QUIZ 4 - ch. 11/12

Olivia's dad, Benson, died on August 10 of this year. Six years ago, Benson had gifted ownership of a paid-up $1,000,000 whole life insurance policy on his life with a replacement value of $150,000 and an adjusted basis of $100,000 to Olivia. If Olivia, as designated beneficiary, receives the death benefit of the life insurance policy this year, how much will be taxable to her?

$0. Rationale A gift of a life insurance policy is not a transfer for valuable consideration and as such the death benefit, payable by reason of Benson's death, is not included in Olivia's taxable income.

Mel died this year. His will specifically bequeaths $1,000,000 to his daughter, Vera, and bequeaths the residual of his estate to his wife, Alice. At the time Mel had written his will, his net worth was in excess of $4,000,000, but at his death his net worth had plummeted to $1,050,000. Because Vera's mother would only receive $50,000 ($1,050,000-$1,000,000) of her father's assets, Vera fully disclaimed her bequest in writing three months after her father's death and prior to receiving any benefit from the bequest. How much will Vera have to report as a taxable gift because of this disclaimer?

$0. Rationale A qualified disclaimer is a disclaimer that is made in writing, filed within nine months of the decedent's date of death, does not allow the disclaiming party to specify to whom the property will pass, and does not allow the disclaiming party to benefit from the property before disclaiming their interest. If a disclaimer is qualified the property will pass to the residual heirs of the estate, or as directed by a disclaimer clause, with no effect to the disclaiming party. In this case, Vera has no taxable gift related to this disclaimer.

Four years ago, Rhett gave a life insurance policy with a $750,000 death benefit to his daughter, Marcelle. At the time of the gift, the value of the life insurance policy was $65,000, and Rhett paid $10,000 in federal gift tax. Rhett unexpectedly died this year. What amount will be included in Rhett's federal gross estate related to this life insurance policy?

$0. Rationale Because Rhett died more than three years after the gratuitous transfer of the life insurance policy, Rhett's federal gross estate would not include any amount related to this life insurance policy.

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Caesar gifted the policy to his daughter. Six months prior to the gift, Caesar had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor. Caesar died four years after the gift of the life insurance policy. What amount is included in his federal gross estate related to this whole life insurance policy?

$0. Rationale Caesar's federal gross estate would not include any value related to this life insurance policy because he is not the owner or beneficiary of the life insurance policy at his death, and the gift was made more than three years prior to his death. An individual's federal gross estate only includes the death benefit of a life insurance policy on the insured, if the individual is the owner or beneficiary, or if there was a gratuitous transfer of the life insurance within three years of the individual's death.

Twelve years ago, Sebastian purchased a single premium $1,000,000 life insurance policy on his own life for $150,000 and named his daughter, Holly, as the sole beneficiary. Sebastian gifted ownership of the policy to Holly this year when the value of the life insurance policy was $200,000. Sebastian paid $15,000 of gift tax on the transaction. At Sebastian's death, how much of the death benefit that Holly receives will be subject to income tax?

$0. Rationale Even though the life insurance policy is considered a modified endowment contract, the receipt of the death benefit remains income tax free to the extent the policy had not been transferred for valuable consideration. In this case, the transfer to Holly was a gift, not a transfer for valuable consideration, so the death benefit is not subject to income tax.

Before his death in 2023, Melvin, age 66, incurred $65,000 in medical bills which were not reimbursed by insurance. Melvin's taxable estate at his death was $675,000 and his adjusted gross income for 2023 was $100,000. How much of Melvin's medical expenses will be deducted on his estate tax return?

$0. Rationale In this situation, Melvin's executor would not elect to deduct any of the final expenses on Melvin's estate tax return because the medical expenses will not change the estate tax due on Melvin's estate tax return - Melvin's taxable estate is less than the applicable estate tax credit equivalency. Melvin's executor will deduct the expenses, to the extent they exceed 7.5% of Melvin's AGI, on Melvin's final income tax return.

Selena was recently diagnosed with stage four lung cancer. Her doctors have given her nine months to live. She has many medical expenses and needs money. If Selena sells a whole life insurance policy, with a $1,000,000 face value and a $250,000 adjusted basis to a viatical settlement provider for $350,000, how much capital gain will Selena have to recognize for income tax purposes on the sale?

