Understanding the Transfer Tax and Its Impact onEstate Planning

2016 Skills Training for Estate PlannersSponsored by the Real Property, Trust and Estate Law Section of the American Bar Association

New York Law SchoolNew York, New York

To Be Presented By:

Marc S. BekermanAttorney at Law

Woodbury, New York

Thomas M. Featherston, Jr.Mills Cox Professor of Law

Baylor University School of LawWaco, Texas

Copyright 2016 – Marc S. Bekerman & Thomas M. Featherston, Jr. All Rights Reserved

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CONTENTS

Introduction to Estate & Gift Taxation.......................................................................................................... 2

Generation Skipping Transfer Tax................................................................................................................. 8

Income Tax Considerations.........................................................................................................................10

Basic Marital Planning Techniques .............................................................................................................13

Basic Planning for Descendants ..................................................................................................................17

Some More Sophisticated Planning Techniques.........................................................................................20

APPENDIX....................................................................................................................................................25

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Introduction to Estate & Gift Taxation

1. The federal gift tax and federal estate tax are excise taxes on the transferor’s privilege oftransferring wealth during life or at death.

2. State law concepts, such as community property principles, generally define who is thetransferor and who is the transferee.

3. Gift tax.

a. Defined as lifetime transfers for less than full and adequate consideration(donative intent not required). If transfer is for consideration, possible income taxconsequences.

b. Value of gift is generally the fair market value of the gift at time of transfer, lessany consideration received.

c. Part gift, part sale transactions (gift and income tax consequences).

d. Gift tax liability is transferor’s responsibility.

i. Form 709, due April 15 of the following year.

ii. If tax liability is assumed by donee as part of gift, gift is a “net gift” andcalculation must be performed.

iii. If spouses elect to “split” one spouse’s gift, they incur joint and severalliability.

e. Nontaxable gifts.

i. “Annual exclusion.”

1. Currently $14,000 per donor, per donee, per year.

2. Gift of a present interest usually required.

3. Gifts in trust generally don’t qualify.

4. Spouses may be able to elect to “split” one spouse’s gift and transfer$28,000 per donee.

5. Compare community property gifts.

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ii. “Tuition and medical expenses exclusion.”

1. Unlimited.

2. Must be paid directly to provider.

iii. Marital transfers.

1. Assume valid marriage

2. Unlimited marital deduction.

3. Spouse must be qualified.

4. Transfer must be in proper form.

5. Transfer in trust generally doesn’t qualify.

iv. Charitable transfers.

1. Unlimited charitable deduction.

2. Charity must be qualified.

3. Transfer must be in proper form.

4. Split interests transfers.

a. Charitable and non-charitable interests.

b. Only charity’s interest deductible.

v. “Taxable gift” is generally the net value of the gift less exclusions anddeductions.

f. “Current exemption” of $5.45 million in cumulative taxable gifts per donor after1976.

g. After exemption used, gift tax payable at flat 40% rate.

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4. Estate tax.

a. “Gross estate.”

i. Probate estate.

1. Pass under will or by intestacy (real or personal, tangible or intangible).

2. Exempt assets included (homestead, etc).

3. Tenancies in common (compare joint tenancies).

4. Future interests and present interests.

5. Receivables (secured, unsecured).

6. Household furnishings, personal effects, autos, etc.

7. Life insurance payable to the estate.

8. Insurance on lives of others.

9. Compare treatment of spouse’s community property interest inemployee’s ERISA retirement plans (the “Boggs” rule).

ii. Decedent’s life insurance and retirement benefits.

1. IRAs, 401ks, etc - - also subject to income tax.

2. Life insurance - - if insured possessed “incidents of ownership.”

iii. Other nontestamentary assets.

1. Joint tenancies (spousal and non-spousal rules).

2. Multiple party accounts.

3. Other contractual arrangements (e.g., private annuity with deathbenefit).

iv. Lifetime transfers subject to “string” provisions.

