fundamentals of gift tax
DESCRIPTION
US Federal Gift Tax LawsTRANSCRIPT
Electronic copy available at: http://ssrn.com/abstract=2212313
FUNDAMENTALS OF GIFT TAX
Mark E. Powell
Albrecht & Barney
1 Park Plaza, Suite 900
Irvine, California 92614
(949) 263-1040
Andrea Kushner Ross
Karlin & Peebles, LLP
8383 Wilshire Boulevard, Suite 708
Beverly Hills, California 90211
(323) 852-0039
Electronic copy available at: http://ssrn.com/abstract=2212313
TABLE OF CONTENTS Page
i GIFT TAX JOINT 11-5-12.docx
ARTICLE I HISTORY OF THE GIFT TAX ...................................................................... 1
ARTICLE II 2011 TAX ACT ............................................................................................ 4
2.1 OVERVIEW ...................................................................................................... 4
2.2 GIFT TAX PROVISIONS OF THE 2011 TAX ACT ........................................... 4
2.3 THE GIFT TAX RATE ....................................................................................... 5
2.4 PORTABILITY................................................................................................... 5
ARTICLE III WHAT IS A GIFT? ...................................................................................... 7
3.1 “GIFT” DEFINED ............................................................................................... 7
3.2 ELEMENTS OF A GIFT .................................................................................... 7
3.3 GIFT TAX PAYABLE BY DONOR .................................................................. 15
ARTICLE IV THE DONOR ............................................................................................ 17
4.1 NATIONALITY OF THE DONOR .................................................................... 17
4.2 COMMUNITY PROPERTY, JOINT TENANCY AND TENANCIES IN COMMON ....................................................................................................... 18
4.3 GIFT SPLITTING ............................................................................................ 18
4.4 INDIRECT TRANSFERS ................................................................................ 19
4.5 CORPORATE GIFTS ...................................................................................... 19
4.6 SETTLEMENT OF DISPUTE .......................................................................... 20
ARTICLE V INCOMPLETE GIFTS AND GIFTS WITH RETAINED INTERESTS ......... 21
5.1 INCOMPLETE GIFTS ..................................................................................... 21
5.2 POWERS THAT DON’T MAKE A TRANSFER INCOMPLETE ....................... 22
5.3 COMPLETION OF INCOMPLETE GIFT ......................................................... 23
5.4 TRANSFERS WITH RETAINED INTERESTS ................................................ 23
ARTICLE VI VALUATION OF GIFTS ........................................................................... 28
6.1 GENERAL CONCEPTS .................................................................................. 28
6.2 PUBLICLY TRADED STOCKS AND BONDS ................................................. 29
6.3 CLOSELY HELD BUSINESS INTERESTS ..................................................... 30
6.4 PARTIAL INTERESTS .................................................................................... 37
6.5 LIFE INSURANCE AND ANNUITIES .............................................................. 38
6.6 BELOW-MARKET INTEREST RATE LOANS ................................................ 39
6.7 ENCUMBERED GIFTS ................................................................................... 41
6.8 VALUATION PENALTIES ............................................................................... 41
ARTICLE VII EXCLUSIONS FROM GIFT TAX ............................................................ 43
TABLE OF CONTENTS (continued)
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7.1 EXCLUSIONS GENERALLY .......................................................................... 43
7.2 ANNUAL EXCLUSION GIFTS ........................................................................ 43
7.3 TUITION AND MEDICAL CARE ..................................................................... 45
7.4 GIFTS TO MINORS ........................................................................................ 46
ARTICLE VIII MARITAL DEDUCTION ......................................................................... 47
8.1 UNLIMITED MARITAL DEDUCTION .............................................................. 47
8.2 TERMINABLE INTEREST RULE .................................................................... 47
8.3 EXCEPTIONS TO TERMINABLE INTEREST RULE ...................................... 47
8.4 DONEE SPOUSE NOT U.S. CITIZEN ............................................................ 49
8.5 IRC SECTION 2519 – TRANSFER OF INCOME INTEREST ......................... 49
ARTICLE IX CHARITABLE DEDUCTION .................................................................... 50
9.1 AMOUNT OF DEDUCTION ............................................................................ 50
9.2 GIFTS OF PARTIAL INTERESTS .................................................................. 50
9.3 GIFT TAX RETURNS FOR CHARITABLE GIFTS .......................................... 51
ARTICLE X GENERATION SKIPPING TRANSFER TAX ............................................ 52
10.1 OVERVIEW .................................................................................................... 52
10.2 RELATIONSHIP TO GIFT TAX ....................................................................... 52
10.3 TYPES OF GENERATION SKIPPING TRANSFERS ..................................... 52
10.4 GENERATION-SKIPPING TRANSFER TAX RATE ....................................... 54
10.5 DEFINITION OF “TRANSFEROR” .................................................................. 55
10.6 SKIP PERSONS VS. NON-SKIP PERSONS .................................................. 56
10.7 GENERATION ASSIGNMENTS ..................................................................... 57
10.8 EXCLUSIONS FROM GENERATION-SKIPPING TRANSFER TAX .............. 58
10.9 EFFECT OF DISCLAIMERS ON GENERATION-SKIPPING TRANSFER TAX ............................................................................................. 59
10.10 ALLOCATION OF GST EXEMPTION ............................................................. 59
10.11 SAMPLE NOTICE OF GST ALLOCATION ..................................................... 60
ARTICLE XI COMPUTATION OF GIFT TAX ............................................................... 61
11.1 STEP 1 – COMPUTATION OF TAX IN CURRENT YEAR AND PRIOR YEARS ............................................................................................................ 61
11.2 STEP 2 – SUBTRACTION OF PRIOR TAX PAID .......................................... 61
11.3 STEP 3 – APPLICATION OF UNUSED GIFT TAX CREDIT .......................... 61
TABLE OF CONTENTS (continued)
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11.4 EXAMPLE ....................................................................................................... 61
ARTICLE XII GIFT TAX PROCEDURE ........................................................................ 63
12.1 GIFT TAX RETURNS ..................................................................................... 63
12.2 TIME TO FILE ................................................................................................. 64
12.3 PAYMENT OF TAX ......................................................................................... 66
12.4 STATUTE OF LIMITATIONS .......................................................................... 67
ARTICLE XIII COMMON GIFT STRATEGIES .............................................................. 69
13.1 IRREVOCABLE LIFE INSURANCE TRUST ................................................... 69
13.2 QUALIFIED PERSONAL RESIDENCE TRUST .............................................. 69
13.3 GRANTOR RETAINED ANNUITY TRUST/GRANTOR RETAINED UNITRUST ...................................................................................................... 70
13.4 SALE TO INTENTIONALLY DEFECTIVE GRANTOR TRUST (“IDIT”) .......... 71
ARTICLE XIV PRESIDENT OBAMA’S FEBRUARY 2012 BUDGET PROPOSAL ...... 72
14.1 INTRODUCTION ............................................................................................ 72
14.2 RESTORE 2009 ESTATE, GIFT AND GSTT TAX REGIME .......................... 72
14.3 REQUIRE CONSISTENCY IN VALUATION ................................................... 72
14.4 MODIFY RULES ON VALUATION DISCOUNTS ........................................... 73
14.5 REQUIRE MINIMUM TERM FOR GRANTOR RETAINED ANNUITY TRUSTS ......................................................................................................... 73
14.6 LIMIT DURATION OF GSTT EXEMPTION .................................................... 74
14.7 COORDINATE INCOME AND TRANSFER TAX RULES APPLICABLE TO GRANTOR TRUSTS ................................................................................. 74
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ARTICLE I
HISTORY OF THE GIFT TAX
The first federal gift tax was enacted in 1924.1 Although its opponents labeled it
a direct tax and argued that it amounted to a deprivation of property without due
process, the U.S. Supreme Court sided with the government and upheld the tax.
However, in 1926, Congress repealed the tax because, according to the Senate
Finance Committee, the tax generated relatively small revenue, taxpayers could easily
evade it, and there would be administrative difficulties in administering it.2
In 1932, the U.S. Supreme Court decided that gifts made within 2 years of death
were not necessarily includible in the donor's gross estate for estate tax purposes.3
Fearing that taxpayers would avoid the estate tax by making close-to-death gifts,
Congress enacted a new gift tax,4 which was meant to supplement both the estate tax
(by avoiding close-to-death gifts) and the income tax (by limiting a taxpayer's right to gift
income-producing property to family members who would pay income tax at lower
rates). This gift tax included a $30,000 lifetime exemption (compared to a $60,000
estate tax exemption), and its rates were three-fourths the corresponding estate tax
rates.
A savvy taxpayer took advantage of the lower gift tax rates and reduced his
overall transfer tax liability by making lifetime gifts, which in turn reduced his estate for
estate tax purposes. In 1976, Congress addressed this by combining the estate and gift
tax rates onto a single rate schedule, and taxpayers received a “unified credit” against
1 Revenue Act of 1924, P.L. 68-179.
2 S. Rep. No. 52, 69th Cong., 1st Sess. 9 (1926).
3 Heiner v. Donnan, 285 U.S. 312 (1932).
4 Revenue Act of 1932, P.L. 72-154.
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the estate and gift taxes.5 This credit was phased in over five years, and after 1980,
taxpayers had a $47,000 unified credit against the taxes.
The Economic Recovery Act of 19816 brought several major changes to the gift
tax. Among other things, the unified credit was increased over six years to $192,800,
and the maximum tax rates (applicable to estates over $2,500,000) were reduced from
70% to 50%. In addition, the unlimited marital deduction (for both taxes) was
introduced.
The Tax Reform Act of 19847 introduced § 7872 and the concept that certain
below-market loans included a gift equal to the amount of foregone interest.
The Technical and Miscellaneous Revenue Act of 19888 imposed greater tax
implications for transfers to non-citizen spouses and introduced § 7520, which still says
that value of any annuity, life interest, term-of-years interest, remainder interest or
reversionary interest must be determined using tables based on an interest rate equal to
120% of the federal midterm rate.
The Improved Penalty Administration and Compliance Tax Act, part of the
Omnibus Budget Reconciliation Act of 1989,9 introduced penalties for tax underpayment
due to incorrect valuation.
The Omnibus Budget Reconciliation Act of 199010 introduced Chapter 14 and the
value rules under § 2701 for intrafamily transfers.
5 Tax Reform Act of 1976, P.L. 94-455.
6 P.L. 97-34.
7 P.L. 98-369.
8 P.L. 100-647.
9 P.L. 101-239.
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The maximum estate and gift tax rates were raised to 55% on estates over
$3,000,000 in the Revenue Reconciliation Act of 1993,11 which also imposed a 5%
surtax was imposed on large estates.
The Taxpayer Relief Act of 199712 imposed some significant changes to the gift
tax. The amount a taxpayer could protect using the unified credit was increased over
nine years to $1,000,000. The adequate disclosure rules (discussed in detail below)
were introduced. Section 7477 created a Tax Court declaratory judgment mechanism
for challenging the Service’s determination of the value of a gift.
Fundamental estate and gift tax changes were introduced in the Economic
Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”).13 These are discussed
in detail below along with the Tax Relief, Unemployment Compensation
Reauthorization, and Job Creation Act of 2010.
(Footnote Continued from Previous Page.) 10 P.L. 101-508.
11 P.L. 103-66.
12 P.L. 105-34.
13 P.L. 107-16.
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ARTICLE II
2011 TAX ACT
2.1 OVERVIEW
(a) EGTRRA
(1) EGTRRA increased the estate tax exemption from $675,000
in 2001 to $3,500,000 in 2009. In addition, the maximum estate, gift tax and
generation-skipping transfer tax rate, which was 55% in 2001, was gradually reduced to
45% by 2009.
(2) Under EGTRRA, the estate tax and generation-skipping
transfer tax was repealed in 2010, but a decedent’s assets were subject to carry-over
basis with limited step-up. The estate tax was scheduled to be restored in 2011 with a
$1 million exemption (IRC Section 2010 “applicable exclusion amount”) per person and
a 55% tax rate.
(b) The Tax Relief, Unemployment Insurance Reauthorization, and Job
Creation Act of 2010 (the “Tax Relief Act”) was signed into law by President Obama on
December 17, 2010.
(c) Tax Relief Act sets the gift tax, estate tax and generation-skipping
transfer tax exemption at $5 million per person (indexed for inflation) and a 35% tax
rate.
(d) Under the Tax Act, estates of descendants dying in 2010 have two
choices:
(1) Remain in the estate tax regime and pay estate tax at a 35%
tax rate for estates greater than $5 million, OR
(2) Elect into the carry-over basis regime, which means the
estate will not be subject to estate tax. However, the estate will not receive an unlimited
basis step up in estate assets. Basis will be allocated in a new form, Form 8939.
2.2 GIFT TAX PROVISIONS OF THE 2011 TAX ACT
(a) The gift tax exemption remains $1 million in 2010.
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(b) Starting January 1, 2011, the gift tax exemption is “reunified” with
the estate tax exemption and increased to $5 million.
2.3 THE GIFT TAX RATE
The gift tax rate for 2010, 2011 and 2012 is 35%.
2.4 PORTABILITY
(a) The Tax Act provides for gift and estate tax exclusion “portability”
between spouses, by allowing the surviving spouse to inherit a “Deceased Spousal
Unused Exclusion Amount” (“DSUEA”) that can be applied to shelter both the survivor’s
gifts and taxable estate. The survivor could therefore have a $10,000,000 gift and
estate tax exclusion because the full exclusions of both spouses can be used by the
survivor.
