CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Estate Planning

1. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning Module 5 Estate Planning Issues Related to Generation-Skipping Transfer Tax & Income Tax

2. Learning Objectives 5–1 Identify the purpose and basic features of the federal generation-skipping transfer tax (GSTT).  5–2 Analyze a situation to identify types and consequences of transfers that are subject to the federal generation-skipping transfer tax (GSTT). 5–3 Analyze a situation to calculate the federal generation-skipping transfer tax (GSTT). 5–4 Analyze a situation to identify the income tax implications of an estate transfer technique.

3. Questions to Get Us Warmed Up

4. Generation-Skipping Transfer Tax (GSTT) Nature & Incidence • tax on transfer of wealth (during life or at death) to persons who are deemed to be two or more generations younger than the transferor • GSTT in addition to any gift or estate tax due on the transfer • GSTT exemption is same as estate tax exclusion amount; cumulative over a lifetime • taxed at top regular estate tax rate for year of transfer

5. Generation-Skipping Transfer Tax (GSTT) Skip Persons • Is a transferee of property who is deemed to be two or more generations younger than the transferor or the transferor’s spouse. • If transferee (or the transferee’s spouse) is a lineal descendant of a grandparent of the transferor or the transferor’s spouse, generations are determined by comparing the number of generations from such grandparent to the transferor versus the transferee. • If the transferee is not a lineal descendant of a grandparent of the transferor or the transferor’s spouse, transferee must be more than 37.5 years younger than transferor or transferor’s spouse. • A trust can be a skip person if the only beneficiaries with a current interest in trust assets are all skip persons; if there are no beneficiaries with a current interest, the trust can still be a skip person if all future distributions from the trust can be made only to skip persons.

6. Lineal Descendant Skip Parties

7. Non Lineal Descendant Skip Parties Persons identified in shaded boxes are not considered part of the lineal line and follow the unrelated party rules. Whether the individuals in the gray shaded boxes are skip individuals will depend on age.

8. Generation-Skipping Transfer Tax (GSTT) Nonskip Person • Is a transferee of property who is deemed to be less than two generations younger than the transferor or the transferor’s spouse. • Defined by the IRC as anyone who is not a skip party; thus, if the transferor has retained an interest in the property, the transferor can be a nonskip party. • Transferor’s spouse or former spouse is always considered a nonskip person regardless of the age difference with the transferor.

9. GSTT: Exempt Transfers • direct and exclusive payment of • medical expenses • tuition expenses • transfers to • a spouse or former spouse • to a charity (most) • individuals deemed to be less than two generations younger than the transferor • lifetime direct skip transfers of a present interest under the maximum annual exclusion amount

10. GSTT: Deceased Ancestor/Parent Skip Rule To a Lineal Heir • transferee must be a lineal descendant of a parent of the transferor or transferor’s spouse • parent of the transferee must be deceased at earliest time the transfer is subject to gift or estate tax (completion of the gift or date of death, respectively) • skip party will move into the deceased parent’s generation, which may avoid the GSTT To a Collateral Heir • transferee must be lineal descendant of transferor’s parent, but not a lineal descendant of the transferor • in addition to above, transferor must have no living lineal descendants at completion of the transfer

11. GSTT: Direct Skips • can occur during life or at death • in addition to gift or estate tax • can be in trust or outside of trust • determining factor: only skip parties have a current beneficial interest in the transferred property • reported on either gift tax or estate tax return • tax, if any, will be due at same time as gift or estate tax on the transfer

12. GSTT: Indirect Skips • can occur during life or at death • usually occurs in trust, but can be outside of trust • determining factor: at least one non-skip party has a current beneficial interest in the property after the transfer; at least one skip party must have an interest in the transferred property • will be in addition to gift or estate tax, and will be reported on same return, but tax, if any, will not be due at the same time • GSTT will be due upon taxable termination or distribution

