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Estate and Gift Taxation Law T 510 University of Washington School of Law LLM Program in Taxation Instructor: Dwight Dr

Estate and Gift Taxation Law T 510 University of Washington School of Law LLM Program in Taxation Instructor: Dwight Drake Winter 2009. Contact Info – Office Hours. Email: djdrake@u.washington.edu Phones: 206.616.6385, 425.281.1493, 425.222.5988, 360.778.1862

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Estate and Gift Taxation Law T 510 University of Washington School of Law LLM Program in Taxation Instructor: Dwight Dr

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  1. Estate and Gift Taxation Law T 510 University of Washington School of Law LLM Program in Taxation Instructor: Dwight Drake Winter 2009 Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  2. Contact Info – Office Hours • Email: djdrake@u.washington.edu • Phones: 206.616.6385, 425.281.1493, 425.222.5988, 360.778.1862 • URL:http://faculty.washington.edu/djdrake/EstateandGift/index.shtml • Office Hours: Room 416 - Wednesday 3:30 p.m to 5:00 p.m. - Whenever else you can catch me! Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  3. Course Objectives • Substantive knowledge base – Estate, Gift & Generation-Skipping Taxes • Enhance tax learning skills • Strengthen analytical, problem-solving skills • Importance of the planning process • Your individual role – design, not default Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  4. Core Knowledge Prerequisites • Estate and trust concepts and mechanics – we will look at 20 types of trusts • Basics of common business entities: - C Corporation - S Corporation - General Partnership - Limited Partnership - Limited Liability Company Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  5. Some Tips… • First: Beat Up Code. Learn to talk Code • Then Regs, Commentary and Cases to fill gaps for you. Learn what works for you. • Then: Beat up Code again • Work Study Problems Hard – First solo and slides • Focus in class • Think • Write your personal summary • Get ahead – Stay ahead! Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  6. Grade Criteria • 24 Hour Final – 100% • Use anything that isn’t living • Not a time for research • Nothing that hasn’t been covered in class • No tricks or gimmicks • Combination short essay and analytical problems Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  7. Federal Tax Sources 2001 2002 2003 2004 2005 2006 2007 Pers. Income 994.3 858.3 793.7 809.0 927.2 1,043.9 1,163.5 Corp. Income 151.1 148.0 131.8 189.4 278.4 353.9 370.2 Social Insurance 694.0 700.8 713.0 733.4 794.1 837.8 869.6 Excise Taxes 66.2 67.0 67.5 69.9 73.1 74.0 65.1 Estate & Gift 28.4 26.5 22.0 24.8 24.8 27.9 26.0 Misc. 57.2 52.5 54.4 53.9 56.4 74.0 65.1 Total Revenue 1,991.2 1,853.2 1,782.3 1,880.3 2,153.9 2,407.3 2,567.7 All in billions LLM Corporate Tax Instructor: Dwight Drake

