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Wealth Transfer Taxes. Chapter 12. History. The U.S. has had an estate tax since 1916 and a gift tax since 1932 In 1976, Congress enacted the unified transfer tax system with unified graduated tax rates, ranging from 18% to 55%

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Wealth Transfer Taxes

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Wealth Transfer Taxes

Chapter 12


  • The U.S. has had an estate tax since 1916 and a gift tax since 1932

  • In 1976, Congress enacted the unified transfer tax system with unified graduated tax rates, ranging from 18% to 55%

  • In 2001, Congress voted to reduce top rates gradually until they reach 45% in 2007

    • Estate tax will be repealed in 2010, but gift tax will be retained (sunset provisions automatically reinstate prior law in 2011)

Transfer Tax Features

  • Tax is assessed on transferor (donor or estate), not recipient

  • Base for tax is fair market value of property transferred

  • Gift tax is cumulative over lifetime

    • Gifts given in later years are taxed at higher marginal tax rates

    • Total taxable gifts cause the decedent’s estate to be taxed at higher marginal tax rates

Major Exclusions

  • Annual gift tax exclusion is $11,000 per donee per year

    • If all gifts are less than exclusion, no gift tax return has to be filed

  • Unified credit – lifetime transfer tax exclusion

    • The 2004 unified credit for an estate is $555,800 which is equivalent to tax on $1.5 million (referred to as exemption equivalent)

    • For lifetime gifts the exemption equivalent is $1 million

Transfers Subject to the Gift Tax

  • Gifts made directly or in trust and include gifts of all types of property whether real, personal, tangible, or intangible

    • Services are not taxable

  • A gift could result from the creation of a trust, the forgiveness of debt, or the assignment of benefits in a life insurance policy

Transfers forInsufficient Consideration

  • A transfer is subject to gift tax if the value of the property transferred exceeds the value of money or other consideration given

  • Gift = difference between the sales price and the FMV on the date of the transfer

  • A transfer made in a bona fide business transaction with no donative intent is not a gift

Joint Property Transfers

  • If funds are placed into a joint bank account by a donor in the name of the donor and one or more other persons, no gift occurs at that time

    • A gift occurs when one party withdraws an amount in excess of the amount that person deposited

  • A gift occurs when an individual adds another person’s name to the title of real property

    • Gift = value of other person’s interest

Life Insurance Transfers

  • Naming someone as beneficiary of a life insurance policy is not a gift

  • When all rights of ownership (right to borrow against policy, cash in for cash surrender value, and change the beneficiary) are assigned to another, a gift equal to the cost of a comparable policy is made

    • Paying the premium on a policy owned by another is a gift

Transfers to a Trust

  • A trust is a legal arrangement involving three parties

    • Grantor – the one who transfers assets that become the corpus or principal of the trust

    • Trustee – the one who holds legal title to the assets and makes investment decisions

    • Beneficiary – the one who receives the legal right to the beneficial enjoyment of income or corpus

Transfers to a Trust

  • Income beneficiary – the one who has the right to receive income generated by the trust assets

  • Remainder interest – the one who has the right to receive trust assets upon termination of the trust

  • Parents who want to transfer assets to a minor child can use a Uniform Transfers to Minors Act (UTMA) account

    • Grantor-parent can be trustee and maintain control over the property

Cessation of Donor’s Control

  • A transfer is not a gift if the donor retains an interest in the transferred property; for example, if the donor retains the right to change trust beneficiaries or decide how much beneficiaries will receive

    • A transfer to a revocable trust is not a gift (but actual transfer of income is a gift)

  • Transfer of assets into an irrevocable trust is a gift

    • A trust is irrevocable when the grantor gives up all future control

Transfers Excluded from Gift Tax

  • Transfer of marital property pursuant to a divorce

  • A transfer to meet support obligations (as determined by state law)

  • Direct payment of medical or tuition expenses

    • Payment must be made directly to the educational institution (tuition is excluded, but payment for room, board and books is a gift) or the person providing medical care