(b) The Tax Act14 amends IRC § 2010(c)(2) to provide that the
“Applicable Exclusion Amount” which a person can exclude from transfer taxes in 2011
and 2012 is now the sum of his Basic Exclusion Amount (the portion of the $5 million
exemption not used against lifetime gifts), plus the DSUEA.
(1) The Basic Exclusion Amount is a new term under the Tax
Act, which represents the inflation adjusted amount which was previously simply
referred to as the “Applicable Exclusion Amount” (or AEA). The DSUEA is also a new
term, which is defined at new IRC § 2010 (c)(4)(B) as being the unused Basic Exclusion
Amount of the “last deceased spouse.”
(2) The DSUEA is available only from the “last deceased
spouse”, thus preventing a particular individual who has survived multiple husbands
from “accumulating” DSUE amounts from each husband. In the context of remarriage,
the calculation of the DSUEA is based only upon the Basic Exclusion Amount of the last
14 See § 303(a) of the Tax Act.
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deceased spouse, rather than the full “Applicable Exclusion Amounts” of the last
deceased spouse.
(3) Since the Applicable Exclusion Amount under the new law is
comprised of two components (the Basic Exclusion Amount, plus the new DSUEA) and
the definition of DSUEA itself references only the Basic Exclusion Amount, the portion
that is effectively excluded from the definition is the DSUEA of that person’s previously
deceased spouse if she survives more than one spouse. This has the result of
preventing any DSUEA that a wife had available from her first husband carrying over
(upon her death) to her second husband.
(4) New IRC § 2010(c)(4)(B)(i) instead references only the Basic
Exclusion Amount, so any amount carried over to the second husband does NOT
include any DSUEA received by the wife from a previous first husband.
(c) There are significant limitations and technical issues with the new
portability provisions:
(1) The law creating portability will expire in 2013.
(2) An estate tax return must be filed at the first death in order
for the surviving spouse to claim the unused exclusion even if there is little or no taxable
estate.
(3) There is no inflation adjustment for the unused exclusion.
(4) The DSUEA allowance is helpful only if both spouses die
between January 1, 2011 and December 31, 2012.
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ARTICLE III
WHAT IS A GIFT?
3.1 “GIFT” DEFINED
(a) The gift tax is imposed on the “transfer of property by gift.”15 “Gift” is
defined very broadly to include “any transaction in which an interest in property is
gratuitously passed or conferred on another, regardless of the means or device
employed.”16
(b) The gift tax was intended to be comprehensive. When the gift tax
was reinstated in 1932, Congressional committee reports document this intention.
According to these reports, the term “property” was used in the “broadest and most
comprehensive sense” to “reach every species of right or interest protected by law and
having an exchangeable value,” and the term “transfer by gift” was meant to include
every transaction in which “property or a property right is donatively transferred or
conferred upon another, regardless of the means of the device employed in its
accomplishment.”17
3.2 ELEMENTS OF A GIFT
(a) Transfer for Less than Adequate and Full Consideration
The gift tax is meant to complement the estate tax by preventing depletion
of a taxpayer’s estate through tax-free transfers.18 If property is transferred for less than
15 IRC § 2501(a)(1).
16 Treas. Reg. § 25.2511-1(c).
17 H.R. Rep. No. 708, 72nd Cong., 1st Sess. 27 (1932); S. Rep. No. 665, 72nd Cong., 1st Sess. 39 (1932).
18 Harris v. Comr, 340 U.S. 106, 107 (1950).
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adequate and full consideration in money or money’s worth, the excess of the value of
the transferred property over the value of the consideration received is a gift.19
The consideration received by a transferor may be either tangible or
intangible, but the consideration must be measurable in money or money’s worth.20
Consequently, the following are not consideration for purposes of the gift tax:
(1) A promise of love or affection or a promise to marry;21
(2) A promise to graduate from college;22
(3) A parent’s support obligation;23
(4) A divorce settlement, including child support payments;24
and
(5) Settlement of a lawsuit.25
(b) Donative Intent is Not Required
Early on, the U.S. Supreme Court ruled that donative intent is an “elusive”
state of mind and that the gift tax turns on the more workable external test of transfers
for less than adequate and full consideration.26 The tax is based on the objective facts
19 IRC § 2512(b).
20 Treas. Reg. § 25.2512-8.
21 Treas. Reg. § 25-2512-8; Comr v. Wemyss, 324 U.S. 303, 308 (1945).
22 Rev. Rul. 79-384, 1979-2 C.B. 344.
23 Hooker v. Comr, 10 T.C. 388 (1948), aff’d, 174 F.2d 863 (5th Cir. 1949). Cf. Wiedemann v. Comr, 26 T.C. 565 (1956) (payments for support of adult child were taxable gifts).
24 IRC § 2516; Treas. Reg. § 25-2516-1.
25 Noland v. Comr, T.C. Memo 1984-209.
26 Comr. v. Wemyss, 324 U.S. 303, 306 (1945).
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of the transfer and the circumstances under which it is made, not on the subjective
motives of the donor.27
Although donative intent is not required to create a gift, lack of donative
intent can prevent a transfer from being deemed a gift. Transfers made in the ordinary
course of business are a common example. Sometimes, a transfer is made in a
business setting for less than adequate and full consideration, but these bad bargains
do not result in gifts if the transfer is (1) bona fide, (2) at arm's length, and (3) free from
donative intent.28
(c) Part Gift, Part Sale Transactions
As noted above, where unrelated parties engage in an arm's-length
transaction in which one party receives more value than the other, there should be no
gift. But where related parties (or any others not dealing at arms' length) engage in
such a transaction, the transaction is treated as part gift and part sale.29 In such a
transaction, a gift occurs in an amount equal to the excess of the value of the property
transferred and the value of the consideration received. A common example is the
transfer of encumbered property. To the extent the donor is relieved of liability on the
debt (i.e., the donee assumes the liability), a gift results.30 Since relief of indebtedness
causes income tax ramifications, it should not be a surprise that the same transaction
can have gift tax implications.
27 Treas. Reg. § 25.2511-1(g)(1).
28 Treas. Reg. § 25-2512-8.
29 IRC § 2513(b).
30 Treas. Reg. § 25.2512-8.
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(d) Exercise or Release of Power of Appointment
If a taxpayer has a power of appointment over property, his exercise – or
in some cases release – of that power may result in a gift of the property.31 The term
"power of appointment" is not defined in the IRC, but the gift tax regulations and IRS
rulings assimilate common law definitions and show that the term includes any
"authority . . . to designate recipients of beneficial interests in property" and all powers
that enable the taxpayer to determine to whom or to what extent a beneficial interest will
pass.32 Under Regulation § 25.2514-1(b), the following are examples of powers of
appointment:
(1) A beneficiary's unlimited right to consume principal;
(2) A beneficiary's power to affect the beneficial enjoyment of a
trust by altering, amending, revoking or terminating the trust; and
(3) A person's power to remove a trustee and appoint himself as
the trustee if the trustee has the right to benefit under the trust (and the Service has
asserted33 that such a trustee makes a gift to the remainder beneficiaries upon
resignation because he has given up his own interest in the trust).
Certain administrative powers are not powers of appointment under
§ 2514, including: a power to amend only the administrative provisions of a trust;
management powers exercisable in a fiduciary capacity; and a beneficiary's right to
approve accountings by a trustee (thereby relieving the trustee of continuing obligation
with respected to reported transactions).
The following terms are important:
31 Always check whether a power of appointment was created before or after October 21, 1942, because very different rules apply to powers created after that date. This text focuses on powers created after that date.
32 Restatement (Second) of Property § 11.1 cmt. a (1986).
33 Rev. Rul. 79-421, 1979-2 C.B. 347.
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(1) General Powers of Appointment – a power that may be
exercised for the powerholder's direct or indirect benefit in that it may be exercised in
favor of the powerholder, his creditors, his estate, or the creditors of his estate;34
(2) Powers Limited by Ascertainable Standards – even if a
powerholder can exercise a power for his or her benefit, the power is not a general
power of appointment if its exercise is "limited by an ascertainable standard relating to
the health, education, support or maintenance of the possessor;"35
(3) Joint Powers – a power is not a general one if it must be
exercised either in conjunction with the creator of the power36 or in conjunction with a
person having a substantial interest in the property37 that will be adversely affected by
an exercise of the power in favor of the powerholder; and
(4) Special Powers – a power is not a general one if it is
exercisable only in favor of one or more designated persons or classes of persons other
than the powerholder, his estate, his creditors, or the creditors of his estate.38
34 IRC § 2514(c).
35 IRC § 2514(c)(1). Although Regulation § 25.2514-1(c)(2) allows for some variation in language concerning the ascertainable standards ("support in reasonable comfort," "maintenance in health and reasonable comfort," and even "medical, dental, hospital and nursing expenses and expenses of invalidism" are acceptable), use of the words "welfare," "enjoyment," and "happiness" will make a power of appointment a general one. See, e.g., Miller v. U.S., 387 F.2d 866 (3rd Cir. 1968). And even though "comfort" is used in the example in the Regulation, it should be avoided. Id. In all likelihood, use of "emergency" will cause a power to be a general one. Sowell Est. v. Comr., 74 T.C. 1001 (1980).
36 IRC § 2514(c)(2).
37 Treas. Reg. § 25.2514-3(b)(2) requires the joint powerholder have an interest in the property that is "not insignificant," and the Tax Court has written that there must a possibility that the joint powerholder may, presently or in the future, personally benefit from the property. Towle's Est. v. Comr., 54 T.C. 368 (1970).
38 Treas. Reg. § 25.2514-1(c)(1).
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State law may impose formalities on the "exercise" of a power of
appointment,39 but generally a taxpayer is deemed to have exercised a power when he
takes any action meant to designate recipients of beneficial interest in property. A
power is deemed exercised even though the disposition cannot occur until a future
event (for example, the powerholder's death) if the exercise is irrevocable and the
disposition is not impossible at the time of the exercise. For example, a beneficiary's
execution of instructions directing the distribution of assets after his death is an
"exercise" if the instructions are irrevocable.
A "release" of a power of appointment may occur indirectly.40 In fact, they
usually occur indirectly, and they are often based on particular circumstances. If, for
example, a taxpayer holds a general power of appointment over a trust holding shares
of a closely held corporation and consents to a recapitalization that reduces the value of
the shares, then he has released his power of appointment based on the reduction in
value.41
The "lapse" of a general power of appointment may be treated as a
taxable release of the power. The operation of an irrevocable life insurance trust
provides a common example of a lapse. These trusts often include withdrawal powers
by which a gift in trust qualifies for the annual gift tax exclusion. For a limited period of
time each year, each beneficiary has a noncumulative right to withdraw a proportion of
the assets contributed to the trust. When the withdrawal period ends, all withdrawal
rights lapse. Typically, this would amount to a release of the withdrawal rights and a gift
(from the current beneficiaries to the remainder beneficiaries or even among the current
beneficiaries). However, IRC § 2514(e) specifically provides that the lapse of such a
right is not considered a release if the value of the assets actually affected does not
39 Treas. Reg. § 25.2514-1(d).
40 Treas. Reg. § 25.2514-1(b)(2).
41 Rev. Rul. 86-39, 1986-1 C.B. 301.
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exceed the greater of $5,000 or 5% of the aggregate value of the assets subject to the
withdrawal right.
Generally, only general powers of appointment give rise to taxable gifts,
but in certain circumstances special powers can result in taxable gifts. If a special
power is exercised to create another power of appointment and if local law provides that
the rule against perpetuities begins on the creation of the new power of appointment,
then the exercise is treated as if it were an exercise of a general power of
appointment.42 This specific statutory provision was meant to prevent property from
passing through generations of beneficiaries without ever being subject to the estate
tax.43 It only applies in states that have extended their rule against perpetuities period
or extinguished the rule altogether. Consequently, it is sometimes called the "Delaware
Tax Trap."
(e) Disclaimers
A taxpayer can renounce unwanted gifts, bequests, and powers without
adverse gift tax implications through the disclaimer mechanism set forth in IRC § 2518.
If the disclaimer is a "qualified disclaimer," then the disclaimer causes the transfer to be
treated as a transfer from the original donor (not the person making the disclaimer) to
the taker of the interest. A nonqualified disclaimer, on the other hand, may be treated
as a release, causing the transfer to be treated as a gift from the original donor to the
disclaiming person followed by a transfer from the disclaiming person to the taker of the
interest.
42 IRC § 2514(d).
43 S. Rep. No. 382, 82d Cong., 1st Sess. 3 (1951).
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Under the current rules,44 there are four requirements for a qualified
disclaimer:
(1) It must be in writing;
(2) It must be received by the holder of legal title of the property
to which it relates within nine months of the later of the day on which the transfer
creating the interest is made or the day on which the disclaiming person attains the age
of 21;
(3) The disclaiming person must not have accepted the interest
or any of its benefits before the disclaimer; and
(4) As a result of the disclaimer, the interest passes without any
direction on the part of the disclaiming person to either the spouse of the transferor or a
person other than the disclaiming person.45
(f) Indirect Gift Through Other "Failures" to Act
Gifts can be made indirectly, and any transaction that shifts
economic value, right or benefit to another person may cause a gift tax. The following
transactions have been found to cause gifts:
(1) Mom makes a loan to son and never attempts to collect it,
and the statute of limitations renders the loan unenforceable;46
44 To determine which rules apply, you must know when an interest was created. Treas. Reg. § 25.2511-1(c)(2) provides rules from disclaiming interests created before Jan. 1, 1977. Section 2518 originally applied to disclaiming interests created after Dec. 31, 1976. The current version of § 2518 applies to disclaimers of interests created after Dec. 31, 1981. Most significantly, a disclaimer of a post-1981 interest can be effective under federal tax laws even if it is not effective under local law.