13. GSTT Taxable Termination • occurs upon the termination of the beneficial interests of all non-skip parties in property that is the subject of an indirect skip, whether by death, lapse of time or otherwise Taxable Distribution • occurs upon the actual distribution of property that is the subject of an indirect skip to a skip party other than as a result of a taxable termination

14. GSTT: Reverse QTIP Election • can be made when remainder beneficiaries of QTIP trust are skip persons in relation to the transferor and the transferor’s spouse, and the regular QTIP election has been made • must be made on the same return as the regular QTIP election • reverses the presumption that the grantor’s spouse is the transferor of the trust assets to the remainder beneficiaries at death (because trust assets must be included in spouse’s gross estate by IRC 2044) • grantor then becomes the transferor to the skip persons and can thus assign his/her GSTT exemption • saves GSTT exemption of spouse for subsequent transfers

15. Generation-Skipping Transfer Tax (GSTT): Exemption • Is a cumulative lifetime exemption for each transferor in the amount of the current estate tax exclusion amount. • Deemed allocation rules automatically apply sufficient exemption (if available) to prevent payment of tax unless transferor (or PR) affirmatively elects otherwise. • If sufficient exemption is allocated to cover the taxable amount on the first gift or estate tax return on which the transfer is reported, all future distributions will be free from payment of tax even if transferred amount increases in value. • If transferred amount would have to be included in transferor’s gross estate (estate tax inclusionary period-ETIP) exemption cannot be allocated until ETIP ends.

16. Question 1 Which one of the following is a true statement about taxable distributions? • The return used to report a taxable distribution is the federal estate tax return, Form 706. • The trust involved in a taxable distribution is responsible for paying any GSTT due. • Each skip person who received a taxable distribution is responsible for paying the GSTT due. • If the skip person is incompetent, it is the responsibility of the fiduciary of the trust making a taxable distribution to pay the GSTT out of additional trust funds.

17. Question 2 A transfer where at least one non-skip party has a current interest in the transferred property after completion of the transfer is known as • an indirect skip. • a taxable distribution. • a taxable termination. • a direct skip.

18. Question 3 Which one of the following is a true statement about the GSTT? • Only that part of a gift that will go to non-skip parties is subject to the GSTT. • GSTT due on an indirect skip is reported when the gift is given on Form 706 or Form 709. • The transferor reports the GSTT due on an indirect skip and the federal gift or estate tax due on the transfer at the same time. • GSTT on indirect skips cannot be immediately determined upon completion of the transfer.

19. Question 4 Which one of the following is the valuation date used to establish the value of property transferred during the life of the transferor whenever an indirect skip is involved? • the date of completion of the transfer • the date a taxable distribution or termination occurs • the date that the direct skip portion of the transfer occurs • six months after the actual date of transfer

20. Question 5 With respect to the GSTT, which one of the following is an election that allows the donor or decedent’s estate to be deemed the transferor of property that qualifies as an indirect skip? • gift tax election • QTIP election • reverse QTIP election • marital deduction election

21. Question 6 Which one of the following is not a prerequisite for application of the GSTT? • gratuitous completed transfer • transferee deemed to be two or more generations younger than the transferor • transfer qualifies as a direct skip transfer • no exceptions or exemptions from the normal rules apply

22. Question 7 The applicable credit amount can be applied to offset generation-skipping transfer taxes, gift taxes, or estate taxes. True False

23. Question 8 If generations are determined by age, for the GSTT to apply, the transferee must be • 32½ years younger than the transferor. • more than 32½ years younger than the transferor. • 37½ years younger than the transferor. • more than 37½ years younger than the transferor.

