e.g., property held in joint tenancy)

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Federal Estate Tax Gross estate consists of: Fair market value of property possessed or owned by a decedent at death (the probate estate) plus Value of certain automatic property transfers that take effect at death The gross estate includes more property than the probate estate

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Federal Estate Tax Property interests dictate the type of testamentary transfer Tenants in common hold divided rights to property and have the ability to transfer these rights during their life or upon death Property held by tenants in common is transferred in probate Joint tenancy with right of survivorship transfers title automatically to the surviving tenant upon the joint tenant’s death no probate necessary so this type of property is specifically included in the gross estate

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Federal Estate Tax Property specifically included in the gross estate: Property owned by the decedent in joint tenancy with right of survivorship 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) (e.g., life insurance transferred within 3 years of death would be included in gross estate)

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Life insurance 21. Proceeds of a life insurance policy payable to the estate’s executor, as the estate’s representative, are a. Includible in the decedent’s gross estate only if the premiums had been paid by the insured. b. Includible in the decedent’s gross estate only if the policy was taken out within three years of the in sured’s death under the “contemplation of death” rule. c. Always includible in the decedent’s gross estate. d. Never includible in the decedent’s gross estate.

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Federal Estate Tax

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Gross estate 17. Following are the fair market values of Wald’s assets at the date of death: Personal effects and jewelry $1,750,000 Land bought by Wald with Wald’s funds five years prior to death and held with Wald’s sister as joint tenants with right of survivorship 3,800,000 The executor of Wald’s estate did not elect the alternate valuation date. The amount includible as Wald’s gross estate in the federal estate tax return is a. $1,750,000 b. $3,800,000 c. $5,000,000 d. $5,550,000

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Gross estate 15. Fred and Amy Kehl, both US citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. The gross estate of the first spouse to die a. Includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration. b. Includes only the property that had been acquired with the funds of the deceased spouse. c. Is governed by the federal statutory provisions relating to jointly held property, rather than by the decedent’s interest in community property vested by state law, if the Kehls reside in a community property state. d. Includes one-third of the value of all real estate owned by the Kehls, as the dower right in the case of the wife or curtesy right in the case of the husband

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Gross estate 16. In connection with a “buy-sell” agreement funded by a cross-purchase insurance arrangement, business associate Adam bought a policy on Burr’s life to finance the purchase of Burr’s interest. Adam, the beneficiary, paid the premiums and retained all incidents of ownership. On the death of Burr, the insurance proceeds will be a. Includible in Burr’s gross estate, if Burr owns 50% or more of the stock of the corporation b. Includible in Burr’s gross estate only if Burr had purchased a similar policy on Adam’s life at the same time and for the same purpose. c. Includible in Burr’s gross estate, if Adam has the right to veto Burr’s power to borrow on the policy that Burr owns on Adam’s life. d. Excludible from Burr’s gross estate.

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Basis for inherited property 10. Fred and Ethel (brother and sister), residents of a non community property state, own unimproved land that they hold in joint tenancy with rights of survivorship. The land cost $100,000 of which Ethel paid $80,000 and Fred paid $20,000. Ethel died during 2012 when the land was worth $300,000, and $240,000 was included in Ethel’s gross estate. What is Fred’s basis for the property after Ethel’s death? a. $140,000 b. $240,000 240,000 c. $260,000 +20,000 d. $300,000 260,000

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Federal Estate Tax Valuation Property is included in the estate at its fair market value at the date of the decedent’s death Fair market value is defined by the willing-buyer, willing-seller rule as – “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 having reasonable knowledge of the relevant facts” Executor can elect to value the estate on an alternate valuation date, six months after death, if it reduces the gross estate and the estate tax

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Alternate valuation 20. With regard to the federal estate tax, the alternate valuation date a. Is required to be used if the fair market value of the estate’s assets has increased since the decedent’s date of death. b. If elected on the first return filed for the estate, may be revoked in an amended return provided that the first return was filed on time. c. Must be used for valuation of the estate’s liabilities if such date is used for valuation of the estate’s assets. d. Can be elected only if its use decreases both the value of the gross estate and the estate tax liability

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Federal Estate Tax Taxable estate Administrative expenses, debts, losses, and state death taxes Unlimited marital and charitable deductions Computation of estate tax Adjusted taxable gifts Are taxable gifts other than gifts included in the gross estate Objective is to allow estate tax base to reflect all transfers

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Deduction from gross estate 18. Which one of the following is a valid deduction from a decedent’s gross estate? a. Foreign death taxes. b. Income tax paid on income earned and received after the decedent’s death. c. Federal estate taxes. d. Unpaid income taxes on income received by the decedent before death.