45 IRC § 2518(b).
46 Lang Est. v. Comr., 613 F.2d 770 (9th Cir. 1980).
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(2) Grandmother transfers some class A shares in a closely-
held corporation to an irrevocable gift trust for the benefit of her grandchildren and never
converts her shares to class B shares, and as a result, she forfeits the right, attached
only to class B shares, to put her interest in the corporation if it fails to pay the
prescribed dividend, sending economic benefit to her grandchildren;47 and
(3) A trust beneficiary fails to exercise a power to convert
unproductive property into productive property, resulting in loss of income to the current
beneficiary while preserving the value of the principal passing to the remainder
beneficiaries.48
3.3 GIFT TAX PAYABLE BY DONOR
The gift tax is an excise tax on the donor’s transfer of property, not a tax on the
donee’s receipt of the property.49 As a result, the donor is primarily responsible for the
tax.50
If a donor dies before payment of the gift tax, the executor or administrator of his
estate is responsible for paying the tax,51 and the executor or administrator will be
personally liable for any unpaid gift tax to the extent assets are distributed to anyone
else.52
47 Snyder v. Comr., 93 T.C. 529 (1989).
48 Dickman v. Comr., 465 U.S. 330 (1984); see also PLRs 9045047, 9035029 & 9035022.
49 Treas. Regs. §§ 25.2511-2(a).
50 IRC § 2502(c); Treas. Reg. § 25.2502-2, 25.2511-2(a).
51 Treas. Reg. § 25.2502-2.
52 31 USC § 3713(b); Treas. Reg. § 25.2502-2.
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A donee becomes personally liable for the tax if it is not paid when due to the
extent of the value of the gift to the donee.53
53 IRC § 6324(b).
17 GIFT TAX JOINT 11-5-12.docx
ARTICLE IV
THE DONOR
4.1 NATIONALITY OF THE DONOR
(a) The gift tax applies to any individual who is a citizen of the United
States, or who is a resident of the United States as defined in IRC § 7701(b).54
(b) Nonresident aliens (“NRAs”) are subject to U.S. federal gift tax as
follows:
(1) NRAs are taxed on gifts of real property located within the
United States.55
(2) Intangible property “located” in the United States is not
subject to gift tax unless the NRA was an expatriate (as defined in IRC § 2501(a)(3)).56
Generally speaking, an expatriate is a donor who, within the ten year period ending with
the date of the gift, lost his or her U.S. citizenship.57
(c) The U.S. gift and estate taxation of NRAs, as well as the foreign gift
and estate taxation abroad of U.S. citizens and residents, can be affected by applicable
treaties between the United States and foreign countries.
(d) PRACTICE TIP: If you are working with a donor with family
overseas, be mindful of the Form 3520, which is an informational return that must be
filed to report, among other things, (i) the formation of a foreign trust, (ii) the transfer of
assets or cash to a foreign trust, (iii) distributions from a foreign trust made to a U.S.
54 IRC § 2501(a)(1).
55 IRC § 2511(a); Treas. Reg. § 25.2511-3(a)(1)(i).
56 IRC § 2501(a)(2); Treas. Reg. § 25.2511-3(a)(2)(i).
57 See IRS Notice 97-19. The income tax, gift tax and estate tax rules governing NRAs are very complex and are beyond the scope of this presentation. Special care should be taken when advising NRAs and U.S. residents living abroad.
18 GIFT TAX JOINT 11-5-12.docx
person and/or (iv) the receipt of $100,000 or more from a NRA or a foreign estate.
There is no additional tax assessed with this form, but the penalties for failure to timely
file a Form 3520 are substantial. The initial penalty is the greater of $10,000 or (i) 35%
of the gross value of the property transferred to a foreign trust for a U.S. person who
failed to report the establishment of a foreign trust or (ii) 35% of the distributions
received from a foreign trust for a U.S. person who failed to report distributions received
or (iii) 5% of the gross value of the trust’s assets treated as being owned by a U.S.
person for failure of that U.S. person to report the U.S. owner information.
4.2 COMMUNITY PROPERTY, JOINT TENANCY AND TENANCIES IN
COMMON
(a) General Rule: If the property transferred is co-owned with another
individual or individuals, then each owner is the transferor of his or her pro-rata share.58
(b) HOWEVER, beware of IRC § 2040, which provides that the entirety
of joint tenancy property is includible in a joint tenant’s estate for estate tax purposes
unless (i) the joint tenants were married, in which case one-half (1/2) of the property is
includible, or (ii) it can be shown that the surviving joint tenant provided consideration
toward the acquisition of the property, in which case the surviving tenant’s interest is
subtracted from the valuation. Thus, it is critical that records are kept to document the
respective interests in property.
4.3 GIFT SPLITTING
(a) A husband and wife may elect to treat a gift of noncommunity
property as made one-half by each spouse for gift tax purposes. The election is made
on a gift tax return.59
58 Treas. Reg. § 25.2511-1(e).
59 IRC § 2513.
19 GIFT TAX JOINT 11-5-12.docx
(b) Gift splitting maximizes the use of annual exclusion gifts by using
the annual exclusions available to both spouses.
(c) Example: Husband wants to make a gift of $25,000 to each of his
two children (total of $50,000) from a prior marriage with his separate property funds.
Will husband have to use gift tax exemption to cover these gifts? No, provided husband
and wife elect gift splitting. Husband can make annual exclusion gifts to his children of
$26,000 ($13,000 per child), and wife can make annual exclusion gifts of $26,000 to
husband’s children ($13,000 per child). If husband and wife elect gift splitting, then the
full $50,000 will be covered by husband and wife’s annual exclusions.
4.4 INDIRECT TRANSFERS
If X makes a transfer to Y on the condition that Y make a subsequent
transfer to Z, then Y is merely an intermediary, and the transfer is treated as a gift made
by X to Z.60 Examples of indirect transfers:
(a) Trusts: If X establishes a trust that directs Y, the Trustee, to make
income distributions to Z, then X has made a gift to Z.
(b) Life Insurance: If X purchases life insurance and then directs the
life insurance company to change the named owner to Z, then X has made a gift.
4.5 CORPORATE GIFTS
If a corporation makes a gift (i.e., a charitable contribution), how is the gift
treated?
(a) General Rule: A gift by a corporation is attributable to the
shareholders on a pro rata basis.61
60 Treas. Reg. § 25.2511-1(h)(2).
61 Treas. Reg. § 25.2511-1(h)(1).
20 GIFT TAX JOINT 11-5-12.docx
(b) Exception: If a renegade shareholder makes a gift of corporate
assets by raiding the coffers without consulting the other shareholders, then the gift is
not attributed to the shareholders who did not participate in the gift.62
4.6 SETTLEMENT OF DISPUTE
A makes a payment to B to settle a contract dispute. B accepts less than what
was originally stated as the sales price in order to settle the dispute. Is A’s transfer to B
a taxable gift as to B?
NO. A bona fide settlement of a dispute is not a taxable gift.63
62 See Neeley v. United States, 613 F. 2d 802 (Ct. Cl. 1980).
63 Commissioner v. Estate of Vease, 314 F. 2d 79 (9th Cir. 1963); Estate of Reed v. Commissioner, 171 F. 2d 685 (8th Cir. 1948).
21 GIFT TAX JOINT 11-5-12.docx
ARTICLE V
INCOMPLETE GIFTS AND GIFTS WITH RETAINED INTERESTS
5.1 INCOMPLETE GIFTS
A transfer must be complete to be a taxable transfer. The following types of
transfers will be considered incomplete for gift tax purposes:
(a) Power retained by transferor. If the transferor retains a power
over the property (i.e., a general power of appointment pursuant to IRC § 2041), then
the transfer will be incomplete.
(b) Power to revoke a transfer. If the transferor can revoke the gift,
then it is not a completed gift for gift tax purposes.64
(c) Power to amend or alter a transfer. If the transferor has the
power to amend or alter the transfer, then the transfer will not be considered a
completed gift.
(1) Power to amend. If the transferor has the power to amend
the trust to which the transferor transferred property, then the gift will not be a
completed gift.
(2) Power to alter. If the transferor retains the power to alter
the beneficial interests of the gift (i.e., change the beneficiaries), then the gift is not a
completed gift.65 However, Chief Counsel Advice Memorandum 20120802666, which
was released on February 24, 2012, involved an irrevocable trust over which the donors
retained a limited power of appointment to appoint the Trust as constituted at their
deaths. The ruling found that the donors relinquished dominion and control of the Trust
during their lifetimes, and as such, the IRS found that the donors made a completed gift
64 Treas. Reg. § 25.2511-2(b).
65 Treas. Reg. § 25.2511-2(c).
66 Chief Counsel Advice Memorandum 201208026 (September 28, 2011).
22 GIFT TAX JOINT 11-5-12.docx
for gift tax purposes. Thus, the state of the law on using limited powers of
appointment to create incomplete gifts is unsettled for now. One suggested
strategy is to give the donors a power over lifetime distributions (i.e., the power
to veto income distributions).
(d) Power to revoke, alter or amend with consent of another party.
(1) A gift will be deemed incomplete even if the transferor holds
the power with another party if the other party is not adverse to the transferor.
(2) A power to revoke, alter or amend is will not be deemed to
be held by the transferor if the transferor holds the power with an adverse party.67
(3) Adverse Party Defined. An adverse party is a person
whose interest would be adversely affected by the exercise of the power.
Example: A makes a gift to a trust for the benefit of B, C and D. A retains the
power to revoke the trust (in which case all property returns to A), but A can only
exercise this power with B. B is considered an adverse party because the exercise of
the power of revocation will adversely affect B’s interest.
5.2 POWERS THAT DON’T MAKE A TRANSFER INCOMPLETE
(a) Power to affect time or manner of enjoyment. A power to affect
the manner or timing of enjoyment of a gift without affecting the underlying beneficial
interests will not render a gift incomplete.68
(b) Administrative powers. A transferor may retain administrative
powers over transferred property without causing the gift to be deemed incomplete.
67 Treas. Reg. § 25.2511-2(e).
68 Treas. Reg. § 25.2511-2(d).
23 GIFT TAX JOINT 11-5-12.docx
Administrative powers include investment powers and powers relating to the purchase,
management and sale of property.69
(c) Ascertainable standard. A transferor can retain control over the
disposition of property and have the transfer be considered a completed gift as long as
the transferor’s power is limited by the ascertainable standard, commonly known by the
acronym “HEMS,” which stands for health, support, maintenance and education.70
5.3 COMPLETION OF INCOMPLETE GIFT
An incomplete gift becomes complete when the transferor releases the
power that caused the gift to be incomplete, or when the property is no longer subject to
the power.71
5.4 TRANSFERS WITH RETAINED INTERESTS
(a) If a donor makes a gift and retains an interest, the retained interest
is generally not subject to gift tax.
Example: A makes a transfer to a trust. A receives all of the income for life, with
remainder to B. If A does not have the power to revoke the trust, then A has made a
completed gift, but only as to the actuarial present value of the remainder interest.
(b) The burden is on the donor to demonstrate the value of the retained
interest. A transfer with a retained interest is treated as a gift of the entire property less
the retained interest, but only if the donor can demonstrate the value of the retained
interest.72
69 Treas. Reg. § 25.2511-2(b).
70 Treas. Reg. § 25.2511-1(g)(2).
71 Treas. Reg. § 25.2511-2(f).
72 Treas. Reg. § 25.2511-1(e).
24 GIFT TAX JOINT 11-5-12.docx
(c) IRC § 2702 Exception. IRC § 2702 applies to transfers in trust.
IRC § 2702 provides that the value of the retained interest is not subtracted for gift tax
purposes if the following conditions are present:
(1) The donor retains an interest in the property transferred.
(2) The donor has transferred the property for no consideration.
If the donor receives consideration for the transfer, then IRC § 2702 will not apply.
(3) The transfer is made to one or more members of the donor’s
family. For purposes of these rules, the donor’s family includes the donor’s spouse, any
ancestor or descendant of the donor or the donor’s spouse, and any spouse of an
ancestor of the donor or the donor’s spouse.73
(4) Exceptions to IRC § 2702 Treatment.
(A) Incomplete Gifts. If a gift is incomplete due to the
donor’s retained right to revoke or amend, then the transfer will not be subject to IRC
§ 2702.