1. Revocable transfers.

2. Retained life estates.

3. Reversions.

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4. Transfers within 3 years of death (only applicable to life insurance andstring provisions).

v. General powers of appointment.

1. Whether exercised or not.

2. “HEMS” exception.

vi. “QTIP” property (qualified terminable interest property).

vii. Gift taxes paid within 3 years of death.

b. Valuation.

i. Fair market value of property generally determined as of date ofdeath.

1. “Alternate valuation date” (AVD) is earlier of 6 months afterdeath or date of disposition of asset.

2. Can elect alternate valuation only if it will reduce estate tax.

3. AVD election is “all or nothing.”

ii. “Special use valuation.”

1. Normally assets valued at their “highest and best” use.

2. Real property used as a family farm or ranch or in a closelyheld business may be valued at its “current” use.

c. Deductions.

i. Importance of state law.

ii. Funeral and administration expenses.

iii. Claims (secured and unsecured).

iv. Losses during administration.

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v. Marital transfers.

1. Assume valid marriage

2. Unlimited “marital deduction.”

3. Spouse must be qualified.

4. Transfer must be in proper form.

5. Transfer in trust generally doesn’t qualify.

vi. Charitable transfers.

1. Unlimited “charitable deduction.”

2. Charity must be qualified.

3. Transfer must be in proper form.

4. Split interests transfers.

a. Charitable and non-charitable interests.

b. Only charity’s interest deductible.

vii. State death taxes (where applicable).

viii. Special rules concerning deductibility of contingent claims not paid whenreturn filed.

d. Gross Estate less Deductions is the “Taxable Estate.”

e. Prior taxable gifts are generally not included in gross estate (but some are - - See4.a.(iv)).

f. Taxable Estate plus post 1976 taxable gifts is the “Tax Base.”

g. “Tentative Tax” is computed by applying tax rate to the Tax Base.

h. Tentative Tax is reduced by certain credits to calculate actual tax liability, if any.

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i. Credits.

i. “Unified” Credit.

1. Basic exclusion amount – The applicable credit amount is $5,450,000for 2016.

2. Deceased spouse’s unused exclusion amount (“DSUEA”) which permitsportability of the unused exclusion amount from a deceased spouse tothe surviving spouse.

ii. See Appendix for a more technical explanation of how the applicable creditamount is incorporated into the estate tax calculation as a credit.

iii. Gift taxes paid.

iv. Taxes paid on prior transfers.

v. Foreign death taxes.

j. Essentially, a flat 40% tax after available exemption is applied.

k. Form 706, due 9 months from date of death.

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Generation Skipping Transfer Tax

1. Transfers of income or principal to a transferee who is at least two generations youngerthan the transferor.

2. The triggering events.

a. “Taxable distribution” – distribution to a skip person from a trust with skip andnon-skip beneficiaries, if the distribution is not subject to estate or gift tax. (e.g.,trust for settlor’s child, as the non-skip person, and grandchild, as the skip person,and trustee distributes income or principal to the grandchild).

b. “Taxable termination” -- the termination of the interest in a trust of the last non-skip person, if the termination does not result in the inclusion of the trust estatein the gross estate of the non-skip person (e.g., 2.a., supra, but the child dies).

c. “Direct skip” -- a transfer that is subject to either the estate or gift tax directly toa skip person or to a trust that has no non-skip persons as beneficiaries, (e.g.testator leaves property to the testator’s grandchild while the grandchild’s parent,testator’s child, is still alive).

d. Generally, inter vivos direct skips that are excluded from the gift tax (i.e., annualexclusion and tuition/medical expense exclusion, 2503c trusts) are exempt fromthe GST tax (but not “Crummey trusts” – See Basic Planning for Descendants, 1.d.).

