Federal Estate and Gift Taxation OK
Federal Estate Tax Deductions
1. Expenses, Indebtedness, and Taxes 2. Casualty or Theft Losses 3. The Charitable Deduction 4. The Martial Deduction
Marital Deduction
A gift from one spouse to the other is generally not subject to the gift tax, by reason of the 100% gift tax marital deduction. 1. Terminable Interests: To be eligible for the marital deduction, a gift cannot be of a terminable interest. A terminable interest for gift tax purposes is the same as that for estate tax purposes with the additional factor that, because the donor is still living, he cannot retain an interest or a general power of appointment in himself. At the election of the donor spouse, certain terminable interests are eligible for the marital deduction. 2. Joint Interests: A joint survivorship interest is not considered as an interest retained by the donor in determining whether the gift is one of a terminable interest.
Portability Between Spouses
A spouse may add to her unified credit any unused portion of her predeceasing spouse's credit, so that spouses can effectively exclude up to $10 million in gifts.
Exclusions and Credits
A taxpayer is entitled to a unified credit against the estate and gift tax that effectively exempts the first $5 million (adjusted annually for inflation) in gifts above the annual exclusion made by the taxpayer during life or death. Any of the $5 million exemption used to eliminate the tax on lifetime gifts will be subtracted from the otherwise available $5 million estate tax exemption
Lifetime Exemption/Credit
An exemption is available to shield the first $5 million (adjusted annually for inflation) in taxable gifts made during the donor's life.
Computation of the Tax
Conceptually, to determine whether a taxpayer owes any gift tax in a particular year, the taxpayer must add together the amount of the taxable gifts that he made that year (excluding the first $14,000 in gifts to each donee and gifts shielded by the marital deduction and the charitable deduction). The taxpayer then subtracts this amount from the $5 million lifetime gift tax exemption (or whatever portion of the exemption that has not been used in previous years). No tax is owed unless the lifetime exemption has been used up. Once that occurs, tax is owed on the amount of the gifts in excess of the exemption. (Remember: If the taxpayer's spouse has predeceased her, the taxpayer's exemption may be more than $5 million - because it may be increased by whatever is left of the predeceasing spouse's $5 million exemption).
Exceptions to Generation-Skipping Transfer Tax
Each person can transfer an amount equal to the estate tax exemption amount ($5 million) free of the GST tax. As with the gift tax annual exclusion, spouses are permitted to split the GST exemption, allowing married couples to transfer up to twice the available exemption amount free of the GST tax.
Gift Splitting
If a husband or wife makes a gift to a third party, the gift may be considered as being made one-half by each spouse if both are citizens or residents of the US and both consent to the gift splitting. The couple must be married at the time of the gift and the donor spouse cannot remarry during the remainder of the calendar year. Two $14,000 annual exclusions are available.
Federal Estate Tax - Powers of Appointment
If the decedent possessed a general power of appointment as defined in section 2041 at the time of her death, she will be treated as the owner of the property subject to the power. Furthermore, the termination of the power, whether by exercise release, or lapse (including death without exercising the power during the decedent's lifetime), will be treated as a transfer by the decedent of the property subject to the power.
Federal Gift Tax Indirect Gifts
Indirect gifts are possible - if A gives B $5,000 in consideration of B's giving $7,000 to C, A has made a gift to C of $5,000.
Federal Estate Tax Computation
Once the value of the decedent's estate has been determined, the estate tax can be computed by subtracting from the estate's value whatever portion of the decedent's gift and estate tax exemption that has not already been use to offset the tax on lifetime gifts. (Remember to add the decedent's exemption amount portion of a predeceasing spouse's $5 million exemption that was unused by the predeceasing spouse.) The appropriate unified rate is applied to the amount of the estate that remains to determine the estate tax.
Federal Estate Tax - Transfer with Retained Life Estate
Section 2036 requires the inclusion of transferred property where the decedent has retained for her life or for any period that does not in fact end before her death: (i) the right to possession or enjoyment of the property or its income, or (ii) the power to designate who shall enjoy the property or its income.