(B) Qualified Interest. If the retained interest is a
qualified interest, then it will be deducted from the value of the property for purposes of
determining the gift. A qualified interest is defined as (i) the right to receive a fixed
annuity, at least annually; (ii) the right to a unitrust interest (right to fixed percentage of
principal), valued at least annually; or (iii) a remainder interest following an annuity or
unitrust interest described in (i) or (ii) above.74
(C) Qualified Personal Residence Trust. IRC § 2702
does not apply to Qualified Personal Residence Trusts (“QPRTs”), which are trusts in
73 IRC § 2702(a)(1) and IRC § 2704(c)(2).
74 IRC § 2702(a)(2)(B) and IRC § 2702(b).
25 GIFT TAX JOINT 11-5-12.docx
which the donor transfers his or her personal residence (or an undivided interest
therein) and retains the right to live in the residence.75
(d) IRC Section 2701 Exception. IRC § 2701 is similar to IRC § 2702,
except that IRC § 2701 applies to transfers with retained interests in entities.
(1) General Rule: If the donor makes a transfer of junior equity
(common stock) and retains senior equity (preferred stock), the donor is treated as
making a gift by the donor of the donor’s entire interest in the entity without a reduction
for the donor’s retained interest in the nontransferred senior equity.
(2) IRC § 2701 applies to transfers between family members.
(3) Applies to “applicable retained interests,” which are generally
rights to dividends and liquidation rights.
(4) After the transfer, the applicable retained interest must be
held by the donor or a member of the donor’s family.
(5) IRC § 2701 does not apply if one of the following conditions
is present76:
(A) Market quotations are readily available (as of the date
of the transfer) for such interest on an established securities market,
(B) Such interest is of the same class as the transferred
interest, or
(C) Such interest is proportionally the same as the
transferred interest, without regard to nonlapsing differences in voting power (or, for a
partnership, nonlapsing differences with respect to management and limitations on
liability).
75 Treas. Reg. § 25.2702-5.
76 IRC § 2701(a)(2).
26 GIFT TAX JOINT 11-5-12.docx
(6) Determination of value of gift
(A) The entity as a whole is appraised.
(B) Subtract the value of all interests senior to the
transferred interest.
(i) “Applicable Retained Interests” held by the
donor and the donor’s family members are generally deemed to be worth zero.77
However, a right to receive a qualified payment (i.e., a right to receive a fixed dividend)
is valued by determining the present value and disregarding liquidation rights.
(ii) Other senior interests are valued at fair market
value.
(C) The remaining value is allocated among the junior
interests. There is a “minimum value rule” which provides that the value of the junior
equity must be deemed to be worth at least 10% of the entity’s value.78
(7) Example: A owns 1000 shares of common stock and 1000
shares of preferred stock of corporation. A decides to give 500 shares of common stock
to B, her daughter. Each share of the preferred stock has a dividend right of $200. The
corporation is valued at $1 million. What is the value of the gift?79
(A) Step 1: Start with the value of the corporation, which
is $1,000,000.
(B) Step 2: Value the senior equity, which is A’s
preferred stock. A has a right to receive a qualified payment (dividend); the value of the
preferred stock is $200,000.
77 IRC § 2701(a)(1) & (3)(A).
78 IRC § 2701(a)(4).
79 Treas. Reg. § 25.2701-3(b)
27 GIFT TAX JOINT 11-5-12.docx
(C) Step 3: Determine the value of the junior equity
being transferred - $1,000,000 - $200,000 = $800,000. The minimum value rule doesn’t
apply because the gift is deemed to be worth more than 10% of the corporation.
(8) Planning consideration: Gifts of corporate interests in
which the donor retains an interest can still work, but care must be taken in devising
these gifts. The retained interests must be qualified payment rights in order for the
planning to be useful.
28 GIFT TAX JOINT 11-5-12.docx
ARTICLE VI
VALUATION OF GIFTS
6.1 GENERAL CONCEPTS
(a) The amount of a gift generally is the fair market value of the
property transferred.80 "Fair market value" generally means the price at which the
property would change hands between a willing buyer and a willing seller, both of whom
have reasonable knowledge of all relevant facts and neither of whom is under any
compulsion to buy or sell.81 In determining fair market value, both the buyer and the
seller are hypothetical persons,82 not the specific transferor or transferee,83 which
means the actual buyer and seller's relationship must be ignored.
(b) Gifts of partial interests are valued based on actuarial tables,84 not
the willing buyer/willing seller regime mentioned above, including life estates, term-of-
year interests, remainders or reversions, and interests in private annuities. Using these
tables avoids an examination of the facts and circumstances of every case and provides
administrative convenience.85 Of course, there are situations in which it is appropriate
to look at the facts and circumstances surrounding a transaction because using the
tables would lead to a "substantially unrealistic and unreasonable" valuation.86 There
80 IRC § 2512(a).
81 Treas. Reg. § 25.2512-1.
82 Bright Est. v. U.S., 658 F.2d 999 (5th Cir. 1981).
83 Rev. Rul. 92-12.
84 IRC § 7520.
85 Shapiro Est. v. Comr., T.C. Memo 1993-483.
86 O'Reilly v. Comr., 95 T.C. 646 (1990), rev'd, 973 F.2d 1403 (8th Cir. 1992), rem'd, T.C. Memo 1994-61.
29 GIFT TAX JOINT 11-5-12.docx
are two tests for determining that the tables should not be used: a beneficial interest
test and a mortality test.87
Ordinary annuity, income, remainder or reversionary interests are valued
using the tables, but "restricted beneficial interests" (i.e., interests subject to a
contingency, power or other restriction) may warrant a facts and circumstances fair
market valuation.88
The mortality test recognizes that the tables will not work in situations
where the transferor's life expectancy is not aligned with the assumptions in the tables.
If a taxpayer is terminally ill at the time of the transfer, the rates in the tables are to be
adjusted89 by a special factor.90 A taxpayer is "terminally ill" if there is at least a 50%
probability that he will die within a year of the transaction; however, if he survives at
least 18 months after the transfer, he is deemed not have been terminally ill at the time
of the transfer.
(c) The value of a gift is determined as of the time the transfer is
complete; there is no alternate valuation date for gift tax purposes.
6.2 PUBLICLY TRADED STOCKS AND BONDS
(a) If there is a market for the securities, such as a public stock
exchange, the fair market value of the security is the average of the highest and lowest
selling price on the day of the transfer.91 If there are no sales that day, the value is the
87 Treas. Reg. § 25.7520-3(b).
88 Treas. Reg. § 25.7520-3(b)(1)(ii).
89 Treas. Reg. § 25.7520-3(b)(3).
90 The IRS will provide the special factor upon a request for a ruling. Treas. Reg. § 25.7520-1(c).
91 Treas. Reg. § 25.2512-2.
30 GIFT TAX JOINT 11-5-12.docx
weighted average of the highest and lowest selling prices on the nearest date before
and the nearest date after the date of the transfer on which there are sales.92
(b) If there are no sales during a reasonable period before and after
the date of the transfer, then the value may be determined by averaging the "bid" and
"asked" prices on the date of the transfer93 or, if there are no bid and asked prices on
that date, on the nearest trading dates before and after the date of the transfer.94
(c) A blockage discount may be applied to gifts of large blocks of
publicly traded stock if the block "is so large in relation to the actual sales on the existing
market that it could not be liquidated in a reasonable time without depressing the
market."95 The size of the discount depends on several factors, including the size of the
block compared with the total outstanding stock of the company, the amount of stock
the market will absorb immediately, and the amount of time needed to liquidate the
stock without depressing the market. When a transferor simultaneously transfers stock
to several transferees, the gift to each transferee must be considered separately.96
Even if the total amount of stock transferred on the date in question could not be sold
without depressing the market, no blockage discount is available if each separate gift
could be sold without affecting the market.97
6.3 CLOSELY HELD BUSINESS INTERESTS
(a) Since closely held business interests, including shares in
corporations, partnership interests and limited liability company membership interests,
92 Treas. Reg. § 25.2512-2(b)(2).
93 Treas. Reg. § 25.2512-2(c).
94 Id.
95 Treas. Reg. § 25.2512-2(e).
96 Id.
97 Calder v. Comr., 85 T.C. 713 (1985).
31 GIFT TAX JOINT 11-5-12.docx
are sold infrequently, determining the value of an interest depends on the facts and
circumstances of each transfer.98
(b) The IRS identified the following factors for consideration in such
transfers:
(1) The nature of the business and the history of the enterprise
since its inception;
(2) The economic outlook in general and the condition and
outlook of the specific industry in particular;
(3) The book value of the stock and the financial condition of the
business;
(4) The earning capacity of the company;
(5) The dividend-paying capacity of the company;
(6) The company's goodwill or any other intangible value;
(7) Sales of the stock and the size of the block of stock to be
valued; and
(8) The market price of interests in similar businesses traded in
a free and open market.99
(c) Courts have applied various discounts in valuing these interests.
The minority interest (or lack of control) discount is based on the fact that a minority
interest is worth less per share to a willing buyer than a controlling interest. According
to the Tax Court, this discount reflects the fact that a minority interest holder cannot
98 Northern Trust Co. v. Comr., 87 T.C. 349 (1986), aff'd sub nom., Citizens Bank and Trust Co. v. Comr., 839 F.2d 1349 (7th Cir. 1988).
99 Rev. Rul. 59-60. 1959-1 C.B. 237.
32 GIFT TAX JOINT 11-5-12.docx
compel liquidation of the business and realize his share of the business's net asset
value.100
(1) The Regulations refer to this as "the degree of control of the
business represented by the block of stock to be valued."101
(2) A higher discount applies when a shareholder holds only a
small percentage of stock and consequently has less effective control. A smaller
discount applies if a minority interest gives its holder a swing vote based on the facts
and circumstances. 102
(3) For a long time, the Service asserted that a minority interest
discount is inapplicable when stock of a family-controlled business is transferred to a
family member, but the Service retreated from that position in 1993.103 Now, a minority
interest discount may be applied even if a transferred interest and the other family-
controlled interests constitute a majority interest.
(4) As a corollary to this discount, a block of stock that
represents a controlling interest may be worth more per share than a block of minority
interest, and the value of a controlling block may be increased by a control premium.104
(d) The lack of marketability discount is appropriate if there is no ready
market for the transferred interest.105 This discount is separate from the lack of control
100 Newhouse Est. v. Comr., 94 T.C. 193 (1990).
101 Treas. Reg. § 25.2512-2(f)(2).
102 See generally 831 T.M., Valuation of Corporate Stock.
103 Rev. Rul. 93-12, 1993-1 C. B. 202.
104 Treas. Reg. § 25.2512-2(f)(2).
105 See generally 831 T.M., Valuation of Corporate Stock.
33 GIFT TAX JOINT 11-5-12.docx
discount explained above. It reflects the fact that a shareholder of a closely held
business cannot readily sell his interest in the business.106
(e) If a transferred interest is subject to an agreement that limits a
transferee's right to transfer the interest, such as buy-sell agreements and tenancy-in-
common agreements, the value of the transferred interest may be less than fair market
value.107
(f) Federal income tax liability may reduce the value of an interest. If
the value of a corporation is based on the value of its real property, the value may be
reduced by the federal income tax payable upon disposition of the property.108 Current
corporate-level tax liability may also be considered and may lead to a reduction in value
of shares in the corporation (even S-corporations).109
(g) Chapter 14 (IRC §§ 2701 – 2704) was enacted110 to limit gift tax
valuation abuses related to "estate freeze" techniques that relied on transfers of closely-
held business interests. These techniques were designed to shift future appreciation to
younger generations at a low gift tax cost, while reducing the estate tax value of the
interest retained by the older generation. In contrast to prior law, which focused on
estate tax inclusion, Chapter 14 imposes a gift tax on subject transactions.
106 Newhouse Est. v. Comr., 94 T.C. 193 (1990).
107 See, e.g., Harwood v. Comr., 82 T.C. 239 (1984) (partnership interest), and Citizens Bank and Trust Co. v. Comr., 839 F.2d 1249 (7th Cir. 1988) (corporate stock).
108 See generally 831 T.M., Valuation of Corporate Stock.
109 See generally 831 T.M., Valuation of Corporate Stock.
110 Omnibus Budget Reconciliation Act 1990, P.L. 101-508 (applying to transfers made after Oct. 8, 1990).
34 GIFT TAX JOINT 11-5-12.docx
(1) IRC § 2701 applies to the "transfer" of an interest to or for
the benefit of a "member of the transferor's family" by which the transferor or an
"applicable family member" holds an "applicable retained interest" after the transfer.111
A "transfer" includes a direct transfer to or for the benefit of a
member of the transferor's family of an interest in a corporation or partnership following
a redemption, recapitalization, or other change in the capital structure of the entity.112
"Transfer" does not include any shift of rights resulting from a qualified disclaimer under
IRC § 2518 or the exercise, release or lapse of a special power of appointment.113
A "member of the transferor's family" includes the transferor's
spouse, lineal descendants of the transferor or the transferor's spouse, and the spouse
of any such lineal descendant.114
An "applicable family member" includes the transferor's spouse,
any ancestor of the transferor or the transferor's spouse, and the spouse of any such
ancestor.115
An "applicable retained interest" is any interest with which there is
either a right to receive distributions (other than a qualified payment right)116 or an
extraordinary payment right (i.e., any put, call, conversion right or any right to compel
111 Treas. Reg. § 25.2701-1(b)(2)(i)(B)(1).
112 See H.R. Conf. Rep. No. 964, 101st Cong., 2d Sess. 1136-1137 (1990).
113 Treas. Reg. § 25.2701-1(b)(3)(ii), -(3)(iii).
114 IRC § 2701(e)(1).
115 IRC § 2701(e)(2).
116 IRC § 2701(c)(1)(A). A "qualified payment right" includes dividends and any other cumulative distribution payable on a periodic basis (at least annually) if the dividends or other payments are determined at a fixed rate. Treas. Reg. §25.2701-2(b)(6)(i)(A), -(i)(B). A transferor may elect whether to treat other distribution right as either qualified or nonqualified payment rights. IRC § 2701(c)(3)(C)(i), (ii).