$0. Rationale The IRC (Section 101(g)) states that amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill may be excluded from gross income. Because her doctors expect her to die within 9 months, Selena is considered terminally ill. A terminally ill individual is a person who has been certified by a licensed health care provider as having a condition or illness that can reasonably be expected to result in death within 24 months.

Neil was diagnosed as chronically ill and was in need of additional funds to pay for increased medical expenses so he sold his $100,000 life insurance policy, which had a cash value of $30,000, to a licensed viatical settlement provider for $55,000 in cash. If the viatical company paid a total of $10,000 in premiums between the time they purchased the policy and the time of Neil's death, what amount of the death benefit is taxable income to the viatical company?

$35,000. Rationale From the viewpoint of the viatical settlement provider, the transfer of the life insurance policy is a transfer for valuable consideration. If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee's adjusted basis will be subject to income tax. The viatical company paid Neil $55,000, plus paid an additional $10,000 in premiums, for a total cost basis of $65,000. The difference between the $100,000 death benefit received and their $65,000 cost basis ($100,000 - $65,000 = $35,000) is taxed as ordinary income. From Neil's perspective, the $55,000 he received in exchange for the policy is tax free (if used to pay qualified medical expenses) because he is chronically ill and sold the policy to a licensed viatical settlement company.

Last year, Omar gave a life insurance policy with a $400,000 death benefit to his son, Scout. At the time of the gift, the value of the life insurance policy was $50,000 and Omar had to pay $5,000 in federal gift tax. Omar unexpectedly died this year. What amount will be included in Omar's federal gross estate related to this life insurance policy?

$405,000. Rationale Life insurance proceeds on policies gratuitously transferred within three years of death are included in the gross estate of the donor. Gift tax paid within three years of death is included in the federal gross estate as well under the gross-up rule.

In July 2023, the year of Casper's death, Casper has a taxable estate equal to $13,660,000. At the time of Casper's death, his only asset is a closely-held business interest. Casper's executor properly elects Sec. 6166 installment payments on a timely filed estate tax return. If the long-term annual AFR is 3%, how much is the first annual interest payment? (Assume no previous taxable gifts.)

$5,920.

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Drake gifted the policy to his daughter. Six months prior to the gift, Drake had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor. What is the gift tax value of the gift of this policy?

$500,000 discounted for Drake's six month life expectancy. Rationale If a physician has determined that the insured has a physical condition that is terminal, the value of a life insurance policy for gift tax purposes will be the death benefit, discounted for the predicted life expectancy of the insured.

The owner of a life insurance policy has decided to surrender the life insurance policy to the insurer. Since inception of the life insurance contract, the owner has paid premiums of $100,000 and received cash policy dividends equal to $20,000. If at the surrender date, the owner receives a cash payment of $140,000 from the insurer, what is his gain/ loss subject to income tax on the life insurance policy?

$60,000. Rationale The owners adjusted basis in the property would be $80,000 - the sum of the premiums paid on the policy less any dividends received (a dividend on a life insurance policy is a return of the policy owner's adjusted basis). If the insurer pays a cash surrender value of $140,000, the gain on the policy would be $60,000 ($140,000-$80,000).

Darnell was a majority owner in a closely-held corporation. He had an adjusted basis in his interest of $400,000, and at his death this year, the fair market value reported on his estate tax return was $6,000,000 (which is 45% of the value of his adjusted gross estate). Like most majority owners in closely-held businesses, Darnell did not have much liquidity in his estate and his executor was forced to redeem some of his interest in the business. If Darnell's executor redeemed 30% of Darnell's interest back to the corporation for $2,500,000 to pay the estate tax and administration fees, how much is subject to capital gains tax?

$700,000. Rationale Darnell's estate would have an adjusted basis in the 30% interest equal to 30% of the fair market value at Darnell's date of death, or $1,800,000. If the executor of Darnell's estate redeemed the interest back to the corporation for $2,500,000, the gain of $700,000 ($2,500,000-$1,800,000) would be subject to capital gains tax under Section 303 (only available at the death of the owner). Ordinarily, unless a redemption is a complete redemption, the redemption is treated as a dividend.