  • Contributions to political organizations

Valuation of Gift Property

  • Gifts are taxed on FMV at the date of the gift

  • FMV is price that would be arrived at by a willing buyer and willing seller in an arm's length agreement when neither is under compulsion to buy or sell

    • FMV is not a distressed sale price or wholesale value

  • Stock or securities sold on an established securities market are valued at the average of the high and low price on the date of the gift

Annual Gift Exclusion

  • Annual gift tax exclusion ($11,000) only allowed for gifts of present interest

  • Present interest includes

    • Outright transfers

    • Life estates (right for life)

    • Term certain interests (right for specific time)

  • Future interests are not eligible

    • Remainder interests

    • Reversions

Gifts to Minors

  • Section 2503(c) minors trusts qualify for annual gift tax exclusion if

    • Trustee may pay out income and/or trust assets before beneficiary reaches 21

    • Remaining assets and income must be distributed to the child when the child reaches age 21 (or to the estate if minor dies before age 21)

Gifts to Minors

  • Crummey trust – transfers qualify for annual exclusion if the trust has an annual demand provision (no distribution required at 21)

  • Transfers to Coverdell education savings accounts qualify for annual exclusion

  • Transfers to qualified tuition programs (Section 529 plans) eligible for annual exclusion

    • Election can be made to spread gift over 5 years; thus up to $55,000 can be transferred at one time with no gift tax consequences (provision can be used only once every 5 years)

Gift Splitting

  • Allows spouses to combine their $11,000 exclusions so together they can together 22,000 per donee per year by treating each gift as if half made by each spouse

    • Requires consent of both spouses

    • Applies to all gifts made during that year (or during time they are married)

    • Requires filing a gift tax return

Gift Tax Deductions

  • Charitable deduction – unlimited gifts to qualified charitable organizations (after subtracting annual exclusion)

  • Marital deduction – unlimited gifts to spouse (after subtracting annual exclusion)

    • Similar deduction allowed for estates; thus no estate tax owed if entire estate left to spouse

Computing Taxable Gifts

Includible current gifts

Plus: Half of spouse’s gifts (if gift splitting)

Less: Half of taxpayer’s gifts (if gift splitting)

Less: Annual exclusions

Less: Charitable and marital deductions

Equals: Taxable gifts for current period

Plus: Taxable gifts in previous periods

Equals: Cumulative taxable gifts

Computing Gift Tax Payable

Gift tax on cumulative taxable gifts

Less: Gross gift tax on previous taxable gifts

Less: Available unified credit

Equals: Gift taxes payable on current period’s gifts

  • Gift tax return due by April 15 of following year (eligible for same extension as for individual income tax return)

Gift Tax Return

  • Form 709 gift tax return must be filed if there were any of the following transfers

    • Transfers of present interests in excess of the annual exclusion ($11,000)

    • Transfers of future interests

    • Transfers to charitable organizations in excess of annual exclusion

    • Transfers with gift splitting elected

Tax Consequences for Donees

  • Donor’s adjusted basis (and holding period) generally carries over to the donee

    • If appreciated property, basis increased by proportionate amount of gift tax paid on appreciation

    • If FMV is less that basis, lower FMV is used to determine loss on subsequent disposition

Kiddie Tax

  • Under the kiddie tax, unearned income (in excess of $1,600) of children under age 14 is taxed at their parents’ marginal tax rate

    • First $800 covered by standard deduction

    • Second $800 (and all earned income) taxed at child’s tax rates

Education Savings Plans

  • Earnings are not currently taxed and is never subject to tax to the extent income is used for qualified education expenses

  • Section 529 qualified tuition plan

    • No annual limit on contributions

    • Can change beneficiary

    • Donor can cash out account by paying income tax + 10% penalty

Education Savings Plans

  • Coverdell education savings accounts

    • Annual contribution limit of $2,000 (phased out as modified AGI exceeds $95,000 if single or $190,000 for married couples)

  • Donor can contribute to both types of savings plans for same child in same year

  • Other relatives (grandparents) can also use these plans to save for a child’s education

The Estate Tax

  • The estate tax is a tax levied on the right of a decedent to transfer of property to beneficiaries or heirs upon his or her death