35 GIFT TAX JOINT 11-5-12.docx
liquidation).117 Section 2701 is aimed at discretionary rights that may be ignored (such
as dividends on preferred stock), so it does not apply to any right that must be exercised
at a specific time and at a specific amount.118
Since Chapter 14 focuses on valuation abuses, § 2701 does not
apply to transfers of property for which market quotations are readily available for either
the transferred interest or the retained interest.119 Similarly, it does not apply to
transfers that result in a proportionate reduction of each class of equity interest held by
the transferor and all applicable family members.120
If § 2701 applies, the value of the gift is based on the difference
between the value of all family-held interests before the transfer and the value of
interests held by the transferor or an applicable family member after the transfer.121 IRC
§ 2701 deems the value held by the transferor to be zero in certain circumstances,
making the gift 100% of the value of the transferred property.
(2) IRC § 2702 applies to a "transfer in trust" to or for the benefit
of "family members" if the transferor or an "applicable family member" retains an interest
in the transferred property.
The term "transfer in trust" includes a transfer to a new or existing
trust and an assignment of interest to an existing trust. It does not include the exercise
of a qualified disclaimer under IRC § 2518 or the exercise, release or lapse of a special
power of appointment.122
117 Treas. Reg. § 25.2701-2(b)(2).
118 IRC § 2701(c)(2)(B)(i).
119 IRC § 2701(a)(2)(A).
120 Id.
121 Treas. Reg. § 25.2701-1(a)(2), -3(a).
122 Treas. Reg. § 25.2702-2(a)(2).
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The term "family member" includes the transferor's spouse, any
ancestor or lineal descendant of the transferor or the transferor's spouse, the
transferor's siblings, or the spouse of spouse of any ancestor, descendant or sibling
mentioned above.123
The term "interest" must be understood by comparing it to the term
"qualified interest." A qualified interest is a qualified annuity interest, a qualified unitrust
interest, or a qualified remainder interest,124 and such interests are valued under IRC
§ 7520. Other retained interests are valued by § 2702 at zero for gift tax purposes. As
with § 2701, the result is that the gift is 100% of the value of the transferred property.
While § 2702 sounds fearsome, its primary effect is that grantor
retained income trusts ("GRITs") are no longer useful as planning techniques for
transfers in trust between family members (although GRITs remain available to same-
sex couples who are not considered "spouses" under federal law). Grantor retained
annuity trusts and grantor retained unitrusts remain viable options.
(3) IRC § 2703 distinguishes restrictive agreements among
family members from those with bona fide business purposes. It provides that the first
type of agreement will be disregarded in determining the value of an entity for estate,
gift and generation-skipping transfer taxes.
In order for a restrictive agreement to affect the value of the entity,
it must be a bona fide business arrangement, it cannot be a device to transfer property
to a family member for less than full and adequate consideration in money or money's
worth, and it must have terms that are comparable to similar arrangements entered into
123 IRC §§ 2702(e), 2704(c)(2), Treas. Reg. § 25.2702-2(a)(1). This definition is significantly broader than the one under IRC § 2701.
124 IRC § 2702(b). See Treas. Reg. § 25.2702-2(a)(6), -3(b), (d) (qualified annuity interest); § 25.2702-2(a)(7), -3(c), (d) (qualified unitrust interest); and § 25.2702-2(a)(8), -3(f) (qualified charitable remainder interest).
37 GIFT TAX JOINT 11-5-12.docx
at arm's length.125 In cases where family members own part of the entity, the
requirements are met if more than 50% of the value of the property subject to the
agreement is owned directly or indirectly by non-family members.126
6.4 PARTIAL INTERESTS
(a) The value of a gift of a partial interest is determined using an
interest rate equal to 120% of the federal mid-term rate.127 Taxpayers are allowed to
choose the rate in effect for the month in which the transfer occurs or in either of the two
preceding months.128
(b) The value of a life estate is the present value of the income interest.
The value of the transferred property is multiplied by a factor representing the income
interest.129 Income factors can be found in Table S of Publication 1457 for the month of
the transfer.
(c) The value of a term of year is determined the same way a life
estate is valued.130 Income factors for term of year gifts can be found in Table B of
Publication 1457 for the month of the transfer.
(d) The value of a remainder or reversionary interest is the present
value of the remainder or reversionary interest. The value of the transferred property is
multiplied by a factor representing the remainder interest.131 Factors for remainder or
125 Treas. Reg. § 25.2703-1(b)(4)(i).
126 Treas. Reg. § 25.2703-1(b)(3).
127 IRC § 7520.
128 Treas. Reg. § 25.7520-2(a)(2).
129 Treas. Reg. § 25.2512-5T(d)(2)(iii).
130 Id.
131 Treas. Reg. § 25.2512-5T(d)(2)(ii).
38 GIFT TAX JOINT 11-5-12.docx
reversionary interests can be found in Table B of Publication 1457 for the month of the
transfer.
(e) The value of a private annuity is determined by multiplying the
aggregate amount payable annually by an annuity factor.132 Annuity factors for a term-
of-years annuity can be found in Table B of Publication 1457 for the month of the
transfer, and factors for a lifetime annuity can be found in Table S of Publication 1457.
If the payment is to be made more frequently than annually, an adjustment must be
made using factors found in Table K of Publication 1457.133 If the payment is to be
made at the beginning of the payment period, an adjustment must be made using
factors found in Table J of Publication 1457.134
6.5 LIFE INSURANCE AND ANNUITIES
(a) New Policies/Contracts
If a new life insurance policy135 is transferred, the value is the cost of the
policy.136 The same rule applies to a commercial annuity contract, which means "an
annuity issued by a company regularly engaged in the selling of contracts of that
character."137
132 Treas. Reg. § 25.2512-5T(d)(2)(iv).
133 Treas. Reg. § 25.2512-5T(d)(2)(iv)(B).
134 Treas. Reg. § 25.2512-5T(d)(2)(iv)(C).
135 "New" means only the first premium has been paid. See Phipps v. Comr., 43 B.T.A. 790 (1941).
136 Treas. Reg. § 25.2512-6(a).
137 Treas. Reg. § 25.2512-6(a).
39 GIFT TAX JOINT 11-5-12.docx
(b) Paid-Up Insurance Policies
The value of a policy on which no future premium payments are to be
made is the replacement cost of the policy at the time of transfer.138 Replacement cost
is the cost of a single-premium policy of the same face amount on the life of a person
the same age as the insured.139
(c) Permanent Policies With Additional Premium Payments Due
The value of a permanent policy on which additional premium payments
are due is the "interpolated terminal reserve" of the policy plus the proportionate amount
of the last premium payment that covers the period extending beyond the date of the
gift.140 The interpolated terminal reserve is obtained directly from the insurance
company.
6.6 BELOW-MARKET INTEREST RATE LOANS
(a) A loan that bears less than market rate interest gives the borrower
an economic benefit that is treated as a taxable gift.141 IRC § 7872 applies to loans
made after June 6, 1984, and provides the method for determining the amount of the
gift in such a situation.
(b) Under IRC § 7872, if the value of the property transferred (the
amount loaned plus the amount of foregone interest) exceeds the consideration
received and if the transaction is not made in the ordinary course of business, then a
below-market rate loan is treated as a gift loan.
138 Treas. Reg. § 25.2512-6(a).
139 Treas. Reg. § 25.2512-6(a).
140 Treas. Reg. § 25.2512-6(a).
141 Dickman v. Comr., 465 U.S. 330 (1984).
40 GIFT TAX JOINT 11-5-12.docx
(c) If IRC § 7872 applies, two transfers are imputed: a gift transfer
from the lender to the borrower in an amount equal to the foregone interest, and
payment of interest by the borrower to the lender.
(d) If the loan is a demand loan (one that is payable at any time on
demand of the lender142), the lender is treated as having transferred (by gift) the
difference between the amount of interest payable during the calendar year if the
interest had accrued at the AFR using semiannual compounding and the interest
payable on the loan for that year.143 This calculation is run every year the loan remains
outstanding, and the lender is deemed to have made the calculated gift amount on
December 31 of the year.144 If the loan remains outstanding for a period that involves
multiple AFRs, the calculation is made using a blended annual rate.145
(e) If the loan is not a demand loan, then it is deemed a term loan by
IRC § 7872(f)(6). With regard to a term loan, the lender is treated as having transferred
(by gift) the difference between the amount of the loan and the present value of all
payments due under the loan.146 The present value is computed using the AFR in effect
on the day the loan was made, and interest is treated as if compounded semiannually.
(f) There is a de minimis exception to § 7872 that prevents the Section
from applying if the aggregate principal amount of all outstanding loans (both below-
market rate loans as well as market-rate loans) from one lender to one borrower is less
than $10,000.147
142 IRC § 7872(f)(5).
143 IRC § 7872(e)(2).
144 IRC § 7872(a)(2).
145 Prop. Treas. Reg. §1.7872-13(a)(1),
146 IRC § 7872(b)(1).
147 IRC § 7872(c)(2).
41 GIFT TAX JOINT 11-5-12.docx
6.7 ENCUMBERED GIFTS
(a) When property secures a debt of the transferor and the transferor
transfers the property by gift, the amount of the gift is the excess of the unencumbered
fair market value of the property over the amount of indebtedness.148
(b) Generally, the donor is liable for payment of the gift tax,149 and the
payment of the tax does not reduce the value of the gift. But if the donor and donee
agree that the donee must pay the tax out (either from his own assets or from the
transferred property), the result is a "net gift," and the value of the gift is the excess of
the fair market value of the transferred property over the amount of the gift tax paid by
the donee.150 The facts must show that the donee's obligation to pay the gift tax is a
condition of the transfer.151
6.8 VALUATION PENALTIES
(a) If tax is underpaid as a result of a substantial valuation
understatement, then the penalty is equal to 20% of the underpayment.152 A substantial
valuation understatement occurs when the value of the property reported on a gift tax
return is 50% or less of the amount determined to be correct.153
(b) If tax is underpaid as a result of a gross valuation understatement,
then the penalty is equal to 40% of the underpayment.154 A gross valuation
148 See, e.g., Laughinghouse v. Comr., 80 T.C. 425 (1983).
149 IRC § 2502(c).
150 See, e.g., Harrison v. Comr., 17 T.C. 1350 (1952), acq. 1952-2 C.B. 2.
151 Rev. Rul. 75-72, 1975-1 C.B. 310.
152 IRC § 6662(b)(5).
153 IRC § 6662(g)(1).
154 IRC § 6662(h)(1).
42 GIFT TAX JOINT 11-5-12.docx
understatement occurs when the value of the property reported on a gift tax return is
40% or less of the amount determined to be correct.155
(c) Both penalties can be abated if there was a reasonable cause for
the understatement and the taxpayer acted in good faith.156
155 IRC § 6662(g)(1). 40% is the test for returns field after Aug. 17, 2006. For earlier returns, 25% was the threshold for a gross valuation misstatement.
156 IRC § 6664(c).
43 GIFT TAX JOINT 11-5-12.docx
ARTICLE VII
EXCLUSIONS FROM GIFT TAX
7.1 EXCLUSIONS GENERALLY
The amount of any net gift is reduced by any available exclusions.157
7.2 ANNUAL EXCLUSION GIFTS
IRC Section 2503 provides for a $10,000 per donor, per donee per year
annual exclusion adjusted for inflation. The adjusted annual exclusion for 2012 is
$13,000 per donor, per donee per year.158
(a) The annual exclusion is only available for gifts of present interests.
(1) Present interest is defined as follows:159
(A) The donee must have an unrestricted right to the
immediate use, possession, or enjoyment of property or the income from property;
(B) The donee must be identifiable; and
(C) The value of the gift must be presently ascertainable.
(b) Crummey powers
(1) A transfer to a beneficiary in trust that would not otherwise
qualify as a gift of a present interest may qualify if the beneficiary is granted Crummey
powers.
(2) A Crummey power is a power given to a person (i.e., a trust
beneficiary) to withdraw amounts transferred to the trust for a period of time (i.e., thirty
157 IRC § 2503.
158 Rev. Proc. 2011-52.
159 See Treas. Reg. § 25.2503-3(b).
44 GIFT TAX JOINT 11-5-12.docx
days) following the transfer. This process was established by Crummey v.
Commissioner.160
(3) The right of withdrawal must be respected by the Trustee in
order for the trust transfers to qualify for the annual exclusion.161
(4) The withdrawal power is a general power of appointment in
the hands of the beneficiary. If the beneficiary does not exercise this power, it lapses
and the beneficiary makes a gift, subject to the “five and five” rule discussed above.
(c) Methods for maximizing annual exclusion
(1) Maximizing donors. Gifts of community property are gifts
by two donors if spouses elect gift splitting under IRC § 2513.
(2) Maximizing donees. A gift to a husband and wife is
considered a gift to two donees, not one.
(3) Installment gift, i.e., forgiveness of a loan over a period of
years. Each cancellation is a gift of a present interest. However, care should be taken
before a client is advised to do this because loan forgiveness may trigger income tax
gain.