  8. Estate Tax Agenda Exem. Eq. UC Max Rate • $1.5 million 47% 2006 $2.0 million 46% • $2.0 million 45% • $2.0 million 45% 2009 $3.5 million 45% 2010 N/A 0% 2011 $1.0 million 55% Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  9. Wealth Accumulation Non-Tax Planning Agenda - Last chance to spend it – Family priorities - Structural money planning - Basic Goal: Not outlive the money Taxable Planning Agenda - 1/3 of America’s income from capital - 1% own 56% of financial assets - 1/3 of America’s elderly have no income producing assets - Average 50 yr old has 40k in financial assets Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  10. Arguments For Estate Tax • Rich people tax – 5% pay 91% • Death is a great time to strike • Big bucks down the road: 2002- 2010: $294 billion 2011- 2021: $750 billion • We’re gonna need – Boomers are coming • Easy way to redistribute wealth – Person is dead! Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  11. Arguments Against Estate Tax • Wrong to cash-in on tragedy – Sick to face undertaker and taxman on same day • Peanut tax that does more harm than good • Costly to administer – valuation games • Will suck up needed investment capital in future – big damage to economy • Will solidify American’s position as worse savers in the industrial world • Destroys businesses and jobs Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  12. Dena & Mark • Both age 61 • 3 kids, 6 grandkids • Own ABC Inc. - 350 employees - Sales: $38 million - Net After-Tax Profit: $1.1 million - Owners Salaries: 400K Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  13. ABC Value • Adjusted EBITDA Calc: - Net After-Tax: $1,100,000. - Income Taxes: 560,000. - Interest 800,000. - Depr/Amort 340,000. - Owner Add-Back 200,000. Adjusted EBITDA $3,000,000. • EBITDA multiple: 6 • Sales Price: $18 million (1/3 cash; 2/3 stock) Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  14. Projected Estate Tax Hit If Keep • Assumptions: Other Assets = $2 million Full unified credits • Estate Tax: Last death 2009: $5,850,000. Last death 2010 or repeal: 0. Last Death 2011 or beyond: $9,380,000. Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  15. Tax Hits If Sell • Income tax on recognized sales proceeds: $3,400,000. • Potential future estate and gift taxes: $7,306,000. Total $10,706,000. Right? Wrong! Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  16. Dena & Mark Estate Plan Remainder Per. Res. Trust Family L.L.C. Daughter Trust Daughter Trust Term Use Invest. Assets Income Son Trust Home Char. Rem. Trust GC Trust - 1 LLC Units Dena & Mark Living Trust GC Trust -2 Stock GC Trust - 3 Income Remainder Charitable Deduct Cash GC Trust - 4 GC Trust - 5 Alma Maters Dynasty Trust Income, Support GC Trust - 6 Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  17. Dena & Mark Sell and… • Have solid income stream rest of lives • Two-third reduction in income tax hit on sale • Estate tax burden near-nada • Big time Heroes at Alma Maters • Huge Dynasty trust forever free of transfer taxes • Business is leaned, stripped • 210 employees soon lose job • Local vendors lose big customer • Dena & Mark miss action, age fast, die Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  18. Six Big Tax Tools • Annual Gift Tax Exclusion – Now 13k • Unified Credit – Now 3.5 mill • GST Exemption – Now 3.5 mill • Marital Deduction – Unlimited • Charitable Deduction • Valuation Games Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  19. The 20 Trust Agenda • Revocable living trust • Credit shelter trust • QTIP Trust • Clayton Trust • Bypass Trust • QDOT • Irrevocable life insurance trust • 2503(c) minors trust • 2503(c) gift trust • Dynasty trust • Charitable Annuity Trust • Charitable Unitrust • Charitable lead trust • Personal Residence Trust • Qualified Personal Residence trust • Qualified Subchapter S Trust • Electing Small Business Trust • Descendants’ Trusts • Grantor Retained Annuity Trust (GRAT) • Intentionally Defective Grantor Trust (IDGT) Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  20. Trust Lingo Players Trustor Settlor Grantor Honcho Trustee Fiduciary Title Holder Beneficiary Income Beneficiary Remainder holder Contingent, non-contingent He Who Sets Up Revocable or irrevocable Testamentary or inter vivos He Who holds legal title Mandatory Discretionary Ascertainable standard He Who Gets Benefits Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  21. Trust Mechanics • Legal document • Separate bank account • Transfer documents • Title insurance • Tax ID number • Separate tax return (Form 1041) • Trustee communications • Accounting requirements • Income distributions • Investment management • Fiduciary obligations • Corpus invasion issues • Trustee succession • Creditor protection and spendthrift limitations • Domestic vs. Foreign – Import Law vs. Export Assets Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  22. Trust Taxes • Three Income Tax Scenarios • Grantor Trust (671-678) –Income all taxes to Grantorby virtue of control. • Simple Trust – Income taxable to beneficiaries; distribution mandatory. • Complex trust – Income taxable to trust or Bs. T rate structure 15% to 35%. Max Rate kick in at low income level. • Estate Tax • Generally “any interest” per 2033. • Inclusion rules of 2035, 2036, 2037, 2038, 2041, 2043, 2044. • Gift Tax • All completed gifts • Present v. Future Interests • GST Tax • Transfers to skip persons • Direct skips, Taxable Terminations, Taxable Distributions Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  23. Gift Tax Computation Model • Value of gifts current year (§§2511-2519) • Annual exclusion (§2503(b)) • Marital & charitable deductions (§§2522 & 2523) • Taxable gifts from prior years • Item 1. plus 4. minus 2. minus 3 = “Taxable Gifts” • §2001(c) tax on 5. • §2001 (c) tax on 4. • Item 6 less 7 = “Gift Tax Pre-Credits” • Maximum gift tax unified credit (§2505) • Unified credit used in prior periods (§2505(a)(2) • Item 9 less 10 = “Available Unified Credit” • Credit for foreign gift taxes • Item 8 minus 11 and 12 = “Gift Tax Due” Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  24. Estate Tax Computation Model 1. Gross Estate - (§§2031-2046) 2. Gift taxes on gifts within 3 yrs – (§2035(b)) 3. Estate deductions – (§§2051-2058) 4. Sum of 1 & 2, less 3 = “Taxable Estate” 5. Taxable gifts post 12/31/76 not included in estate 6. Tax on sum of 4 & 5 = “Tentative Tax” (§2001(b)(1)) 7. Gift tax payable on post 12/31/76 gifts (§2001(b)(2)) 8. Subtract 7 from 6 = “Gross Estate Tax” 9. Compute and sum: - Unified credit (§2010) - Credit for pre-’77 gift taxes (§2012) - Credit for taxes on prior transfers (§2013) - Credit for foreign death taxes (§2014) 10. Subtract 9 from 8 = “Net Estate Tax” Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  25. Mildred’s 2001 Gift Current year gift: $2,400,000. Annual exclusion: 0. Deductions: 0. Prior years taxable gifts 0. §2001(c) Tax 976,800. Less: Unified credit 220,550. Gift Tax $ 756,250. Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  26. Fact Changes • Scenario 1: Mildred makes 2001 gift, dies in 2009 with taxable estate of $4.5 million • Scenario 2: Mildred makes no 2001 gift, dies in 2009 with taxable estate of $7,656,250. (Sum of $4.5 million and 2001 gift amount and gift tax) 2009 Estate Tax Hit Under Each? Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  27. Mildred 2009 Estate Tax Hit 2001 Gift No Gift Taxable Estate 4,500,000. 7,656,250. Post-76 Gifts 2,400,000. 0. Tentative Tax 2,985,000. 3,325,312. Post-76 Tax (960,000 – 220,550) 739,500. 0. Gross Estate Tax 2,245,500. 3,325,312. Unified Credit 1,455,800 1,455,800. Net Estate Tax 789,700. 1,869,512. Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  28. Recap Mildred Scenarios Gift No Gift Gift Tax Paid 756,250. 0 Estate Tax Paid 789,700. 1,869,512. Total taxes paid 1,545,950. 1,869,512. Difference: $323,562. WHY? Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  29. Jim’s 2004 Gift Taxes Gifts value $3,000,000. Annual exclusions 33,000. Deductions 0. Prior year taxable gifts 0. Taxable gifts 2,967,000. Tax under §2001(c) 1,244,960. Less: Unified Credit 345,800. Gift Tax 899,160. Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  30. Jim Dies 2009 - Estate Tax Taxable Estate: 9,000,000. Gift taxes within 3 yrs. 0. Post 76 Taxable gifts 2,967,000. Total 11,967,000. Tentative Tax 5,265,950. Tax on Gifts (1,215,950 – 345,800) 870,150. Gross Estate tax 4,395,800. Unified credit 1,455,800. Estate Tax 2,940,000. Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

  31. The GST Nightmare Grandparent gives 200k ball to grandchild - All unified credits and GST exemption gone - Max 2001(c) rate of 45% (2009 rate) Gift tax on transfer $ 90,000 GST tax on direct skip $ 90,000 The 2515 Whammy – Gift Tax on GST Tax (45% of 90k) $ 40,500 Total Transfer Taxes $ 220,500 Net Impact: Taxes equal to 110% of gift value Law T 510 - Estate & Gift Tax - Instructor: Dwight Drake

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