Federal Estate Tax - Transfers Taking Effect at Death
Section 2037 requires inclusion of property transferred by the decedent if: (i) the transferee obtains possession and enjoyment only by surviving the decedent; and (ii) the decedent retained a reversionary interest worth more than 5% of the value of the property immediately before her death.
Federal Estate Tax - Retained Power to Revoke or Alter
Section 2038 requires the inclusion of property transferred by the decedent if she retained the power to revoke the transfer, or to alter the identity of the beneficiaries or the time at which their interests are made available to them. The decedent must possess the power alone or consent to its exercise by another. **Generally, any power that permits shifting of enjoyment from one person to another, or acceleration or other shift in the time of enjoyment, is within the above section.
Federal Estate Tax - Proceeds of Insurance on Decedent's Life
Section 2042 requires inclusion of the proceeds of insurance on the decedent's life if (i) the proceeds are receivable by the executor, or (ii) the decedent possessed at his death any of the incidents of ownership of the police, exercisable either alone or in conjunction with any other person. **Payment of premiums by the decedent/insured on life insurance in which she possessed no incidents of ownership during the three years prior to her death will not cause the policy proceeds to be includible in the decedent/insured's gross estate.
Federal Estate Tax Valuation of Includible Items
The Code prescribes valuation as of the date of the decedent's death, but permits the personal representative to elect an alternate valuation date of 6 months after the decedent's death. Value is defined as "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." The Code permits realty used in farming or in a closely held business to be valued on the basis of its current farm or business use rather than its potential use.
Federal Estate Tax - Certain Gifts Made Within Three Years of Death
The Code requires the inclusion in the decedents gross estate of any property given away within 3 years prior to her death if the interest would have been included under section 2036, 2037, 2038, or 2042 if retained until death. In addition, any gift tax paid on gifts made within 3 years of death is to be included in the gross estate.
Federal Estate Tax Gross Estate
The determination of the value of the decedent's gross estate for federal estate tax purposes is a two-step process. First, the items includible in the gross estate must be ascertained. Second, the appropriate time and method of valuation of these items must be selected. 1. All Property to Extent of Decedent's Interest at Death 2. Certain Gifts Made Within Three Years of Death 3. Transfer with Retained Life Estate 4. Transfers Taking Effect at Death 5. Retained Power to Revoke or Alter 6. Joint Ownership with Rights of Survivorship 7. Powers of Appointment 8. Proceeds of Insurance on Decedent's Life
Annual Exclusion
The donor is entitled toe exclude the first $14,000 of the total gifts made during a calendar year to each donee. The exclusion is denied in the case of a gift of a future interest, which is defined as an interest in which the done does not have a present immediate right to enjoy or possess the interest. Payments of school tuition or medical payments are not regarded as gifts.
Powers of Appointment
The exercise or release of a general power of appointment is deemed to be a transfer of property by the individual possessing such power. A general power of appointment is one that may be exercised in favor of the holder of the power, his estate, his creditors, or creditors of his estate. The lapse of general power of appointment is treated as a release of the power, but the lapse of a power during any year is ignored to the extent of the greater of: (i) $5,000 or (ii) 5% of the aggregate value at the time of the lapse of the asserts out of which the exercise of the power could have been satisfied. ** A timely disclaimer or renunciation of a general power is not equivalent to the exercise or the release of such a power.
Structure of Tax
The federal estate and gift tax is based on a unified rate schedule, applicable to the cumulative total of transfers made during life and at death. Transfers at death are, in effect, taxed as the decedent's final gift. The unified tax rate is 18% on the first $10,000 of covered transfers and graduates progressively to a maximum rate of 40%.
Transfers Subject to Gift Tax
The federal gift tax applies to any completed, irrevocable transfer of property for less than full and adequate consideration in money or money's worth. Donative intent is not required. A bona fide business transaction is not covered by this tax.