Example: Dad establishes irrevocable life insurance trust for the
benefit of his children. Husband makes annual transfers to the trust in an amount equal
to the premiums due on the life insurance owned by the trust. The trust does not
provide that his children have Crummey powers. Will the transfers qualify for the annual
exclusion?
NO. If the children do not have Crummey powers, then the
transfers to the trust will not qualify as annual exclusion gifts. Dad will need to file gift
tax returns and use gift tax exemption to cover the transfers.
160 397 F. 2d 82 (9th Cir. 1968).
161 See Rev. Rul. 83-108, 1983-2 C. B. 167.
45 GIFT TAX JOINT 11-5-12.docx
7.3 TUITION AND MEDICAL CARE
(a) Amounts paid on behalf of a donee for tuition or medical care are
not subject to gift tax, and there is no limit to the exemption.162
(b) Payments for tuition or medical care must be made directly to the
medical care provider.
(c) The exclusion for medical care is lost if the donee is compensated
by insurance.
(d) The exclusion for payments toward medical care applies
irrespective of whether the donor is legally required to support the donee.163
Example: Grandparents give granddaughter $10,000 to pay for books
and other college incidentals. Does this gift qualify for the tuition and medical care
exclusion?
NO. This gift will not qualify under IRC § 2503(e) because the payment
was not made directly to the educational provider.
Example: Grandparents wish to assist granddaughter with her college
education. Grandparents write a check to the UC Regents to help granddaughter with
her college expenses. Will this gift qualify for the tuition and medical care exclusion?
YES. This gift will qualify under IRC § 2503(e) because grandparents
made the payment directly to the educational provider.
162 IRC § 2503(e).
163 Treas. Reg. § 25.2503-6.
46 GIFT TAX JOINT 11-5-12.docx
7.4 GIFTS TO MINORS
(a) Gifts to minors can pose a problem because a minor cannot, in
most cases, own legal title to property until the age of majority. IRC § 2503(c) is
designed to counteract this problem.
(b) IRC § 2503(c)(2) provides that a gift to a minor will qualify for an
annual exclusion if the following conditions are met:
(1) The gift may be expended by, or for the benefit of, the donee
before the donee attains the age of 21 years, and
(2) The gift will to the extent not so expended--
(A) pass to the donee on his or her attaining the age of 21
years, and
(B) In the event the donee dies before attaining the age of
21 years, be payable to the estate of the donee or as he or she may appoint under a
general power of appointment as defined in IRC § 2514(c).
(c) The guardian, custodian or trustee must have broad discretionary
powers on behalf of the beneficiary. The exclusion is lost if the fiduciary’s powers are
limited, i.e., a support trust.164
(d) The amount of the annual exclusion for minors under IRC § 2503(c)
is the same as the annual exclusion for gifts under IRC § 2503(b).
164 See Treas. Reg. § 25.2503-4(b)(1) and Rev. Rul. 69-345.
47 GIFT TAX JOINT 11-5-12.docx
ARTICLE VIII
MARITAL DEDUCTION
8.1 UNLIMITED MARITAL DEDUCTION
(a) IRC § 2523 states that an unlimited marital deduction is available
for gift transfers between spouses.
(b) Requirements for the unlimited marital deduction:
(1) The donee must be married to the donor at the time of the
gift.165
(2) The gift must not be a gift of a terminable interest, discussed
below.
8.2 TERMINABLE INTEREST RULE
(a) A terminable interest is an interest that might fail, expire or
terminate on the occurrence of a certain event.
(b) No deduction is permitted for transfers of terminable interests,
except as discussed in Section 8.3 below.
8.3 EXCEPTIONS TO TERMINABLE INTEREST RULE
(a) Tenancy by the Entirety. This is a form of ownership whereby
spouses are considered a single legal entity. A transfer to a tenancy by the entirety will
qualify for the marital deduction even though it is possible that the interest will fail if the
donee spouse predeceases the donor spouse. California does not recognize tenancy by
the entirety ownership.166
165 IRC § 2523(a).
166See IRC § 2523(e).
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(b) Power of Appointment Trust. IRC § 2523(e) allows a deduction
for a transfer to a power of appointment trust if the following requirements are satisfied:
(1) The donee spouse must be entitled to all of the income,
payable at least annually, and/or sole possession of the property for the spouse’s
lifetime.
(2) The donee spouse must have a general power of
appointment over the trust (i.e., the power to appoint the property in favor of the spouse,
the spouse’s estate, the spouse’s creditors or the creditors of the spouse’s estate).
(3) No individual other than the donee spouse has the power of
appointment described in Section 8.3(b)(2) above.
(c) QTIP Transfer. A qualified terminable interest property (“QTIP”)
transfer will qualify for the unlimited marital deduction if the following requirements are
met:167
(1) The donee spouse must be entitled to all of the income,
payable at least annually, and/or sole possession of the property for the spouse’s
lifetime.
(2) The donor spouse must elect that the transfer qualify for the
marital deduction. This will cause the transferred property to be included in the estate
of the donee spouse for estate tax purposes pursuant to IRC § 2044.
(3) No person (including the donee spouse) has the power to
appoint any of the QTIP property to anyone other than the donee spouse.
(d) Charitable Remainder Trust. A transfer to a spouse for life, with
the remainder to charity, will qualify for the marital deduction as to the donee spouse’s
income interest.168
167 See IRC § 2523(f).
168 IRC § 2523(f).
49 GIFT TAX JOINT 11-5-12.docx
8.4 DONEE SPOUSE NOT U.S. CITIZEN
IRC § 2523(i) states that gifts to a spouse who is not a citizen at the date
of gift are subject to U.S. gift tax to the extent the gift exceeds $100,000, indexed for
inflation. In 2012, the exemption is $139,000.169
8.5 IRC SECTION 2519 – TRANSFER OF INCOME INTEREST
(a) If a donee spouse decides to make a gift of the donee spouse’s
income interest under a QTIP trust, there is a gift of the income interest AND a deemed
transfer by the donee spouse of all other interests in the property.170
(b) The donee spouse is entitled to recover from the QTIP trust the
amount of gift tax attributable to the application of IRC Section 2519.171
(c) If the donee spouse does not exercise the right of recovery granted
under IRC Section 2207A, then the foregone reimbursement is considered a separate
gift by the donee spouse.172
169 Rev. Proc 2011-52.
170 IRC § 2519.
171 See IRC § 2207A.
172 IRC § 2207A(b).
50 GIFT TAX JOINT 11-5-12.docx
ARTICLE IX
CHARITABLE DEDUCTION
9.1 AMOUNT OF DEDUCTION
(a) IRC § 2522 provides that there is a charitable deduction for gift tax
purposes.
(b) The deduction cannot exceed the value of the gift.173
9.2 GIFTS OF PARTIAL INTERESTS
Certain gifts of partial interests qualify for the charitable deduction.
(a) Nontrust transfers
(1) Remainder interest in a residence or farm. A donor gives
her residence to a charity and retains a life estate, which is the right to live in the
residence for her lifetime. The donor is entitled to a charitable deduction equal to the
present value of the charity’s remainder interest.
(2) Undivided interest in donor’s entire interest in property.
A donor owns 100% of Blackacre. The donor gives an undivided 25% interest in
Blackacre to charity. The donor is entitled to a charitable deduction equal to the value
of a 25% undivided interest in Blackacre.
(3) Qualified Conservation Easement. Easement granted to
charity for charitable use of land.
(b) Charitable remainder trusts. Trust whereby donor (or another
person) is given an income interest for life, with remainder to charity.
(1) Charitable remainder annuity trust. Income interest is a
set as a fixed amount per year.174
173 IRC § 2503(a).
174 IRC § 664(d)(2).
51 GIFT TAX JOINT 11-5-12.docx
(2) Charitable remainder unitrust. Income interest is fixed
right to receive certain percentage of the corpus, valued annually.175
(c) Charitable lead trusts. The charity receives an income interest
(annuity or unitrust) for a term of years, remainder to one or more noncharitable
beneficiaries. The donor receives a charitable deduction for the value of the income
interest distributed to charity.176
(d) Pooled income funds. A charitable remainder trust managed by a
charity with multiple donors. Any donor may reserve to himself or herself, or other
donors, an income interest. Contributions to a pooled income fund qualify for the gift tax
charitable deduction.177
9.3 GIFT TAX RETURNS FOR CHARITABLE GIFTS
(a) The best practice is to file a gift tax return to report a gift to charity,
even if the gift is 100% deductible.
(b) As discussed in the Gift Tax Procedure Section below, a gift tax
return must be filed to claim a charitable gift tax deduction for split interest gifts to
charity.
(c) As also discussed below, a significant benefit of filing a gift tax
return is that the filing starts the tolling of the statute of limitations.
175 IRC § 664(d)(1).
176 See IRC § 642(c)(2).
177 See IRC § 642(c)(5).
52 GIFT TAX JOINT 11-5-12.docx
ARTICLE X
GENERATION SKIPPING TRANSFER TAX
10.1 OVERVIEW
The generation-skipping transfer tax applies only to “generation skipping”
transfers that occur with respect to the following:
(a) Transfers by will or inter vivos trust where the decedent died after
December 31, 1986 (or where the decedent died before that time but the will or trust
was executed after October 21, 1986).
(b) Inter vivos (lifetime) transfers other than transfers to revocable
trusts (i.e., outright gifts) after September 25, 1985.
10.2 RELATIONSHIP TO GIFT TAX
(a) The generation-skipping transfer (“GST”) tax is an additional tax on
top of the gift tax.
(b) If a gift is subject to gift tax and generation-skipping transfer tax, the
amount of generation-skipping transfer tax paid by the donor is considered an additional
gift subject to gift tax.
Example: Donor makes a taxable gift of $100. The gift is also subject to
GST. If the gift tax and GST tax rate is 35%, then the donor will incur gift and GST tax
as follows:
GST Tax: $35 (35% of $100)
Gift Tax: $47.25 (35% of $135)
10.3 TYPES OF GENERATION SKIPPING TRANSFERS
There are three (3) types of generation-skipping transfers:
(a) Direct skip transfer: This type of skip occurs upon a transfer,
either outright or in trust, where all of the donees are at least two (2) generations below
the transferor.
53 GIFT TAX JOINT 11-5-12.docx
(1) If a direct skip occurs, it will be imposed in addition to the gift
tax at the time of the transfer.
(2) Common direct skips
(A) Outright gift to a grandchild.
(B) Gift in trust for the benefit of donor’s grandchild or
grandchildren (i.e., an educational trust).
(b) Taxable Distribution: Transfer from a trust or trust equivalent
(i.e., arrangement involving annuities, life insurance, employee death benefits) where
the beneficiary receiving the distribution is at least two generations below the donor.
The creation of the trust (or trust equivalent) is subject to gift tax but not generation-
skipping transfer tax. Generation-skipping transfer tax will not be imposed until all
beneficial interests in the trust are held by a generation at least two generations below
the grantor.
(c) Taxable Termination: Occurs upon the termination of any interest
in a trust, but only if (i) no non-skip person (defined below) has an interest in the trust,
and (ii) after the termination distributions will be made to skip persons.178 A trust may
suffer generation-skipping transfer tax at successive generations.
Example: John creates a trust for son for life, with income to grandson for
life following son’s death and income to great-grandchildren following grandson’s death.
The deaths of son and grandson create taxable terminations.
(d) Exception for taxable distribution or taxable termination
subject to estate or gift tax: If a taxable termination or taxable distribution is also
subject to estate tax or gift tax, then the GST tax will not apply, and the transfer will just
be subject to the estate tax or gift tax.
178 IRC § 2612(b)(1).
54 GIFT TAX JOINT 11-5-12.docx
Example: Father establishes trust for the benefit of his son. Following
son’s death, son has a general power of appointment over the trust estate. If son does
not exercise the general power of appointment, the trust estate passes to son’s children,
the grandchildren of father. Son dies and does not exercise the power of appointment,
so the trust estate passes to son’s children. Is the taxable termination subject to
generation-skipping transfer tax?
NO. The trust estate will be subject to estate tax in son’s estate because
son held a general power of appointment over the assets. Thus, the taxable termination
is not subject to generation-skipping transfer tax.
(e) A GST transfer that involves a skip over more than two generations
is considered one skip for GST purposes. Thus, a transfer to a great-grandchild is one
taxable event.179
10.4 GENERATION-SKIPPING TRANSFER TAX RATE
(a) The tax rate is the maximum estate tax rate multiplied by the
inclusion ratio.180
(b) Inclusion Ratio: The inclusion ratio with respect to any property
transferred in a generation-skipping transfer is the excess (if any) of 1 over--
(1) except as provided in subparagraph (2), the applicable
fraction determined for the trust from which such transfer is made, or
(2) in the case of a direct skip, the applicable fraction
determined for such skip.181
179 IRC § 2653(a).
180 IRC § 2641.
181 IRC § 2642(a)(1).
55 GIFT TAX JOINT 11-5-12.docx
(c) Applicable Fraction: A fraction--
(1) The numerator of which is the amount of the GST exemption
allocated to the trust (or in the case of a direct skip, allocated to the property transferred
in such skip), and
(2) The denominator of which is--
(A) The value of the property transferred to the trust (or
involved in the direct skip), reduced by
(B) the sum of--
(i) any Federal estate tax or State death tax
actually recovered from the trust attributable to such property, and
(ii) any charitable deduction allowed under § 2055
or § 2522 with respect to such property.182
Example: Mark makes an outright gift to his grandson of cash in the
amount of $1,000,000 in 2010. What is the GST tax rate for this gift?