3. The “GST Exemption.”

a. The GST exemption is equal to the applicable credit amount for the estate taxwhich is currently $5,450,000

b. A proper allocation exempts most transfers from the GST tax.

c. Once the GST exemption is exceeded, transfers are taxed at the highest estate taxrate which is currently 40%.

d. Note that there is no “portability” of a predeceased spouse’s GST Exemption. SeeBasic Marital Planning Techniques, 1.b.

4. Direct skips.

a. Testator devises the Testator’s $5.45 million estate to the testator’s grandchildren(or a trust for the grandchildren). Assuming no prior taxable gifts, thegrandchildren receive the $5.45 million, estate tax and GST tax free.

b. Any amounts in excess of applicable exemption would be subject to both estatetax and the GST tax.

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5. Generation skipping trusts.

a. Testator devises $5.45 million in trust, child for life, remainder to grandchild.

i. If the entire GST exemption can be allocated to the trust, the trust isforever exempt from the GST tax under current law.

ii. Any distributions to the grandchild are GST tax free and the child’s deathwill not result in a taxable termination, even if the trust estate increases invalue during the child’s lifetime.

b. If the testator devises $7 million to the trust, part of any distribution to thegrandchild during the child’s lifetime will be subject to the GST tax, using acomplicated formula, calculated by multiplying the taxable amount by theapplicable rate. When the child dies, a taxable termination occurs and part of thetrust estate is subject to the GST tax, again using the same complicated formula.

c. Well drafted documents and state law in some jurisdictions permit trustees todivide larger trusts into two trusts, one exempt from the GST and the secondsubject to the GST tax in order to simplify the administration of the two trusts.

6. Liability for GST tax.

a. Taxable distribution - - the transferee is liable.

b. Taxable termination - - the trustee is liable.

c. Direct skip - - either the transferor or the trustee (if a direct skip from a trust).

7. Generation Assignments.

a. Actual family generations are used when the transferor is related to thebeneficiary.

b. Spouses, regardless of age, are deemed to belong to the same generation of theblood relative.

c. Nonfamily members are assigned generations using a mathematical test based on25 year generations.

d. Certain transfers to a grandchild are not considered a direct skip, if thegrandchild’s parent who was related to the transferor was dead at the time of thetransfer.

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Income Tax Considerations

1. Income Tax Aspects of Gifts and Inheritances.

a. Property received by gift or inheritance (including life insurance) is generallynot subject to income tax in hands of donee, but post-transfer income issubject to income tax in the hands of the donee, or estate beneficiaries, orthe decedent’s estate (if probate asset subject to administration).

b. During the administration of a decedent’s probate estate, the estate’sincome is taxed to the estate on Form 1041, or to the beneficiaries, but notboth, according to a complex distributable net income (“DNI”) computation.

c. Basis in hands of donee will depend on whether the transfer was inter vivosor at death and whether or not it is income in respect of a decedent.

i. At death.

1. “Step up” in basis (but not always - - can be step down).

a. Basis in hands of beneficiary will generally be the fairmarket value at time of death (“FMV”).

i. If AVD elected, take AVD as basis.

ii. Can be affected by transactions during estateadministration.

iii. Special use valuation affects basis.

b. Holding period is long term.

c. Can result in a step down in basis if FMV is less than basis, abuilt in loss (“BIL”).

i. Loss is gone forever.

ii. Don’t want to die with BIL – Instead sell propertyand recognize loss.

d. Special community property rules

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ii. Inter vivos.

1. “Carryover basis” (i.e., donee takes donor’s basis plus any actual gifttax liability and donor’s holding period).

2. If property given has a built in loss and property is sold by donee for aloss, basis used to calculate loss will be the fair market value at timeproperty is transferred.

a. Prevents shifting of tax losses.

b. BIL is gone forever.

c. Don’t want to give property with BIL – Instead sell property,recognize loss, and give proceeds.

iii. New "Basis Consistency" Reporting Requirement

1. There was formerly no coordination between the estate and incometax systems.

a. An executor often is trying to justify a lower value for estate taxpurposes (to decrease estate taxes due)

b. When a beneficiary sells the asset later on, he or she may claim itwas worth more, providing the beneficiary with a higher basis anddecreasing the capital gain on which the beneficiary is taxed.

c. Up until recently, the value used by the executor only created apresumption for income tax purposes; a beneficiary could rebutthat presumption by providing “clear and convincing” evidencethat the value was higher.