Ike and Tina, unrelated business partners, began operating a drug store in southern Florida. They funded a buy/sell agreement with a cross-purchase life insurance arrangement. Tina purchased a life insurance policy with Ike as the insured, and Ike purchased a life insurance policy with Tina as the insured. If Tina dies, which of the following is/are true? 1. The death benefit of the life insurance policy on Tina's life, owned by Ike, is excluded from Tina's federal gross estate. 2. The death benefit of the life insurance policy on Tina's life, owned by Ike, is included in Tina's federal gross estate if Tina own's 50% or more of the stock of the drug store. 3. The value of the life insurance policy on Ike's life, owned by Tina, is included in Tina's federal gross estate. 4. The death benefit of the life insurance policy on Tina's life, owned by Ike, is included in Tina's federal gross estate.

1 and 3. Rationale Option 1 is correct because Tina's federal gross estate will not include the death benefit of the life insurance policy on her life owned by Ike because Tina does not possess any incidents of ownership in the policy. Option 3 is correct because when an individual dies owning a life insurance policy on the life of another person, the value of the life insurance policy will be included in their federal gross estate. Option 2 is incorrect because Tina's ownership in the drug store does not change the fact that Tina does not possess any incidents of ownership in the life insurance policy on her life, owned by Ike. The death benefit of a life insurance policy on Tina's life would only be included in Tina's federal gross estate if she possessed any incidents of ownership in the life insurance policy. Option 4 is incorrect because Tina does not possess any incidents of ownership in the policy.

Watson, LLP. has four equal partners. All four partners are interested in entering into a buy-sell arrangement. How many life insurance policies would be purchased to properly fund a cross-purchase agreement?

12 policies. Rationale Each owner would need to purchase a life insurance policy on each of the other owners. Therefore, 12 policies would be purchased in total or 4(4-1) = 12.

Which of the following statement(s) is/are correct regarding buy-sell arrangements? 1. Entity purchase arrangements increase the income tax basis for some surviving owners upon the death of another owner. 2. Cross-purchase arrangements increase the income tax basis for all surviving owners (who are parties to the agreement) upon the death of another owner.

2 only. Rationale Entity arrangements do not increase the income tax basis of surviving owners.

Which of the following statement(s) is/are correct regarding buy-sell arrangements? 1. Entity purchase arrangements increase the income tax basis for some surviving owners upon the death of another owner. 2. Cross-purchase arrangements increase the income tax basis for all surviving owners (who are parties to the agreement) upon the death of another owner.

2 only. Rationale Entity arrangements do not increase the income tax basis of surviving owners.

Which of the following statements regarding universal life insurance policies is true?

A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost. Rationale A universal life insurance policy is similar to a term life insurance policy but with a cash accumulation account attached to it. In the initial years of the policy, the premium paid is in excess of the pure cost of the insurance, and the excess is deposited into the cash accumulation account. In the later years of the life insurance policy, the pure cost of the insurance will increase, but the insured will continue to pay the same premium (assuming a planned level premium). Funds within the cash accumulation account will pay any difference between the pure cost of the insurance and the premium paid by the owner. However, if the cash accumulation account does not have the funds to pay the difference, the life insurance contract will lapse. Only a whole life insurance policy will remain in force at all times when the pure cost of the insurance is in excess of the premium paid. Option a is incorrect because the universal life insurance policy will lapse if the policy premium is not paid and the cash accumulation account does not have the funds necessary to pay the mortality and expense fees. Even if the policy premium is paid, the universal life insurance policy will also lapse if the cash accumulation account does not have the funds to pay the excess pure insurance cost (in which case the premium amount must be increased in order to avoid a policy lapse). Option c is incorrect because withdrawals are permitted from the cash accumulation account of a universal life policy. Option d is incorrect because the insured does not select the investments for the cash accumulation account.

Travis, 28, and his wife, 26, have recently moved into a new home. They financed $350,000 of the $500,000 purchase price and utilized all of their savings to pay the down payment of $150,000. Travis's wife, Shanna, stays at home with their 3-year old son, Barker, and is expecting a baby in two months. Which of the following statements is not correct?

A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death. Rationale A whole life insurance policy is a permanent type of insurance - eliminating a mortgage is a temporary need. Also, whole life insurance at Travis' age would have the highest premium. All of the other statements are correct.