The denominator of the applicable fraction is $1,000,000, because that is
the value of the property. There are no deductions for estate tax or State death tax
recovered or a charitable deduction. $1,000,000 will be allocated toward this gift. Thus,
the applicable fraction is $1,000,000/$1,000,000 = 1. The inclusion ratio will be zero,
because the applicable fraction does not exceed 1. Accordingly, the transfer will not
bear GST tax.
10.5 DEFINITION OF “TRANSFEROR”
(a) “Transferor” refers to the person who transfers property during life
or at death, such that (i) the initial transfer is subject to estate or gift tax, and (ii) a GST
182 IRC § 2642(a)(2).
56 GIFT TAX JOINT 11-5-12.docx
transfer occurs either at the time of the transfer or will or may occur later as the result of
a taxable distribution or a taxable termination.
(1) A beneficiary who possesses a general power of
appointment is deemed to be the “transferor” of that property at death, irrespective of
whether the power is exercised or whether the beneficiary made the initial transfer of
property. Thus, the son in the example in Section 10.3(d) is considered the transferor,
which is why the taxable termination is not subject to generation-skipping transfer tax.
(2) A surviving spouse is deemed to be the transferor of a QTIP
Trust established by the surviving spouse’s spouse where a QTIP election is made, and
the QTIP Trust is subject to gift or estate tax with respect to the surviving spouse.
(A) The transferor spouse who established the QTIP
Trust can make what’s called a “reverse QTIP election”, which is effective for
generation-skipping transfer tax purposes only. In that event, the transferor spouse,
and not the surviving spouse, will be treated as the “transferor” for generation-skipping
transfer tax purposes.
(B) A transfer is subject to estate or gift tax if it is included
in the transferor’s gross estate (for estate tax purposes) or it is treated as part of the
gross gift made by the transferor (for gift tax purposes), even if there is no actual estate
or gift tax paid because of exclusions, deductions or credits.
(3) Gifts of community property and gifts subject to a gift splitting
election under IRC § 2513: Each spouse is deemed to be the transferor of one-half
(1/2) of the gift.
10.6 SKIP PERSONS VS. NON-SKIP PERSONS
Skip persons and non-skip persons are defined in IRC § 2613.
(a) A “skip person” is any individual who is two or more generations
below the transferor. The most common skips occur between grandparents and
grandchildren.
(b) A “skip person” includes a trust in which all of the beneficial
interests are held by skip persons, OR
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(1) There is no person holding an interest in such trust, and
(2) At no time after such transfer may a distribution (including
distributions on termination) be made from such trust to a nonskip person.
(c) A non-skip person is anyone who isn’t a skip person. Charities and
qualified charitable remainder trusts can’t be skip persons.
10.7 GENERATION ASSIGNMENTS
The generation assignment rules are set forth in IRC § 2651.
(a) Spouses, former spouses and charities are deemed to be in the
same generation as the transferor.
(b) Relatives of the transferor are assigned generations according to
lineal relationship and not age.
(1) Relationships by half-blood are treated as whole-blood
relationships for purposes of these rules.
(2) Relationships based on adoption are treated as whole-blood
relationships for purposes of these rules.
(3) Relationships by marriage (i.e., step-parent and step-child)
are measured by lineal relationship and not age.
(c) Individuals who are not lineal descendants
(1) An individual born not more than 12 ½ years after the
transferor is considered a member of the transferor’s generation.
(2) An individual born more than 12 ½ years but not more than
37 ½ years after the transfer is assigned the first generation younger than the
transferor.
(3) Similar rules for a new generation every 25 years.
(d) Planning for same sex couples. Same sex marriage is
recognized in several states, but it is not recognized by California or the federal
government.
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(1) What if a partner wants to make a gift to a child of the other
partner? Do the lineal relationship rules apply? It is unclear under California domestic
partnership law whether certain familial relationships based on the partnership (i.e.,
step-relatives and in-laws) will be recognized.
(2) Best practice: Follow the rules for individuals who are not
lineal descendants and count the years until the laws are clarified.
(e) Move-up-a-generation rule: A grandchild of the transferor will be
deemed the child of the transferor if the grandchild’s parent who is the child of the
transferor predeceased the transfer. In that event, the grandchild will not be considered
a skip person.183
10.8 EXCLUSIONS FROM GENERATION-SKIPPING TRANSFER TAX
(a) Gifts that are direct payments of tuition or medical care expenses
are not subject to generation-skipping transfer tax.184
(b) If a gift is exempt from gift tax due to IRC § 2503(b) (annual
exclusion gift) or IRC § 2503(c) (gift to minor), then the gift will not be subject to
generation-skipping transfer tax.
(c) Gifts in trust, even if they are exempt from gift tax pursuant to IRC
§ 2503(b) or IRC § 2503(c), will be subject to generation-skipping transfer tax unless:
(1) Only the beneficiary can receive income or principal during
the beneficiary’s lifetime; and
(2) Any amount remaining at the beneficiary’s death is includible
in the beneficiary’s estate for estate tax purposes (i.e., the beneficiary has a general
power appointment as defined under IRC § 2041, or an interest in the property pursuant
to IRC § 2033).
183 IRC § 2651(e).
184 IRC § 2611(b)(1).
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(d) A transfer is exempt if the property transferred was subject to a
prior generation-skipping transfer.
(e) As discussed above, taxable terminations and taxable distributions
that are subject to estate tax or gift tax are not subject to generation-skipping transfer
tax.
10.9 EFFECT OF DISCLAIMERS ON GENERATION-SKIPPING TRANSFER
TAX
If an individual makes a qualified disclaimer under IRC § 2518, the
disclaiming individual is not the transferor for gift tax purposes. However, the transfer
could be a generation-skipping transfer.
Example: Dad gives property to daughter, who makes a timely disclaimer
such that grandchild takes the property. This results in a direct skip from Dad to
grandchild.
10.10 ALLOCATION OF GST EXEMPTION
(a) Direct skips: GST exemption is automatically allocated to direct
skips. However, the donor can opt out of automatic allocation185.
(b) Indirect skips: Indirect skips are gifts currently subject to gift tax
that may be subject to GST later (i.e., taxable termination or taxable distribution). The
donor does not have to affirmatively elect to allocate GST to these transfers186.
185 See IRC § 2632(b) and Form 709, Schedule A, Part 2. 186 See IRC § 2632(c) and Form 709, Schedule A, Part 3.
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10.11 SAMPLE NOTICE OF GST ALLOCATION
Attached to and made a part of
United States Gift (and Generation-Skipping Transfer) 2010 Tax Return (Form 709)
JOHN DOE Social Security No. 123-45-6789
NOTICE OF ALLOCATION
TRUST:
Doe Family Life Insurance Trust (Item 1 on taxpayer’s Form 709 for 2010), Jane
Doe, Trustee
(Address)
EIN____________
[Copy of the Trust is attached hereto as Exhibit A]
NET VALUE FOR GST EXEMPTION ALLOCATION PURPOSES:
$10,000
AMOUNT OF GST EXEMPTION ALLOCATED:
The taxpayer allocates to the Trust the smallest amount of the taxpayer’s
GST exemption necessary to produce an inclusion ratio (as defined in Internal
Revenue Code Section 2642(a)) for the Trust that is closest to or, if possible,
equal to zero. This is a formula election which will change if values are changed
on audit. Based on values as returned this allocation will result in $10,000 of GST
exemption allocated to the Trust, computed as described below.
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ARTICLE XI
COMPUTATION OF GIFT TAX
11.1 STEP 1 – COMPUTATION OF TAX IN CURRENT YEAR AND PRIOR
YEARS
(a) Determine the tentative tax on all taxable gifts through the current
year and gifts for prior years.187
(b) The amount of GST tax paid in the current year is added to the
base of the taxable gifts for that year. In other words, the donor pays gift tax on any
GST tax paid.
(c) Marital and charitable deductions are applied to determine the tax
base upon which the tentative tax is calculated.
11.2 STEP 2 – SUBTRACTION OF PRIOR TAX PAID
The gift tax on all taxable gifts made prior to the current taxable year is
subtracted.188
11.3 STEP 3 – APPLICATION OF UNUSED GIFT TAX CREDIT
Any unused gift tax credit is applied. It is used on a first come, first served
basis. This is the only credit applied against gift tax.189
11.4 EXAMPLE
Dad made a gift to his son of $500,000 in 2011. What is Dad’s gift tax
liability, if any, in 2011?
187 IRC § 2502(a).
188 IRC § 2502(a)(2).
189 IRC § 2505(a).
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(a) STEP 1: Calculate tentative tax on current gifts plus prior gifts.
The tax on $500,000 is $155,800. The tax base does not include GST paid because
these are not GST gifts.
(b) STEP 2: Subtract the tentative tax on prior gifts. That is $0
because there are no prior taxable gifts.
(c) STEP 3: The gift tax is 0 because the gift tax credit exceeds the
gift, but the available credit under IRC § 2010(c) is reduced.
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ARTICLE XII
GIFT TAX PROCEDURE
12.1 GIFT TAX RETURNS
(a) Form
Federal gift tax returns are filed on Form 709, United States Gift (and
Generation-Skipping Transfer) Tax Return.
(b) When Return Required
(1) Any individual U.S. citizen or resident who transfers a
present interest by gift is required to file a gift tax return (regardless of whether gift tax is
due) for the calendar year in which the gift is made unless the gift is excluded by:
(A) The annual exclusion;
(B) The gift tax marital deduction;
(C) The gift tax exclusion for qualified tuition or medical
expenses; or
(D) The gift tax charitable deduction. 190
(2) Joint gift tax returns by spouses are not allowed; instead,
gifts may be split by the spouses as discussed above.
(3) Even if no tax is due on a transfer to a spouse, a return may
be required to make a QTIP election.
(4) The gift tax charitable deduction does not cover split interest
gifts to charity, so gift tax returns are required to report gifts to charitable remainder
190 IRC § 6019.
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trusts, charitable lead trusts, and any other charitable gift of less than the donor's entire
interest.191
(c) Filer
(1) Generally, the donor must file a gift tax return.
(2) If a donor dies before filing a required return, the executor or
administrator of the estate must file the return.192
(3) If a donor cannot file a required return due to illness,
absence, or nonresidence, the donor's guardian must file the return.193 If an agent files
a return, a statement explaining the circumstances must accompany the return, and the
fact that filing a return is inconvenient for the donor is not enough to allow an agent to
file the return.194 A return filed by an agent must be ratified by the donor within a
reasonable time after the taxpayer becomes able to do so; otherwise, the return is not
considered complete.195
(d) Where to File
Gift tax returns are filed with the Internal Revenue Service Center,
Cincinnati, Ohio 45999.
12.2 TIME TO FILE
(a) Generally, gift tax returns are filed on a calendar year basis,196 and
a required return must be filed by April 15th of the year following the year in which the
191 IRC § 6019(3).
192 Treas. Reg. § 25.6019-1(g).
193 Treas. Reg. § 25.6019-1(g).
194 Treas. Reg. § 25.6019-1(h).
195 Treas. Reg. § 25.6019-1(h).
196 IRC § 6019.
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gift is made.197 If the due date falls on a weekend or a legal holiday, the return is due
the next day that is not a weekend or a legal holiday.198
(b) If the donor dies during the calendar year in which a gift is made,
the gift tax return must be filed by the earlier of the due date for the donor's estate tax
return (regardless of whether that return is extended) or April 15th of the year following
the year in which the gift was made.199 If no estate tax return is required, the gift tax
return is due April 15th of the following year.200
(c) The time for filing a gift tax return may be extended by six months
by filing either Form 4868, Application for Automatic Extension of Time To File U.S.
Individual Income Tax Return (which automatically extends the due date for a gift tax
return required for the same calendar year), or Form 8892, Application for Automatic
Extension of Time To File Form 709, before the original due date.201 Extending the time
to file does not extend the time to pay any gift tax, so payment of the estimated tax must
be made by the original due date.202
(d) The automatic six-month extension is generally the only extension
allowed for the time to file gift tax returns.
197 IRC § 6075(b)(1).
198 Treas. Reg. § 25.6075-1(d).
199 IRC § 6075(b)(3).
200 Treas. Reg. § 25.6075-1(b)(2).
201 IRC § 6075(b)(2).
202 Treas. Reg. § 25.6161-1(a)(3).
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12.3 PAYMENT OF TAX
(a) The gift tax must generally be paid at the original time for filing the
gift tax return, regardless of any extension of time to file the return.203
(b) The IRS may extend the time to pay if the taxpayer shows that
payment on the due date will result in undue hardship that amounts to a substantial
financial loss, such as the sale of property at a "sacrificial" price.204
(c) A taxpayer may request an extension of the time to pay in
writing.205 The request should include documentation supporting the undue hardship, a
statement of the taxpayer's assets and liabilities, and an itemized list of all receipts and
disbursements for each of the three immediately preceding months. The request should
be sent to the Department of the Treasury, Internal Revenue Service, Cincinnati, Ohio
45999.