  • Anestateis created at an individual’s death to own and manage the decedent’s property until ownership of the property is transferred to the beneficiaries or heirs

  • Estate taxes are levied on the value of all property owned by a decedent and transferred at the decedent’s death

  • The estate pays the tax

The Taxable Estate

  • Steps to compute the taxable estate

    • Identify and value the assets included in the gross estate

    • Identify the deductible claims against the gross estate and deductible expenses of estate administration

    • Identify any deductible bequests

  • The gross estate includes all property and property interests of the decedent

  • Probate

    • Probate – the process under state law by which a will is declared legally valid and decedent’s property is transferred to the beneficiaries

      • Probate estate includes only the property governed by the will (or the state’s intestacy laws if there is no valid will) and does not include property transferred by law

    • Gross estate includes property that transfers by will and by law

    Living Trust

    • One strategy for avoiding probate costs is to use a living trust that holds title to all of the individual’s assets and specifies how they are transferred at death

      • The will only needs to designate the treatment of any asset not in the trust

      • Unlike a will, a living trust is not a public document

      • Property in a living trust is must be included in the gross estate

    The Gross Estate

    • Gross estate includes all property in which the decedent had an interest and may include some items not actually owned by the decedent at death

      • Gifts with strings attached (decedent retained right to income or right to designate who may enjoy property)

      • Transfers in which the decedent possessed the right to alter, amend, revoke, or terminate the terms of the transfer

    Life Insurance Proceeds

    • Included in the gross estate if:

      • Decedent’s estate is the beneficiary or

      • Decedent possessed any incident of ownership at death (power to change the beneficiary, surrender or cancel the policy, assign the policy, revoke an assignment, pledge the policy for a loan, or obtain a loan from the insurer against the surrender value of the policy)

    • Insurance is included in the estate if it was transferred by gift within 3 years of death

    Valuation Issues

    • The gross estate includes the value of all property, regardless of location, as of date of death

    • Alternative valuation date is 6 months after the decedent’s date of death

      • If elected it applies to all assets

      • Gross estate and estate tax must both be reduced to use the alternate date

      • If assets are sold prior to alternate date, they are valued at date of sale

    Valuation Issues

    • Market price method – used for stocks, bonds, and real estate

      • Stocks valued at average of their high and low selling prices on valuation date

    • Actuarial valuation used for annuities, life estates, terms certain and remainder interests

    • Capitalization of earnings used when valuing businesses

    Estate Deductions

    • Any debts of the decedent and claims against property included in the gross estate

    • Funeral expenses and administrative costs of settling the estate

    • Casualty and theft losses incurred during the administration of the estate

    • Bequests to charitable organizations

    • Property transferred to surviving spouse

      • Qualified terminal interest property (QTIP) trust allows the decedent to exclude value of property transferred in trust to spouse

    Computing Estate Tax

    Gross estate

    Less: Deductible expenses, debts, taxes, losses

    Less: Charitable deduction

    Less: Marital deduction

    Equals: Taxable estate

    Plus: Adjusted taxable gifts - prior periods

    Equals: Tax base

    Computing Estate Tax

    Gross estate tax

    Less: Gift tax on prior gifts

    Less: Unified credit

    Less: Other allowable credits

    Equals: Net estate tax liability

    • Estate tax return, Form 706, due 9 months after death (6 month extension possible)


    • Generation skipping transfer tax applies a separate flat tax at the highest transfer tax rate (48%) when a transfer skips a generation

      • A direct transfer from grandparent to grandchild is a generation skip

    • $1,500,000 GSTT exemption is allowed each each grantor in 2004

    Benefits of Planned Giving

    • Transfer of investment property (bonds) allows a family to shift income to lower-bracket family members but offers few transfer tax benefits if there are small differences between current and future value

    • Transfer of equity interest in flow-through entity offers both current income tax and future transfer tax benefits

      • Buy-sell agreement

      • Gift-leaseback arrangement

    Advantages of Lifetime Gifts

    • Shield post-gift appreciation from estate taxes (taxed on date of gift value)