Colleen transferred ownership of a whole life insurance policy on her life to an Irrevocable Life Insurance Trust (ILIT) six years ago and retained the right to borrow against the policy. When Colleen dies, the proceeds of the life insurance policy are:

Always included in Colleen's federal gross estate. Rationale The IRC (Section 2042) states that if a decedent owns a life insurance policy on her own life or possesses any incidents of ownership in the policy on the date of her death, the policy death benefit will be included in her gross estate. The right to borrow against the life insurance policy is considered an incident of ownership which would cause inclusion in Colleen's federal gross estate. Because Colleen retained this right, her federal gross estate would include the death benefit of the whole life insurance policy owned by the ILIT. Option a is incorrect because as long as the decedent has the right to take a loan against the policy, it is considered an incident of ownership. There is no requirement that a loan be outstanding. Option b is incorrect because paying the premium on a policy transferred to an ILIT does not create the incidents of ownership that would cause inclusion in Colleen's federal gross estate.

Rashad purchased a life insurance policy on his own life and never designated a beneficiary. In this case, the life insurance policy death benefit is:

Always included in Rashad's federal gross estate. Rationale Because Rashad did not list a beneficiary, the death benefit is payable to Rashad's estate and will be distributed per Rashad's will or the intestacy laws of his state of residency. There is no three-year rule with regard to the initial premium payment of the life insurance policy as listed in option a.

Which of the following estates will most likely have the greatest liquidity problem?

An estate comprised of a closely held business interest valued at $142,500,000, and cash of $100,000. Rationale The estate in option d will most likely have the greatest liquidity problem because of the lack of cash that will be necessary to pay the estate tax, and the fact that the closely-held business interest will generally not be very liquid. Option a is completely comprised of marketable securities, which can easily be converted to cash. Option b owes no estate tax, and there are marketable assets which can be liquidated to use to pay the other estate expenses. The estate in option c may have a liquidity problem but not as bad of a liquidity problem as option d.

Which of the following statements regarding selling an estate's assets to generate cash is not correct?

Any losses on the sale of the assets are deductible as losses on the estate tax return. Rationale Any losses on the sale of the assets are income tax losses and are deductible on the estate's income tax return, not on the estate tax return. All of the other answers are true statements.

As part of his employee benefit package, Hugo's employer provided him with a $50,000 term life insurance policy. Hugo named his wife, Nina, as the sole beneficiary of the life insurance policy. Which of the following statements is true with regard to this life insurance policy?

At Hugo's death, the death benefit payable to Nina will be included in Hugo's federal gross estate. Rationale The death benefit of the life insurance policy will be included in Hugo's federal gross estate because Hugo was the owner of the life insurance policy and had the right to change the designated beneficiary of the policy. Option a is incorrect because the death benefit payable from a policy issued under a group term life insurance policy is treated just like the death benefit payable from any other life insurance policy. As long as the policy has not been transferred for valuable consideration, the beneficiary will receive the death benefit without any income tax ramifications. Option c is incorrect because the owner of the policy can change the beneficiary designation without any authorization from the current beneficiary. Option d is incorrect because the beneficiary of a life insurance policy does not have any right to the death benefit until the insured has died. In this case, Nina, the beneficiary, has died before the insured on the policy, Hugo, so Nina will not include any amount related to the life insurance policy in her federal gross estate.

Raphael is the owner of a variable life insurance policy on his life. His wife, Haven, is the designated beneficiary. Which of the following statements is correct?

At Raphael's death, the variable life insurance policy death benefit will be paid to Haven. Rationale As listed beneficiary, Haven will receive the death benefit of the life insurance policy at Raphael's death. Option a is incorrect because only the owner of a life insurance policy is required to include the value in their federal gross estate. In this question, Haven is only the beneficiary; she does not have any right to the life insurance policy until Raphael's death. Option c is incorrect. A life insurance policy is included in the insured's probate estate only when the death benefit is payable to the insured (or the insured's estate) or no designated beneficiary has been selected. Option d is incorrect because the beneficiary of a life insurance policy cannot borrow against the death benefit.

Walden owned a life insurance policy with his brother, Allen, as the insured. When Walden died, his will specifically bequeathed the policy to his sister, Judith. Which of the following statements regarding the value of the life insurance policy to include in Walden's federal gross estate is not true?

Because Allen is still alive, the value of the policy included in the gross estate is zero. Rationale This statement is completely false. There is no such exception. The policy, like all other assets owned by the decedent, will be included in the gross estate, (with very few exceptions). All of the other statements are true.

Cooper is the owner, the insured, and the beneficiary of a whole life insurance policy. Which of the following situations regarding this scenario is incorrect?