2. In 2015, Congress enacted the Surface Transportation and VeteransHealth Care Choice Improvement Act of 2015, which was signed intolaw July 31st, effective immediately and which imposed a newrequirement that executors file information statements with the IRSand provide beneficiaries information about the basis of assets theyreceive.

3. The statutory deadline for this new information return is 30 days afterthe date the estate tax return is required to be filed, or 30 days afterthe return is actually filed, if earlier.

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4. The IRS extended the deadline for all returns several times since it didnot finalize the new form (Form 8971) and instructions. Proposedregulations providing further guidance have been published.

5. This new reporting requirement applies to all estate tax returns filedafter July 31, 2015 that were required to be filed, whether or notestate taxes were due. It does not apply to returns that were“optionally” filed, such as returns filed solely to elect portability or toallocate GST exemption.

2. Income in respect of a decedent (“IRD”).

a. Defined as items included in the decedent’s gross estate which would havebeen income taxable to the decedent had he or she lived.

b. Examples include accrued interest and dividends, unrecognized gain oninstallment obligations, bonuses, deferred compensation, and IRA andqualified benefit plans distributions.

c. IRD items don’t receive a new basis by reason of the decedent’s death.

d. The inherent income or gain can be recognized when received by theestate or beneficiary.

e. It can also be recognized by the executor’s distribution of the item itselfduring administration to satisfy a pecuniary bequest (but not if distributedas a specific bequest or as part of the residuary estate).

f. Can generate unanticipated income tax consequences.

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Basic Marital Planning Techniques

1. “Typical” Marital Planning.

a. Traditional use of both spouses’ “available exemption.”

i. Ensure each spouse has sufficient assets to fully use respective applicableexclusion amounts.

ii. Wealthier spouse could make gifts to other spouse whether outright or byQTip trust.

iii. Less wealthy spouse could own life insurance on own life.

iv. Wealthier spouse’s will or revocable trust could utilize “estateequalization” techniques.

b. Portability can now serve as a “savings clause” for preserving an availableexemption if the first spouse to die does not have sufficient assets to utilize entireavailable exemption amount assuming both spouses die after Jan. 1, 2011.

c. Take advantage of deceased spouse’s remaining applicable exclusion amount.

i. Testamentary or nonprobate gifts to or for benefit of descendants.

ii. Testamentary or nonprobate gifts in trust for benefit of surviving spouseand descendants that don’t qualify for marital deductions (e.g., a creditshelter trust).

d. “Credit shelter trusts” (Bypass trusts).

i. A trust created at first spouse’s death, funded with desired amount ofavailable exemption (“CST”).

a. “HEMS” standard – distributions limited to the health, education,maintenance or support of the beneficiary.

b. Surviving spouse can be a permissible beneficiary of income andprincipal, typically limited by the HEMS standard.

c. The 3.8% Medicare Tax may encourage the use of mandatory incomedistribution provisions.

d. If spouse is trustee (if permitted and advisable under state law), theHEMS standard must be used to limit the spouse/trustee’s discretionfor own benefit.