(d) Six months is generally the longest the time to pay may be
extended.206 A longer period may be given to a person who is abroad.207
(e) Even if the time to file is extended, interest will accrue on any
unpaid tax from the original due date until the date the tax is paid.208
203 IRC § 6161(a); Treas. Reg. § 25.6161-1(a)(3).
204 IRC § 6161(a)(1).
205 Treas. Reg. §25.6161-1(c).
206 IRC § 6161(a)(1).
207 Treas. Reg. § 25.6161-1(a)(1).
208 Treas. Reg. § 25.6161-1(d).
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12.4 STATUTE OF LIMITATIONS
(a) Timely filing a gift tax return starts a three-year period for
assessment of additional taxes with respect to the calendar year covered by the
return.209
(b) The statute of limitations does not begin running on any gift that
was not disclosed on the gift tax return in a manner that adequately informs the IRS of
the nature of the transaction.210 Before the adequate disclosure rules, the statute of
limitations did not begin if no gift tax was assessed, so taxpayers had little protection
against future adjustments by the IRS.
(1) The adequate disclosure rules first applied only to gifts
subject to §§ 2701 or 2702, but the rules were extended in 1997 to apply to all gifts.211
(2) Under these rules, the value of a gift is fixed for gift tax
purposes if the gift was reported on the gift tax return in a manner adequate to inform
the IRS of the nature of the transaction and the statute of limitations has run.
(3) A gift tax return adequately discloses a transfer if it contains
all of the following:
(A) A description of the transferred property and any
consideration received by the transferor;
(B) The identity of and relationship between the transferor
and the transferee;
209 IRC § 6501.
210 IRC § 6501(c).
211 1997 Taxpayer Relief Act, P.L. 105-34 (eff. for gifts made after Aug. 5, 1997).
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(C) If property is transferred in trust, the trust's taxpayer
identification number must be given along with a description of the trust terms or a copy
of the trust;
(D) A detailed description of the method used to
determine the value of the property transferred; and
(E) A statement describing any position taken on the
return that is contrary to any regulation or revenue ruling published at the time.212
(c) No statute of limitations prevents the assessment of additional tax
at any time if a false or fraudulent return is filed with the intent to evade tax.
212 Treas. Reg. § 301.6501(c)-1(f)(2)(i) through (v).
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ARTICLE XIII
COMMON GIFT STRATEGIES
13.1 IRREVOCABLE LIFE INSURANCE TRUST
(a) Grantor establishes irrevocable life insurance trust and either
(i) acquires a new policy (preferred) or (ii) transfers an existing policy to the trust.213
(b) Grantor makes gifts to the trust in the amount of the premiums.
The Trustee then pays the premiums with the cash gifts.
(c) ILITs usually include Crummey powers so that the grantor can use
the grantor’s annual exclusion to shield the cash gifts from gift tax.
13.2 QUALIFIED PERSONAL RESIDENCE TRUST
(a) Grantor makes a gift of a property interest to a Qualified Personal
Residence Trust (“QPRT”) for a term of years. At the end of the term, the property
passes to beneficiaries (typically descendants).
(b) The value of the gift is the present value of the remainder interest.
(c) The beneficiaries receive the grantor’s cost basis because it is a
lifetime gift.
(d) If the grantor survives the term, the grantor may continue to reside
in the residence, but the grantor must pay the beneficiaries fair market rent. Otherwise,
the grantor runs the risk that the IRS will determine that the grantor did not relinquish
dominion and control and determine that the residence is includible in the grantor’s
estate for estate tax purposes. However, there are options for paying rent so that it is
not paid monthly (i.e., quarterly payments, automatic deposit).
213 See IRC § 2035. If the grantor transfers an existing policy to the trust and dies within three years of the transfer, the policy will be includible in the grantor’s estate for estate tax purposes. This “three-year rule” does not apply to a new policy acquired by the trust.
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(e) If the grantor does not survive the term, the property is includible in
the grantor’s estate for estate tax purposes.
(f) Because QPRT assets are includible in the grantor’s estate until the
term ends, GST cannot be allocated to QPRT assets until the end of the term.
(g) A QPRT is considered a grantor trust, which means that the grantor
is treated as the owner for income tax purposes and can continue to claim property tax
deductions during the term.
(h) Some clients are reluctant to consider QPRTs because of the fear
that the client can be kicked out of his or her home by the remainder beneficiaries
(usually children). However, the grantor is the sole beneficiary during the term, and the
term is usually based on life expectancy. Thus, this fear is usually unfounded.
13.3 GRANTOR RETAINED ANNUITY TRUST/GRANTOR RETAINED
UNITRUST
(a) A Grantor Retained Annuity Trust (“GRAT”) is a transfer of property
to a trust for a term of years, during which the grantor retains an annuity interest (the
right to receive a fixed annuity, at least annually). A Grantor Retained Unitrust is a
transfer of property to a trust for a term of years, during which the grantor retains a
unitrust interest (right to receive a fixed percentage of principal, values annually).
(b) Typically, the grantor acts as trustee of his or her own
GRAT/GRUT.
(c) The value of the gift is the present value of the remainder interest
passing to the beneficiaries at the end of the term. The longer the term, and the larger
the annuity/unitrust interest, then the lower the value of the gift. “Zeroed-out GRATs”
use the annuity amount and term to reduce the value of the remainder interest to zero.
(d) If the grantor does not survive the term, then the GRAT/GRUT is
included in the grantor’s estate for estate tax purposes.
(e) Because GRAT/GRUT assets are includible in the grantor’s estate
until the term ends, GST cannot be allocated to GRAT/GRUT assets until the end of the
term.
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13.4 SALE TO INTENTIONALLY DEFECTIVE GRANTOR TRUST (“IDIT”)
(a) A sale of a grantor’s assets to an intentionally defective irrevocable
trust (“IDIT”) is a way for a grantor to freeze asset value in the grantor’s estate in a way
that is ignored for income tax purposes.
(b) Grantor establishes an irrevocable grantor trust. Grantor makes a
gift to the trust, usually at least ten percent (10%) of the seed money of the purchase.
(c) An asset, usually an appreciated, income producing asset, is sold
to the IDIT. The purchase price is (i) the seed money, and (ii) a promissory note.
(d) The asset purchased by the IDIT is excluded from the grantor’s
estate because it is a sale.
(e) The grantor does not recognize income tax (i.e., capital gain) on the
sale because the grantor and the IDIT are treated as the same taxpayer for income tax
purposes.
(f) Income of the IDIT is taxed to the grantor.
(g) Only gift is the initial gift of the seed money. Any unpaid balance of
the promissory note is includible in the grantor’s estate at the grantor’s death. Thus, the
note should be for a term within the grantor’s actuarial life expectancy.
(h) If the grantor fails to survive the IDIT term, it is unclear whether
remaining gain on sale from the note is accelerated and recognized by the grantor’s
heirs. Current capital gains tax rates are lower than estate tax rates. It is not
uncommon for a grantor to obtain additional life insurance to pay the capital gains tax if
this occurs.
(i) IRS review of sales to IDITs is aimed at establishing commerciality.
Thus, it is common to use (i) a ten percent (10%) seed gift and (ii) a pledge of the
interest to secure the debt in order to present a bona fide transaction.
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ARTICLE XIV
PRESIDENT OBAMA’S FEBRUARY 2012 BUDGET PROPOSAL
14.1 INTRODUCTION
President Obama’s proposed budget for 2013 was released in February
2012. The proposed budget includes several changes to the estate tax, generation-
skipping transfer tax (“GSTT”) and gift tax regime.
14.2 RESTORE 2009 ESTATE, GIFT AND GSTT TAX REGIME
(a) President Obama’s proposed budget would restore the estate, gift
and GSTT regime in effect in 2009. In that event, the Basic Exclusion Amount214 would
be reduced to $3,500,000, and the top tax rate would be 45%.
(b) The portability of a spouse’s unused Exclusion Amount would be
made permanent.
14.3 REQUIRE CONSISTENCY IN VALUATION
(a) IRC § 1014 provides that the basis of property acquired from a
decedent is the fair market value as of the decedent’s date of death. For estate tax
purposes, the property included in the decedent’s estate is valued the same way, but
current law does not explicitly require that the recipient’s basis in the property be the
same as the value of the property reported for estate tax purposes.
(b) President Obama’s proposed budget would require the basis in
property received from a decedent to equal the value of the property for estate tax
purposes.
(c) The proposed budget would require the executor of a decedent’s
estate and the donor of a lifetime gift, respectively, to provide the IRS and the gift
recipient with valuation and basis information.
214 IRC § 2010(c)(2).
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14.4 MODIFY RULES ON VALUATION DISCOUNTS
(a) IRC §§ 2701-2704, which are discussed above, were enacted to
prevent the reduction of taxes due to certain transactions (i.e., estate freezes) between
family members. IRC § 2704(b) provides that certain “applicable restrictions” are to be
ignored for interests in family-controlled entities if those interests are transferred to other
family members. However, case law and certain state law has had the effect of
recharacterizing these restrictions such that they no longer fall within the definition of an
“applicable restriction.”
(b) President Obama’s proposed budget would create an additional
category of restrictions that could be ignored in valuing an interest in a family-controlled
entity if, after the transfer, the restriction will lapse or may be removed by the transferor
and/or the transferor’s family.
14.5 REQUIRE MINIMUM TERM FOR GRANTOR RETAINED ANNUITY
TRUSTS
(a) A Grantor Retained Annuity Trust (“GRAT”) is an irrevocable trust
in which the grantor retains an annuity interest for a term of years. At the end of the
term, the remaining trust assets are transferred to the trust beneficiaries, who are
generally family members of the grantor. The tax benefit of a GRAT is that if the grantor
survives the term, the appreciation of the assets escapes estate tax. The discounted
value of the remainder interest is reportable as a gift in the year the grantor establishes
the GRAT.
(b) Estate planners often use short terms to reduce the risk that the
grantor will die during the term and cause trust assets to be included in the grantor’s
estate for estate tax purposes. In addition, significant annuity interests are used to
reduce the value of the remainder interest to zero (a “zeroed out GRAT”).
(c) President Obama’s proposed budget would impose a requirement
that a GRAT have a minimum term of ten years and a maximum term of the life
expectancy of the annuitant plus ten years. The proposal would also include a
requirement that the remainder interest have a value greater than zero at the time the
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interest is created and would prohibit any increase in the annuity during the trust term.
The proposal would apply to trusts created after the date of enactment.
14.6 LIMIT DURATION OF GSTT EXEMPTION
(a) GSTT is imposed on gifts and bequests to transferees who are two
or more generations younger than the transferor.
(b) GSTT exemption can be allocated to gifts in trust, and the
allocation exempts from GSTT the amount of trust assets equal to the allocation, but
also all appreciation and income on that amount during the existence of the trust.
(c) Several states have repealed their “rule against perpetuities” laws,
which means several states now permit trusts of unlimited duration.
(d) President Obama’s budget proposal would provide that the GSTT
exclusion allocated to a trust would terminate on the 90th anniversary of the creation of
the trust. This would be achieved by increasing the inclusion ratio215 of the trust to one,
which would cause the entire trust to be “nonexempt” for GSTT purposes.
14.7 COORDINATE INCOME AND TRANSFER TAX RULES APPLICABLE
TO GRANTOR TRUSTS
(a) A grantor trust is a trust of which an individual is treated as the
owner for income tax purposes. A grantor trust can be revocable or irrevocable.
(b) For income tax purposes, a grantor trust is taxed as if the deemed
owner and the trust are the same person. Thus, transactions between the trust and the
deemed owner are ignored.
(c) For transfer tax purposes, the trust and the deemed owner are
separate persons, and if the deemed owner has relinquished all dominion and control
and made a completed gift to the grantor trust, then the assets of the trust are not
includible in the deemed owner’s estate for estate tax purposes. 215 IRC § 2642.
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(d) President Obama’s proposed budget would change the grantor
trust rules as follows:
(1) Assets of a grantor trust would be includible in the grantor’s
estate for estate tax purposes.
(2) Distributions from a grantor trust during the grantor’s life
would be subject to gift tax.
(3) If a trust ceases to be a grantor trust during a grantor’s
lifetime, the remaining trust assets would be subject to gift tax at that time.
(4) The proposal would also apply to any non-grantor who is
deemed to be an owner of the trust and who engages in a sale, exchange or
comparable transaction with the trust that would have been subject to capital gains if the
person had not been a deemed owner of the trust. In that event, transfer tax would be
imposed on the portion of the trust attributable to the property received by the trust in
the transaction, including all retained income therefrom, appreciation thereon, and
reinvestments thereof less the amount of consideration received by the person in the
transaction. The transfer tax would be payable by the trust.
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United States Internal Revenue Service (IRS) Circular 230 disclosure:
To ensure compliance with requirements imposed by the IRS, we inform
you that, unless and to the extent we otherwise state, any U.S. federal tax advice
contained in this communication (including any attachments) is not intended or
written to be used, and cannot be used, by any taxpayer for the purpose of
(i) avoiding penalties under the Internal Revenue Code or (ii) promoting,
marketing or recommending to another party any transaction or matter addressed
herein.
It should be understood that presentations of this nature are for purposes
of discussion and necessarily involve simplification and compression.
Descriptions of tax law in this presentation should be the subject of additional
and more detailed analysis before compliance or planning is implemented in
reliance thereon.