Cooper's estate will include the death benefit in its taxable income. Rationale The IRC (Section 101(a)) provides an income tax exemption for a death benefit paid from a life insurance contract by reason of the death of the insured. In this case, Cooper's estate will receive the death benefit, but it will still be excluded from the taxable income of the estate because of the exemption provided by the IRC (Section 101(a)). All of the other statements are correct.

In which of the following situations would the death benefit of a life insurance policy be taxable, partially or wholly?

Harley sold a $100,000 death benefit life insurance policy to Dusty for $35,000 as part of cross-purchase buy-sell agreement.Harley and Dusty were the only two shareholders of Cupper Corporation and each owned a policy on the other. Rationale If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee's adjusted basis will be subject to income tax. An exception exists for any transfer of the life insurance policy for valuable consideration to the insured, a partner of the insured, a partnership in which the insured is a partner, a corporation in which the insured is a shareholder or officer, or a transferee who takes the transferor's basis in the contract. Option a is an example of a transfer to the insured. Option b is an example of a transfer to a corporation in which the insured is a shareholder. Option c is an example of a transfer to a partnership in which the insured is a partner. Option d does not fit any of the exceptions. The life insurance policy is transferred to Dusty, not Cupper Corporation.

Addison's husband died in October of 2020. Addison has a one-year-old dependent child and has not remarried. Which filing status will Addison use on her 2023 income tax return?

Head of household. Rationale Addison will file as head of household in 2023. Since Addison's husband died in 2020, she will file married filing jointly for the year of her husband's death. In the two years after her husband's death (2021 and 2022), Addison will file as qualifying widow. For the 2023 tax year, Addison will file head of household, and this will continue until she remarries or no longer provides a home for her child.

The Dalton Family Winery (an LLC) has operated a winery with estate grown grapes for generations. Mike owns 100% of the winery valued at $8.5 million, $6.5 million of which is the value of the real property. His estate is valued at $15 million. His son and daughter-in-law have long since toiled in the vineyards to pick the grapes. Mike plans to leave the entire operation to them. Which postmortem election(s) could Mike's executor make use of presuming Mike is not married at the time of his death and that his adjusted gross estate is equal to his gross estate?

IRC Sections 2032A and 6166. Rationale Mike's executor can elect Section 2032A and Section 6166 (not Section 303 as the business is not a C corporation with residual earnings and profits).

Mariah gave a $1,000,000 life insurance policy on her own life to her brother. At the date of the gift, the life insurance policy was valued at $200,000. Which of the following statements regarding the gift of this life insurance policy is correct?

If Mariah dies two years after this gift, her federal gross estate will include $1,000,000. Rationale The three-year rule (IRC Section 2035) states that if an individual gratuitously transfers ownership of a life insurance policy on their life, or any incident of ownership in a policy on their life within three years of death, the death benefit of the policy is included in their federal gross estate. In this case, only option c provides the correct solution. If Mariah dies two years after the gift, the gratuitous transfer of the policy falls within the three-year rule and the death benefit is included in Mariah's federal gross estate. All of the other options are incorrect.

Myles is the owner of a paid-up whole life insurance policy on his own life. All of the following statements are correct except:

If Myles gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium. Rationale Because it is a paid-up whole life insurance policy, the value for gift tax purposes is the replacement cost of the policy. All of the other statements are true.

Talia selected her son as the beneficiary of a whole life insurance policy on her life. Which of the following statements concerning this beneficiary designation is incorrect?

If Talia entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime. Rationale If Talia had entered an irrevocable beneficiary designation, she continues to be the owner of the life insurance policy, but she will need her son's permission to amend the beneficiary designation. All of the other statements are true.

Winona, age 60, purchased a single premium life insurance policy on her life 15 years ago for $65,000. The current value of the policy is $155,000. Which of the following statements regarding Winona's life insurance policy is true?

If Winona takes a loan of $145,000 against the cash surrender value of the life insurance policy, she will recognize $90,000 of taxable gain. Rationale Because Winona's life insurance policy was funded with a single premium payment, the policy is considered a modified endowment contract (MEC). Any loan from a MEC is considered taxable gain, taxed as ordinary income, to the extent there is any gain in the contract. Therefore, option d is correct because Winona takes a $145,000 loan from the contract and has $90,000 ($155,000-$65,000) of gain. Winona must recognize taxable gain as ordinary income to the extent of the gain inherent in the policy before receiving a return of capital. In answer a, if Winona borrowed $130,000, she would also recognize $90,000 of taxable gain, taxed as ordinary income, because gain always comes out first from a MEC (LIFO tax treatment). In option b, Winona would recognize $65,000 of taxable gain, taxed as ordinary income, if she took a loan of $65,000. If Winona borrowed $75,000 as in option c, Winona would have a $75,000 taxable gain, taxed as ordinary income. Note that Winona is not subject to the 10% early distribution penalty because she is over age 59½.