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e. Surviving spouse can be given a non-general power of appointment, ora general power limited by the HEMS standard.

f. At surviving spouse’s death, trust terminates or continues forremainder beneficiaries.

g. Remaining trust estate (regardless of FMV at date of death) is excludedfrom surviving spouse’s gross estate.

ii. After satisfying specific and general devises to surviving spouse and others,amount of initial funding of the CST has been usually determined either bya formula or by a disclaimer of the surviving spouse.

iii. Bottom line - No transfer tax at creation combined with exclusion fromsurviving spouse’s gross estate results in no transfer tax for the CST.

iv. Can also have CST benefit children and grandchildren during spouse’slifetime but in a manner that doesn’t satisfy parent’s legal obligation ofsupport.

v. Can be GST exempt through proper allocation of GST exemption.

vi. Caution: Generally no “step up” in basis upon death of the survivingspouse (compare and contrast with use of “portability” planning)

e. Defer estate tax at death of first spouse.

i. If Tax Base exceeds available exemption amount, take advantage of maritaldeduction to reduce deceased spouse’s Tax Base to amount of availableexemption.

ii. “Marital deduction devise” can be outright to surviving spouse or into aqualifying marital deduction trust.

iii. The most commonly used marital deduction trust is the “QTip trust.”

iv. Other marital deduction trusts are the estate trust and the mandatoryincome/general power of appointment trust (both typically used only inunusual situations).

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2. Traditional “Formula Planning” - - outright to spouse or into QTip trust.

a. Pecuniary formula funds the marital deduction devise as a general gift withsufficient value to reduce the deceased spouse’s Tax Base to the amount ofavailable exemption in the year of death.

i. “True worth pecuniary funding” - - valued when funded.

ii. “Estate tax value pecuniary funding” - - fairly representative or minimumworth tests.

iii. Residuary estate typically passes to a CST.

iv. In reverse pecuniary funding, formula amount typically passes to a CST andthe residuary estate to the QTip trust.

b. “Fractional residuary funding” – proportionate division of the residuary estate intotwo shares, typically funding the CST and the QTip trust.

c. “QTip trusts.”

i. The terms of this trust must mandate all income be paid to the survivingspouse.

ii. Principal may be payable to the surviving spouse, but no other person canbe a recipient of trust distributions during the spouse’s lifetime. Typically,the HEMS standard is used for distributions of principal.

iii. At the surviving spouse’s death, the remainder typically passes to or forthe benefit of the trust’s remainder beneficiaries.

iv. Value of QTip trust is included in surviving spouse’s gross estate.

v. Assets in a QTip trust generally receive a “step up” in basis upon the deathof the surviving spouse since included in the gross estate.

vi. Surviving spouse is usually the transferor for GST tax purposes.

vii. Surviving spouse can have testamentary power of appointment.

viii. If permissible and advisable under state law, surviving spouse can be thetrustee.

d. Balance of first spouse’s estate (available exemption amount) typically passes toor for benefit of the children and grandchildren, or to a CST (bypass trust), free ofestate tax and GST tax.

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e. Alternatives to formula funding.

i. Due to portability, an alternative plan is for a married couple is to leaveentire estate of first spouse to die to a QTip trust for benefit of survivingspouse.

ii. The will or revocable trust is drafted to permit the executor to determinewhether to fully elect QTip treatment, and to the extent QTip treatment isnot elected, have non-qualifying portion pass into a trust with differentterms similar to the CST discussed above.

iii. Another technique is to leave the entire estate of the first spouse to die tothe surviving spouse who can disclaim the available exemption amountinto a trust similar to the CST (but the surviving spouse cannot have apower of appointment).

iv. The disclaimer approach places the surviving spouse in the role of thedecision maker after the first spouse’s death. The partial QTip electionapproach can give the choice of funding to someone other than thesurviving spouse, the executor chosen by the first spouse to die.

f. Miscellaneous.

i. Non-tax advantages of these CSTs and QTip trusts can include creditor anddivorce protection depending on state law (i.e. “spendthrift trusts”).

ii. State law may permit the spouse to be the trustee of the trust if HEMSstandard used for income and principal distributions of CSTs, and principaldistribution for QTip trust without risk to the tax and non-tax benefits.

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Basic Planning for Descendants

1. Common Lifetime Planning Techniques.

a. Annual exclusion gifts.

i. Currently $14,000 per donor, per donee, per year (spouses, combined$28,000 per donee, per year).

ii. The gift itself and its future income and appreciation are removed from theTax Base.

iii. Consider gift “splitting” by spouses.

iv. Consider transferred basis instead of “step up” in basis.

v. Gifts of present interest generally required.