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Federal Estate Tax Under progressive tax rate schedule, adding adjusted taxable gifts is designed to increase the marginal tax rate on the estate To prevent double taxation of prior taxable gifts, the tentative estate tax is reduced by a credit for the taxes that would have been payable on adjusted taxable gifts under the current tax rate schedule The due date for the Federal Estate Tax return (Form 706) is exactly nine months after the decedent’s death

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Federal Estate Tax Unified credit Eliminates transfer taxes on estates with minimal lifetime and testamentary transfers 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 (deceased spousal unused exclusion amount or DSUEA)

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Federal Estate Tax EXHIBIT 25-5 THE UNIFIED CREDIT AND EXEMPTION EQUIVALENT

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Federal Gift Tax

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Federal Gift Tax Levied on individual taxpayers for taxable gifts completed during a calendar year Transfers subject to gift tax Imposed on intervivos gifts, and 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)

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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 individual

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Incomplete transfer 9. Raff created a joint bank account for himself and his friend’s son, Dave. There is a gift to Dave when a. Raff creates the account. b. Raff dies. c. Dave draws on the account for his own benefit. d. Dave is notified by Raff that the account has been created

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Federal Gift Tax Valuation of gratuitous transfers Gifts are taxed at the fair market value of the donated property on the date the gift becomes complete Despite the valuation of a gift at fair market value, the donee generally takes a carryover basis for income tax purposes Example: Donor makes a gift of property with a FMV of $20,000 and a basis of $12,000. The gift is considered to be $20,000 for gift tax purposes, but the donee’s income tax basis is $12,000.

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Federal Gift Tax Annual exclusion Most gifts are gifts of a present interest that qualifies for an annual exclusion of $13,000 (2012) 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 A gift of a future interest does not qualify for exclusion

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Exclusion 2. In 2012, Sayers, who is single, gave an outright gift of $50,000 to a friend, Johnson, who needed the money to pay medical expenses. In filing the 2012 gift tax return, Sayers was entitled to a maximum exclusion of a. $0 b. $12,000 c. $13,000 d. $50,000

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Exclusions 7. Jan, an unmarried individual, gave the following outright gifts in 2012: Donee Amount Use by donee Jones $15,000 Down payment on house Craig 14,000 College tuition Kande 5,000 Vacation trip Jan’s 2012 exclusions for gift tax purposes should total a. $32,000 b. $31,000 c. $29,000 d. $18,000

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Future interest 3. During 2012, Blake transferred a corporate bond with a face amount and fair market value of $20,000 to a trust for the benefit of her sixteen-year old child. Annual interest on this bond is $2,000, which is to be accumulated in the trust and distributed to the child on reaching the age of twenty-one. The bond is then to be distributed to the donor or her successor-in-interest in liquidation of the trust. Present value of the total interest to be received by the child is $8,710. The amount of the gift that is excludable from taxable gifts is a. $20,000 b. $13,000 c. $ 8,710 d. $0

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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 divorced 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

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Gift splitting 1. Steve and Kay Briar, US citizens, were married for the entire 2011 calendar year. In 2011, Steve gave a $30,000 cash gift to his sister. The Briars made no other gifts in 2011. They each signed a timely election to treat the $30,000 gift as made one-half by each spouse. Disregarding the applicable credit and estate tax consequences, what amount of the 2011 gift is taxable to the Briars? a. $30,000 Steve Kay b. $ 6,000 30,000 c. $ 4,000 -15,000 15,000 d. $0 -13,000 -13,000 2,000 2,000

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Federal Gift Tax Marital and charitable 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

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Marital deduction 8. When Jim and Nina became engaged in April 2012, Jim gave Nina a ring that had a fair market value of $50,000. After their wedding in July 2012, Jim gave Nina $75,000 in cash so that Nina could have her own bank account. Both Jim and Nina are US citizens. What was the amount of Jim’s 2012 marital deduction? a. $ 63,000 b. $ 75,000 c. $113,000 d. $125,000

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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 Gift tax calendar-year return is due by the following April 15th

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Federal Gift Tax Unified credit Gift tax formula requires donors to keep track of the portion of the unified credit they used to offset prior taxable gifts, in order to prevent multiple applications of the credit Gift tax on previous gifts are computed using the current tax rate schedule and ignoring the use of the unified credit

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Return filing 6. On July 1, 2011, Vega made a transfer by gift in an amount sufficient to require the filing of a gift tax return. Vega was still alive in 2012. If Vega did not request an extension of time for filing the 2010 gift tax return, the due date for filing was a. March 15, 2012. b. April 15, 2012. c. June 15, 2012. d. June 30, 2012.

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Return filing 5. Which of the following requires filing a gift tax return, if the transfer exceeds the available annual gift tax exclusion? a. Medical expenses paid directly to a physician on behalf of an individual unrelated to the donor. b. Tuition paid directly to an accredited university on behalf of an individual unrelated to the donor. c. Payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor d. Campaign expenses paid to a political organization.

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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 Bypass provisions Reduces estate taxes by using the unified credit of the deceased spouse, transferring some property to beneficiaries other than the surviving spouse

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Wealth Planning Concepts The Step-up in tax basis Testamentary transfers allow a step-up in tax basis to fair market value, thereby eliminating income tax on unrealized appreciation Lifetime gifts eliminate transfer taxes on post gift appreciation, but donee has carryover basis

Summary: ACC 551-Ed Foth Last Updated: 6/27/12

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