Which of the following statements is true?

If a life insurance policyowner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured. Rationale Option d is a correct statement. Option a is incorrect as policy dividends are return of the policy owner's adjusted basis. Option b is incorrect as life insurance policy dividends kept on deposit with the insurer will generate taxable interest income to the life insurance policyowner. Option c is incorrect because the outstanding loan would be off set by the surrender value.

Which of the following statements concerning an illiquid estate is true?

If the executor of an illiquid estate takes a loan to pay estate taxes, and pledges the estate's assets as security for the loan, the interest on the loan is deductible. Rationale The interest on a loan used to pay estate taxes is deductible by the estate. Option b is a false statement as the property is reported on the estate tax return at the fair market value at the decedent's date of death, or the alternate valuation date. Option c is incorrect as the heir would receive the property with an adjusted basis equal to the fair market value at the decedent's date of death. Option d is incorrect as the recapture occurs if property valued under the special use valuation rules is sold within ten years of the decedent's date of death.

Judd, age 71, has been paying the premium on a whole life insurance policy for the past 30 years. The policy has a $1,000,000 death benefit and has built up a cash value of $250,000. Judd's adjusted basis in the life insurance policy is $200,000. Which of the following statements is not correct?

If the insurer pays Judd a life insurance policy dividend of $3,000, his adjusted basis in the whole life insurance policy will increase to $203,000. Rationale Life insurance policy dividends are a return of the policy owner's adjusted basis. Any policy dividends received would decrease, not increase, the owner's adjusted basis. All other options are correct.

Which of the following is not a valid settlement option for the designated beneficiary of a life insurance policy?

Individual retirement account rollover. Rationale A beneficiary of a life insurance policy cannot rollover the death benefit into an IRA. The designated beneficiary of a life insurance policy can choose to receive the death benefit as a lump sum payment, as an annuity (term or life), or the beneficiary can leave the death benefit on deposit with the insurer. In some situations, the owner of the life insurance policy will establish an irrevocable settlement option, thereby choosing the beneficiary's settlement option.

Mary Jane's husband died in October of 2023. Which filing status will Mary Jane probably use on her 2023 income tax return?

Married filing jointly. Rationale In the year of death, the surviving spouse can file either married filing separate or married filing jointly.

In which of the following cases will Preston, the executor of his father's estate, not waive his executor's fee?

Preston is one of three beneficiaries of his father's estate. The beneficiaries will share the residual of the estate equally. Rationale Based on the scenario, Preston will not waive his executor's fee in option d. If he waived the fee he would have to share the residual with two other beneficiaries, and he would be left with less than if he would have taken the executor's fee. Preston would waive his fee in the scenarios under options a and b as the overall tax burden would be lower. Preston would also waive his fee in option c because he would most likely want to help his mother.

The executor of an estate liquidated assets to generate the cash necessary to pay the estate taxes. Of the following assets, which is the least likely to generate income tax consequences upon its sale?

Real estate sold within three months of the decedent's date of death. Rationale The real estate sold within three months of the decedent's date of death would not generally create any income tax consequences because the fair market value on the estate tax return of that piece of real estate would likely be that sales price (real estate prices do not ordinarily fluctuate greatly over short periods of time). So, when the estate sold the real estate within a few months of the date of death it would typically not have any gain or loss on the transaction because its adjusted basis (the fair market value on the estate tax return) would be equal to the proceeds of the sale. Options b and d would create income tax consequences as the adjusted basis of the securities to the estate would be the fair market value of the securities at the decedent's date of death. Since these are publicly traded securities, their value changes daily, and the estate would most likely have some gain or loss on the sales. The stock redemption in option c would create favorable tax consequences. Section 303 redemption takes an otherwise dividend distribution subject to ordinary income tax and subjects any gain to capital gains tax.

Many individuals who have been diagnosed with terminal illnesses sell their life insurance policies to viatical settlement providers. Which of the following statements is true regarding the transfer of a policy from an individual with a terminal illness to a viatical settlement provider?

Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax. Rationale The IRC (Section 101(g)) excludes amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill from the individual's gross income. There is no requirement that the individual die within a certain period of time. Option a is incorrect because the three-year rule (Section 2035) only applies to gratuitous transfers of life insurance. In this case, the life insurance policy was sold to the viatical settlement provider, and thus would not be subject to the three-year rule.

Laverne is the owner and insured on a $1,000,000 face value life insurance policy in pay status. Laverne's adjusted basis in the life insurance contract is $250,000. If Laverne gifts this life insurance policy to her daughter and listed beneficiary, Shirley, which of the following statements is correct?

Shirley can amend the beneficiary designation of the life insurance policy to include her son, Lenny, as a co-beneficiary. Rationale After Laverne has gifted the life insurance policy to Shirley, Shirley can select the designated beneficiary of the life insurance policy. Shirley has the right to change the beneficiary selected by Laverne and does not need Laverne's approval to amend the designation. Shirley should be aware, however, that naming Lenny as a beneficiary will result in a taxable gift from her to Lenny upon Laverne's death because there will be three different parties to the policy (the owner, the insured, and the beneficiary (the "unholy trinity")). Option a is incorrect because any dividends issued on the life insurance policy will be paid to Shirley and the dividends are nontaxable distributions equal to return of capital. Option c is incorrect because the value of a life insurance policy in pay status is the sum of the interpolated terminal reserve plus any unearned premium. Option d is incorrect as the life insurance policy will be included in Laverne's federal gross estate (not the probate estate) if she dies within three years of the gift of the life insurance policy.

In 2021, Sloan created and funded an irrevocable life insurance trust (ILIT) naming her children as the beneficiaries. The trustee purchased a policy on Sloan's life and Sloan contributed cash each year to the trust to pay the life insurance policy premiums. In 2023, Sloan died in a car accident, and the policy death benefit of $1,000,000 was paid to the ILIT. Which of the following statements regarding this ILIT and Sloan's estate is false?

The ILIT will be included in Sloan's gross estate because Sloan made a contribution to the trust within three years of her death. Rationale Option a is false statement. Since Sloan was only making cash contributions to the trust, the value of the ILIT will not be included in Sloan's gross estate. If Sloan had to pay any gift tax on the contributions to the ILIT, the gift tax paid on the contributions would be included in her gross estate. All of the other options are true statements. Option d is a true statement, because to the extent the grantor of an ILIT releases a right to revoke the trust within three years of death, the value of the ILIT is included in their gross estate.

Which of the following is not a reason for using life insurance in an estate plan?

The insured can borrow the death benefit from the life insurance policy to fund his retirement. Rationale The insured can borrow against the cash surrender value of the life insurance policy to fund his retirement. The insured cannot borrow the death benefit of the life insurance policy. All other statements are reasons for using life insurance in an estate plan.

Which of the following is not considered an incident of ownership? A - The right to change the beneficiary of a life insurance policy. B - The insured making cash gifts to the owners of the life insurance policy of the premium amount. C - The right to take loans against the cash value of the life insurance policy. D - A provision in an ILIT that directs the trust to pay the federal estate taxes of the insured.

The insured making cash gifts to the owners of the life insurance policy of the premium amount. Rationale If the insured makes cash gifts to the owners of the life insurance policy equal to the premium amount it is not considered an incident of ownership. All of the other options would be considered an incident of ownership.

Who has the right to surrender a life insurance policy for its cash surrender value?

The owner of the life insurance policy. Rationale The owner of a life insurance policy is the only party to a life insurance policy who can surrender a life insurance policy for its cash surrender value.

The owner of a whole life insurance policy would like to exchange their life insurance policy for an annuity on their life. Currently, the value of the life insurance policy is $150,000, excluding a $50,000 loan the owner has against the life insurance policy, and the owner's adjusted basis in the policy is $65,000. Which of the following statements is true?

The owner's basis in the annuity after the exchange will be $115,000. Rationale In an exchange of a life insurance policy for an annuity, the owner of the life insurance policy must recognize gain to the extent they receive boot in the exchange. Outstanding loans against the life insurance policy are considered boot. In this problem, the owner has potential gain of $135,000 ($150,000 + $50,000 - $65,000), and must recognize gain to the extent they had a loan outstanding, or $50,000. Normally, the owner's adjusted basis in the life insurance policy will be carried over to the annuity, but if the owner recognizes any gain on the exchange or pays additional expenses, they will increase their adjusted basis in the annuity by the gain recognized or the expenses paid. Because the owner had to recognize gain on the loan, they will increase their adjusted basis by this recognized gain of $50,000. After the exchange, the owner's adjusted basis in the annuity is $115,000, the adjusted basis in the life insurance policy increased by the amount of gain recognized on the transaction ($65,000 + $50,000). Option c is incorrect as an exchange is not considered a transfer for valuable consideration. Option d is incorrect because each payment received from the annuity will be partially a return of basis and partially taxable interest income.