24. Question 9 Taxable terminations occur when non-skip parties no longer have an interest in the trust property, whether or not an actual distribution of trust property is made to a skip party. True False

25. Question 10 When transferred property is subject to an estate tax inclusion period (ETIP) the GSTT exemption cannot be assigned until the ETIP period ends. True False

26. Income Tax: Goals Related to Capital Gains • delay or avoid the realization or recognition of capital gain • timing an event to realize long-term (more than one year) rather than short-term gain • shaping an event to qualify for a deferral of the recognition of gain • selecting an asset for transfer that will generate the smallest amount of gain • shaping a transaction so that the gain will be realized by a taxpayer in a lower marginal income tax bracket

27. Income Tax: Goals Related to Ordinary Income • have the income taxed at a lower marginal rate • have income taxed to several different persons or entities to take advantage of multiple personal exemptions and to take another “run up the rate ladder” • avoid alternative minimum tax (AMT), excess accumulations tax, and personal holding company tax • shift receipt/taxation of future income

28. Income Tax: Basis Rules Property Received by Gift • carryover of donor’s basis to donee, except where “loss” property is given and donee subsequently sells property at a loss, in which case the donee’s basis is the fair market value of the property at the time of the gift • if donor (or donee in a net gift situation) pays gift tax out of pocket on the gift, donee may increase the donor’s adjusted basis by such taxes as are attributable to previously unrealized appreciation

29. Donee’s Basis in Loss Property Tony gives Bob an asset with a date-of-gift fair market value of $80,000. Tony has an adjusted basis in this asset before the gift of $100,000. If Bob sells the asset for $70,000, Bob will use the date-of-gift fair market value of $80,000 to compute a $10,000 loss. If Bob sells the property for $90,000, there will be neither gain nor loss. If Bob sells the property for $110,000, Bob will use Tony’s adjusted basis of $100,000 to compute a $10,000 gain. Bob sellsfor $70,000 $80,000 ondate of gift Bob sellsfor $90,000 $100,000 basison date of gift Bob sellsfor $110,000 Bob incurs no gain or loss $10,000 loss Bob incurs$10,000 gain

30. Donee’s Basis when Gift Tax is Paid Out of Pocket In 2012, Ted gave Bert an asset with a date-of-gift fair market value of $113,000 and a taxable gift value of $100,000 (due to the annual exclusion). Ted had an adjusted basis in this asset before the gift of $40,000. Since Ted used his gift tax applicable credit amount on prior gifts, Ted paid a gift tax of $35,000 on this gift. Bert’s basis in the asset will be $65,550—$40,000 (donor’s adjusted basis prior to gift) + $25,550.

31. Income Tax: Basis Rules Property Received from an Estate by a Beneficiary • If property was included in decedent’s gross estate, the estate and beneficiary to whom the property is distributed has a basis in the asset equal to its estate tax value except a reverse gift of one year or less, and except for income in respect of a decedent-IRD— whether measured as of • the date of death, • the alternate valuation date, or • by special use valuation. • With community property, even the half owned by the surviving spouse gets a step up in basis to its estate tax value.

32. Income Tax: Holding & Tacking Rules

33. Income Tax: Installment Reporting of Gain Installment Sale • Not available for sales of marketable securities or sales of depreciated property to a controlled entity. • Available whether payments are secured or unsecured. • Purchase price must be paid in year other than year of sale. • Installment reporting of gain is automatic unless seller elects to report all gain in the year of sale. • Payments composed of three parts: • return of basis, which is tax free • gain or profit taxed as capital gain • interest taxed as ordinary income

34. Income Tax: Installment Reporting of Gain Private Annuity • Is an installment sale in which amount of payment is determined by using the actuarial lifetime of the seller and the applicable federal discount rate for the month of sale. • Payments continue for actual lifetime of seller, whether that is more or less than his or her actuarial lifetime. • If seller is willing to accept smaller payments, they can be made over two (or more) lifetimes. • Installment reporting of gain is not available whether paymentsare secured or unsecured.

35. Income Tax: Installment Reporting of Gain Self Canceling Installment Note • Normal installment sale except all unmatured payments will be canceled at seller’s death. • Cancellation provision must be “paid for” by paying a premium (increased purchase price or interest rate) equivalent to possibility that seller may die prior to due date of all installments (known as a SCIN premium). • Payments can be secured or unsecured.