    • Take advantage of annual exclusion and gift-splitting

    • Nontax advantages of trusts

      • Protects property from creditors

      • Shields assets from public scrutiny

      • Allows ease of management for multiple beneficiaries

    Disadvantages of Lifetime Gifts

    • Carryover basis on gift property

      • If donor had retained property until death, basis would have been stepped up to FMV

    • Early payment of transfer taxes

      • Estate tax exemption increases to $2 million for 2006-2008 and $3.5 million in 2009 while lifetime gift exemption remains at $1 million

    Fiduciary Income Tax Issues

    • The decedent’s final income tax return extends from date of the last tax return to the date of death

    • Income in respect of decedent (IRD) – income earned by cash-basis decedent but not received prior to death is taxed to whoever receives it

      • Examples: unpaid salary, interest, dividends, retirement plan income

      • Decedent’s basis carries over and character of income also carries over

    Fiduciary Income Tax Issues

    • Deductions in respect of decedent (DRD) – expenses or liabilities incurred by cash-basis decedent but not paid prior to death are deductible by party legally required to pay them (usually estate)

      • Examples: property and state income taxes

    Basis Issues

    • Basis of inherited property is its fair market value as of the valuation date used for estate tax purposes

    • The basis rules will change in 2010 (if estate taxes are repealed) to a modified carryover basis rule

      • $1.3 million of basis can be added to certain assets

      • $3 million of basis can be added to assets transferred to a surviving spouse

      • Basis increase cannot increase property to more than FMV

    Income Taxation of Trusts and Estates

    • Fiduciaries (estates and trusts) are taxed following a modified conduit approach that taxes the fiduciary only on income it retains, not on income that it distributes to the beneficiaries

    • Beneficiaries are taxed on income distributed to them

    • Character of income is determined at fiduciary level and retains this character when distributed to beneficiaries


    • Grantor trust – grantor retains some incident of ownership (such as reversionary interest) and income is taxed to the grantor

    • Simple trust – must distribute all of its accounting income annually to its beneficiaries; cannot make charitable contributions

    • Complex trust – any trust that is not a simple trust (estates are considered complex trusts)

    Fiduciary Income Taxation

    • Fiduciary gross income is computed using rules similar to individual income taxation

    • Deductions allowed for expenses of producing taxable income, depreciation, administrative expenses, and charitable contributions

      • Simple trusts allowed $300 exemption

      • Complex trusts allowed $100 exemption

      • Estates allowed $600 exemption


    • Distributable net income (DNI) is the current increase in value available for distribution to income beneficiaries

      • DNI determines the fiduciary’s maximum distribution deduction

      • DNI determines beneficiary’s maximum taxable income

      • Character is retained so beneficiaries do not pay tax on tax-exempt income

    Fiduciary Income Tax Rates

    • 2004 Rates

      • 15% on $0 - $1,950

      • 25% on $1,951 - $4,600

      • 28% on $4,601 - $7,000

      • 33% on $7,001 - $9,550

      • 35% over $9,550

    • Because beneficiaries are usually in lower marginal tax brackets, distributing the income annually to beneficiaries usually results in lower taxes overall

    Fiduciary Income Taxation

    • A trust is required to file a Form 1041 by April 15 of the following calendar year if it has gross income of $600 or more

    • Any estate with gross income of $600 or more is required to file a Form 1041 by the 15th day of the 4th month following the close of its tax year

    • Beneficiaries report their share of income based on the fiduciary’s tax year that ends within the beneficiary’s tax year

    Distributions to Beneficiaries

    • When property is distributed to trust beneficiary, generally no gain or loss is recognized by the trust for difference between FMV and basis

      • Beneficiaries use trust’s adjusted basis

      • If property satisfies a required income distribution, distribution deduction limited to lesser of property’s basis or its FMV (beneficiaries still use basis)

    Distributions to Beneficiaries

    • Trustee can elect to recognize gain on distribution of appreciated property

      • Beneficiary’s basis is FMV

      • If trust has unused capital losses, it can net these losses against any capital gains resulting from the election

    The End

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