Which of the following statements regarding term life insurance is correct?

The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. Rationale The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. Options b and c are incorrect because a term life insurance policy does not have a cash accumulation account. Option d is incorrect because the premium of a term life insurance policy increases as the pure cost of life insurance increases.

Which of the following is not a benefit of taking a loan to pay estate taxes and administration fees?

The principal of the loan is a debt on the estate tax return. Rationale The principal of the loan is not a debt on the estate tax return. The estate tax return would only include those debts that existed at the date of the decedent's death. This debt would have been acquired by the executor after the decedent's date of death. All of the other answers are true benefits.

At age 69, Andre, a widower, needs more than his pension and Social Security income to pay his living and medical expenses. His children do not have the resources to help him and he has already liquidated his individual retirement accounts. Which of the following is true if Andre decides to surrender his whole life insurance policy to the insurer?

The surrender value of the policy would be paid to Andre and the life insurance contract would be canceled. Rationale If Andre surrenders the life insurance policy to the insured, the insurer will pay Andre the surrender value, the contract will be canceled, and correspondingly there will not be a death benefit payment at Andre's death. Option a is incorrect because if Andre surrender the life insurance policy, the surrender value is equal to the cash accumulation account less a surrender charge from the insurer. Option b is incorrect because once the policy is surrendered the contract is canceled and no death benefit would be paid to the beneficiary. Option c is incorrect because Andre would not have to receive the approval of the listed beneficiary unless it was stated that he had made an irrevocable beneficiary designation.

In 2006, Donna, age 30, purchased a regular whole life insurance policy on her life and designated her sister, Robin, as the beneficiary. The policy death benefit is $1,000,000. On January 1, 2023, Donna, on the advice of her CFP® professional, assigned the policy to an ILIT. At the time, the cash value of the policy was $100,000. The named beneficiary of the trust is Robin and the trustee is James. Which of the following statements regarding the life insurance policy is/are correct?

The value of the policy for gift tax purposes is the interpolated reserve plus the unexpired premium. Rationale This is an in-pay status whole life policy. Premiums are paid to age 100 (or higher, depending on the policy).

Which of the following is not a requirement of using the special use valuation of property?

The value of the real property used in a qualifying manner must equal or exceed 75 percent of the value of the decedent's gross estate as adjusted. Rationale Option c simply reads the percentage incorrectly. The value of the real property used in a qualifying manner must equal or exceed 25 percent of the value of the gross estate as adjusted.

Which of the following is not a typical reason an estate will have liquidity needs?

To pay life insurance premiums on the decedent's life. Rationale Generally, an estate does not need cash to pay the premiums on a life insurance policy for the decedent since the decedent is dead. All of the other options are reasons an estate will have liquidity concerns.

The executor of an estate makes many elections before filing an estate tax return and the estate's income tax return. Which of the following is not an available election for the executor?

Utilizing the annual exclusion against the testamentary transfers. Rationale The annual exclusion cannot be used against testamentary transfers. All of the other options are available elections for the executor.

Mariska's father died last month and she is the listed beneficiary on his insurance policy. Mariska has contacted the insurer and has requested a lump-sum payment of the death benefit of the life insurance policy. Which of the following statements regarding this lump-sum payment is true?

When Mariska receives the lump-sum payment of the death benefit from the insurer, the payment will be taxable to the extent of any interest earned between the date of death and the payment to Mariska. Rationale When Mariska receives the lump sum death benefit, she will also receive fully taxable interest on the death benefit that accrued from the time of her father's death to the date the insurer paid Mariska. Option b is a false statement. Option c is incorrect because if Mariska had elected the annuity option, a portion of each annuity payment would have been taxable as interest income and the remaining portion of the payment would have excluded from Mariska's taxable income. Option d is incorrect because if Mariska had chosen to leave the death benefit on deposit with the insurer, she would have to include the earnings on the death benefit in her taxable income each year.