36. Income Tax: Taxation of Trust Income Determination of who is taxable on trust income should be made according to the following hierarchy: • Do any of the grantor trust rules apply? If “yes,” the grantor is taxable to the extent such rules apply; if “no” or to extent such rules do not apply, go to next bullet. • Does anyone have a general power of appointment (such as a Crummey power, or a demand or invasion right) over trust assets? If “yes,” the holder of such power is taxable to the extent of the power whether exercised or not; if “no” or to extent such power does not cover all income, go to next bullet. • Is distribution of trust income mandatory on an annual basis? If “yes,” income beneficiaries are taxable whether trust income is actually distributed or not. If “no” go to next bullet. • Have any discretionary distributions of trust income been made? If “yes,” recipients of such distributions are taxable on such distributions, and the trust gets a deduction; if “no” or to extent of remaining trust income, go to next bullet • Accumulated income is taxed to the trust at trust rates.

37. Income Tax: Grantor Trust Rules Cause trust income to be partially or totally taxed to the grantor of the trust Apply when • grantor or grantor’s spouse has power to amend, alter, or revoke the trust. • trust income is or may be distributed to the grantor or the grantor’s spouse. • trust income is or may be accumulated for future distribution to the grantor or the grantor’s spouse. • trust income is or may be used to pay premiums on insurance on the life of the grantor or the grantor’s spouse. • trust income is used to discharge a legal support obligation of the grantor. • trust income is or may be used to discharge any legal obligation of the grantor. • the grantor retains a reversionary interest that exceeds 5% of the value of the trust at the time of creation. • grantor or grantor’s spouse has the power to control beneficial enjoyment of trust assets, or has certain administrative powers.

38. Income Tax Charitable Deduction • Charity must be qualified for income tax purposes. • Must givecash or property. • Value of what is given to the charity must exceed the value of anything received in return. • Gift must be completed prior to close of the tax year in which it is claimed. • If a gift of a partial interest, must be made in a qualifying form. • Donor must itemize deductions. • Donation must be made inter vivos.

39. Charitable Income Tax Deduction

40. Charitable Income Tax Deduction: Miscellaneous Rules • total charitable deductions in any year cannot exceed 50% of the donor’s AGI • contributions to 50% charities must be deducted in full prior to contributions to 30% charities • contribution of an automobile, boat, or airplane for a claimed value in excess of $500 subject to special rules • special rules for contribution of patents or other intellectual property • noncash contributions in excess of $500,000 require a qualified appraisal

41. Question 11 Which of the following would qualify as common estate planning goals associated with the taxation of capital gains? • delaying or avoiding realization of a capital gain • timing an event that will cause the realization of gain to be short term • selecting an asset for sale that has the least appreciation • designing the transaction so that the gain will be realized by the original owner • I and III only • II and IV only • III and IV only • I, II, and III only

42. Question 12 Which one of the following is not a characteristic of an installment sale? • The seller may recognize any gain from the sale of a capital asset over the period for which payments are made. • Cost recovery recapture is reported ratably over the period for which payments are made rather than all in the year of sale. • The right to the installment recognition of gain is automatic if at least one payment is made in any year other than the year of sale. • Installment sale treatment is available whether the payments are secured or unsecured.

43. Question 13 Which one of the following is not a component of the payments received by the seller under a promissory note originating from an installment sale of a capital asset? • cost recovery recapture • return of basis • gain • interest

44. Question 14 Which one of the following is a true statement about a donee’s basis in property acquired by gift? • If no money changed hands between the donor and donee, the donee’s basis will be zero. • The donee will always receive a “carryover cost basis” from the donor. • For loss property, if the donee sells the property for less than its FMV at the time of gift, then the donee’s basis will be the property’s FMV on the date of the gift. • The donee will receive a step-up in basis to the FMV of the property gifted, if on the date of the gift, the FMV is greater than the cost basis of the donor.

45. CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning Module 5 End of Slides