Generation-Skipping Transfer Tax
The generation-skipping transfer ("GST") tax rate is the maximum estate tax rate, which is 40%. B. Transfers Subject to the Tax - There are three types of GSTs: direct skips, taxable terminations, and taxable distributions. GSTs do NOT include (i) lifetime gifts entitled to the education or medical exclusion (ii) transfers subject to an earlier GST tax, (iii) transfers made by a person in the same or higher generation than an earlier transferee, and (iv) transfers not having the effect of avoiding the GST tax. 1. Direct Skips - A direct skip is a transfer of an interest in property that is subject to gift or estate tax to a "skip person" i.e., a person who is two or more generations below the transferor. A person not assigned to a generation based on family relationship is a member of the transferor's generation if born not more than 12 1/2 years after the transferor, and is a member of the first younger generation if born more then 12 1/2 years but less than 37-1/2 years after the transferor. In the case of a direct skip, the transferor is liable to pay the GST tax. 2. Taxable Terminations - A taxable termination occurs when, after termination of an interest in trust all interests in the trust are held by skip persons. In the case of a taxable termination, the trustee is liable to pay the GST tax. 3. Taxable Distributions - A taxable distribution in any distribution from a trust to a skip person (other than a direct skip or taxable termination). In the case of a taxable distribution, the transferee is liable to pay the GST tax.
Release of Martial Rights w/ Federal Gift Tax
The release of marital rights such as a dower or curtsey is no consideration in money or money's worth. Accordingly, a transfer of property in exchange for the release of such rights is treated as a gift. However, the release of the rights of support and maintenance is valid consideration.
Federal Estate Tax - All Property to the Extent of Decedent's Interest at Death
Under section 2033, the decedent's gross estate must include the value of all property to the extent of the decedent's interest at the time of death. Note that the decedent need not have the entire bundle of rights that constitute absolute ownership in order to have an interest in property that is includible in the gross estate and subject to tax. The interest of the decedent must be a beneficial interest that survives her death and is transferable by her on death. Gratuitously acquired life estates and joint right-of- survivorship property are not includible: future interests that are transferable at death, interests in tenancy in common property, and insurance owned on the life of another are includible.
Federal Gift Tax Certain Property Settlements
Where spouses enter into a written agreement relative to their marital and property rights, and divorce occurs within two years, transfers of property made pursuant to such agreement are not gifts. If the property settlement was incorporated within a decree of divorce and the divorce court had the power to change the terms of the property settlement, the settlement is not a gift.
Federal Estate Tax - Joint Ownership with Rights of Survivorship
a. Joint Tenants Other than Husband and Wife - The entire value of the property held jointly by the decedent and others with rights of survivorship is includible in her gross estate, unless her personal representative can establish that a portion of the consideration for the joint property was contributed by a survivor, in which case that fraction of the value of the property may be excluded. If none of the joint owners paid consideration (i.e., the property was acquired gratuitously through gift, bequest, devise, or inheritance), then on the death of a joint owner, her proportionate share of the value of the joint property is includible in her gross estate. b. Joint Tenancies (and Tenancies by the Entirety) Involving only Husband and Wife - The Code provides that jointly held property owned by a husband and wife is owned one-half by each spouse, and only this one-half interest will be included in the estate of the first to die. This rule applies only if husband and wife are the sole joint tenants.
Federal Estate Tax Marital Deduction
a. Property Subject to Marital Deduction - To qualify for the martial deduction under section 2056, a transfer must be of property: 1) Includible in the decedent's gross estate; 2) That passes, or passed inter vivos, from the decedent to his surviving spouse; and 3) In which the surviving spouse receives a "nonterminable" interest. b. Amount Deductible - The martial deduction is not limited either in amount or as a percentage of the decedent's estate. c. Terminable Interest Rule - Subject to certain exceptions, a "terminable interest" will not be includible in a spouse's gross estate. A "terminable interest" is one that (i) will terminate or fail upon lapse of time or upon the occurrence or failure to occur of any event or contingency where (ii) an interest in the same property passes from the decedent to someone other than the spouse or her estate for less than full consideration, and such person may possess or enjoy any part of the property after the spouse's interest terminates. 1. Exception - Survivorship Requirement: An interest is not terminable simply because it will fail if the spouse does not survive the decedent by six months or less or will fail if the spouse dies as a result of a common disaster. 2. Exception - Election to Qualify: Also, at the election of the decedent's executor, certain terminable interests will be deemed eligible for the marital deduction; in return, such interests will be includible in the gross estate of the surviving spouse at the time of her death.