1. Outright.

2. Uniform Transfers to Minors Act (“UTMA”).

3. Trust exceptions.

a. “2503(c)” trust.

b. “Crummey” trust.

b. Use the $5.45 Million gift tax exemption.

i. Only future income and appreciation removed from the Tax Base.

ii. Amount of taxable gifts is added to the “Taxable Estate” in order tocompute the Tax Base at the donor’s death, effectively reducing theamount available to fund the CST at death.

iii. Gifts can be added to a “Crummey trust” for beneficiary created to takeadvantage of annual exclusion described in a. above.

iv. Alternatively, gifts can be made to a separate asset protection trust for thebeneficiary.

v. Spouses can agree to “split” one spouse’s gift.

vi. As exemption increases, more gifts can be made without incurring gift taxliability.

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vii. Spouses can give a combined $10.9 Million without incurring any gift taxliability.

c. Gifts in trust.

i. These trusts must be irrevocable.

ii. 2503(c) trusts must make income and principal available for thebeneficiary prior to reaching age 21; at age 21, trust must terminate andthe assets delivered to the beneficiary. If the beneficiary dies before 21,the trust estate goes to the beneficiary’s “estate.”

iii. Crummey trusts (CTs) usually use the “safe harbor” approach - - incomeand principal as needed for the beneficiary’s “health, education,maintenance and support” (but not in a manner which satisfies a parent’slegal obligation of support) – The “HEMS standard.” In addition, thebeneficiary is granted a limited withdrawal right (general power ofappointment).

iv. “Asset protection trusts” (APTs) typically use the same safe harbor HEMSlanguage described in (iii), but the beneficiary doesn’t have a withdrawalright.

v. CTs and APTs can terminate at whatever age donor selects, and then thetrust estate is delivered to the beneficiary, free of trust.

vi. CTs and APTs can last for the beneficiary’s lifetime to avoid inclusion of thetrust estate in the beneficiary’s gross estate when the beneficiary dies.

vii. The 3.8% Medicare Tax should be considered in defining when incomedistributions should be made.

viii. Non-tax advantages of these trusts can include creditor and divorceprotection depending on state law (i.e., “spendthrift trusts”).

ix. State law may permit the beneficiary to be the trustee of the trust if HEMSstandard used in a manner that does not satisfy a legal obligation ofsupport without risk to the tax and non-tax benefits.

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d. “GST” Exempt Trusts.

i. CTs and APTs can be created and funded so that their trust estates areexcluded from the beneficiary’s gross estate, thus avoiding estate tax atthe beneficiary’s death, all well as the generation skipping transfer tax.

ii. The key is the proper allocation of the grantor’s $ GST exemption to thetrust at the time the trust is funded so that any appreciation in value in thetrust estate is also exempt.

iii. Caveat, the $14K annual exclusion for GST purposes is not available in thetypical CT or APT, thus requiring more allocation of the GST exemption.

iv. See Introduction to the Generation Skipping Transfer Tax.

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Some More Sophisticated Planning Techniques

1. In addition to creating credit shelter (bypass) trusts, QTIP trusts, Crummey and assetprotection trusts, as well as taking advantage of the $14 thousand annual exclusion, the$5.45 million estate and gift tax exemption, and the $5.45 million GST exemption, themore sophisticated planning techniques for children and grandchildren include:

2. “Irrevocable Life Insurance Trusts” (ILIT).

a. Insured transfers ownership of policy on insured’s life to an irrevocable trust forbenefit of children, such as a CT or APT.

b. The value of the gift is typically much lower than the policy’s face value - - mayeven be covered by the annual exclusion.

c. If insured lives three years after the gift of the policy, face value of the policy isexcluded from the insured’s gross estate. At most, the value of any taxable gift(including subsequent premium payments) is included in Tax Base.

d. If insured dies within 3 years, face amount is included in gross estate.

e. If insured’s spouse is a beneficiary, consider state law and tax concerns.

3. “Intentionally Defective Grantor Trusts” (IDGT).

a. The terms of a CT or APT cause the income of the trust to be taxed to the grantorof the trust and not to the trust or its beneficiary, but without causing the valueof the trust estate to be included in grantor’s gross estate when the grantor dies.

b. The income tax paid by the grantor reduces the grantor’s gross estate. Paymentof the tax is not considered another gift.

c. The income is either accumulated in the trust or distributed to the beneficiary,free of any income tax owing by the trust or beneficiary.

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4. Leveraging techniques (QPRT, GRAT, GRUT).

a. The zero valuation rule requires a non-qualifying retained interest to be valued atzero. Thus, the value of the gift is 100% of the asset’s fair market value on thedate of the gift.

i. Donor gives child a remainder interest in Blackacre worth $1 million,retaining a life estate. The value of the gift is $1 million, not $1 millionreduced by the value of retained life estate. The donor has made a $1million taxable gift, plus the value of Blackacre at the donor’s death will beincluded in the donor’s gross estate.

ii. If donor retains a qualifying interest (i.e., an annuity for a term of years),the value of the qualifying retained interest is subtracted from the value ofthe property transferred. If structured properly and the circumstancesdevelop as hoped (i.e., donor outlives the term), the property is notincluded in the donor’s gross estate, having been removed at a much lowertaxable gift value that is included in the Tax Base.

b. “Qualified Personal residence trusts” (QPRTs) – grantor transfers home into anirrevocable spendthrift trust for the children retaining the right to live in the homefor a term certain. Since the retained right is a qualified one, the value of the termreduces the value of the home transferred into the QPRT. If the grantor outlivesthe term, the home is no longer in the donor’s gross estate, having been removedat a much lower taxable gift value. Retained interest is not protected byspendthrift provision.

c. “Grantor Retained Annuity and Unitrusts” (GRATs and GRUTs) – grantor createsan irrevocable spendthrift trust for the children, retaining a right to receive for aspecific term an annuity. Since the retained interest is qualified, the value of theterm reduces the value of the taxable gift. If the grantor outlives the term, thetrust estate is not included in the grantor’s gross estate, having been removed ata lower taxable gift value. Retained interest is not protected by spendthriftprovision.

d. If the grantor dies during the term of a PRT, GRAT or GRUT, the FMV of the trustestate is included in the grantor’s gross estate.

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5. “Private Annuities.”

a. Parent sells at fair market value property to the children or to a CT or APT for thechildren in exchange for the purchaser’s promise of an annuity.

b. If structured properly, the property and its future appreciation are removed fromthe parent’s gross estate without gift tax consequences. If the parent dies duringthe term of the annuity, the value of the balance of the annuity is included in thegross estate.

c. There are income tax consequences to both the transferor and transferee toconsider.

6. “Installment Sales” and “Self Cancelling Notes” (SCINS).

a. Parent sells at fair market value property to children or to a CT or APT for childrenin exchange for a note with a stated interest rate and a fixed repayment schedule.

b. If the parent dies before the note is paid, the balance outstanding is normallyincluded in the parent’s gross estate, but the value of the property sold and itsappreciation are not included in the parent’s gross estate.

c. However, if the terms of the note provide that, if the parent dies before the noteis fully paid, the remaining balance is cancelled, the balance owing is not includedin the parent’s gross estate, even though the property and its appreciation havebeen removed from the gross estate.

d. As consideration for the self-canceling provision, the sales price or interest rate ishigher than for a note without such a provision.

e. There are significant income tax consequences consider.

7. Split interest charitable techniques (CRAT, CRUT, CLT).

a. “Charitable Reminder Annuity Trusts” and “Unitrusts” (CRATs & CRUTs) - - parentdevises property in trust for children, giving them an annuity interest for a fixedterm, with a remainder to a qualified charity. The transfer tax value is reduced bythe value of the charity’s remainder interest, which qualifies for the charitablededuction.

b. “Charitable Lead Trusts” (CLTs) - - parent devises property in trust for a charity,giving the charity an annuity interest for a term of years with remainder tochildren or grandchildren. The transfer tax value is reduced by the charity’sinterest, which qualifies for the charitable deduction.

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8. “Family limited partnership” (FLP).

a. Parents contribute to a FLP in exchange for limited partnership interests and oneparent or another entity is the general partner.

b. Parents give children or CT or APT for children limited partnership interests thathave a value much less than the pro rata share of the underlying assets due torestrictions on transferability and marketability.

c. At parent’s death, the value of any remaining limited partnership interest issignificantly less than underlying asset value, resulting in a much lower Tax Base.

d. The IRS scrutinizes the creation and administration of FLPs very closely.

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Introduction to Income Taxation of Trusts and Estates, Subchapter J

1. General Rules – Identify the type of “tax entity” (estate, grantor trust or non-grantortrust).

2. Income Taxation of Grantor Trusts.

a. Indicia of grantor trusts.

1. Power to revoke.

2. Reversion in trust to grantor – 5% at time of creation.

3. Powers to control beneficial enjoyment.

4. Certain administrative powers (e.g., power to reacquire trust property forfull and adequate consideration).

5. Power to distribute income to grantor.

b. All income and deductions reported on grantor’s income tax return regardless ofactual distributions.

1. Commonly used to “supercharge” gifts. (IDGT)

2. Cannot have a transaction for tax purposes between grantor and trust.

3. Income Taxation of “Non-Grantor” Trusts and Estates.

a. If income is distributed, taxed to beneficiary receiving distribution.

1. If “simple” trust, income taxed to beneficiary regardless of actualdistributions.

b. If income is accumulated, income taxed to trust.

1. Trust gets certain deductions against income, primarily for administrationexpenses.

2. Exemption is minimal – either $100 or $300.

3. Rates are compressed, top marginal rates are high.

c. When the fiduciary has the discretion to distribute income, the 3.8% Medicare Taxbecomes an important factor for the fiduciary to consider.

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APPENDIX

INTRODUCTION TO TRANSFER TAX PRINCIPLESAfter the 2012 Tax Act

A. Gross Estate- Deductions

Taxable Estate+ Post ‘76 taxable gifts

Tentative Tax Base

B. Gross Estate:

1. Probate (1) real property,(2) stocks & bonds(3) mtgs., notes &cash(4) misc. property

2. Non-Probate (1) insurance(2) JTWROS(3) multiple partyaccounts(4) annuities

3. Gen. Powers of Appointment

4. Special Lifetime Transfers(1) 3 yr. Rule(2) retained life estate(3) effective at death(4) revocable

5. Q-Tip Property

C. Deductions:

1. Ordinary (1) funeral(2) admin. expenses(3) debts & mtgs.

2. Special (1) marital deduction(2) charitable deduction

D. Post ‘76 taxable gifts:

Inter vivos gifts in excess of exclusions amount and which is not included in the grossestate as a special lifetime transfer.

E. Tentative Tax Base:

The amount on which the tentative tax is computed; the net tax owing is the tentative taxreduced by certain credits (most notably the “unified credit” that translates into theapplicable exclusion amount; other credits include the credit for tax on prior transfers).

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F. Applicable Exclusion Amount: Maximum Rate:

2002, 2003 $1,000,000 2002 50%2004,2005 $1,500,000 2003 49%2006-2008 $2,000,000 2004 48%2009 $3,500,000 2005 47%2010 $5,000,000 2006 46%2011 $5,000,000 2007-2009 45%2012 $5,120,000 2010 35% or zero*2013 $5,250,000 2011-2012 35%2014 $5,340,000 2013-2016 40%2015 $5,430,0002016 $5,450,000