R4.3 LLC, Estate tax, trust, and gift taxation

Astor, a cash-basis taxpayer, died on February 3. During the year, the estate's executor made a distribution of $12,000 from estate income to Astor's sole heir and adopted a calendar year to determine the estate's taxable income. The following additional information pertains to the estate's income and disbursements for the year: *Estate income* Taxable interest $65,000 Net long-term capital gains allocable to corpus 5,000 *Estate disbursements* Administrative expenses attributable to taxable income 14,000 Charitable contributions from gross income to a public charity, made under the terms of the will 9,000 For the calendar year, what was the estate's distributable net income (DNI)? a. $39,000 *b. $42,000* c. $58,000 d. $65,000

(b) $42,000 *Rule:* Absent written provisions to the contrary, capital gains and losses are classified as principal and must remain with the estate or trust (i.e., allocated to corpus) *Rule:* All other taxable income (i.e., gross income net deductible expenses) generated by the fiduciary assets is generally classified as distributable net income (DNI). Distributable net income is adjusted total income (line 17 on the form 1041 with modifications for tax-exempt interest (included in DNI and allocated as tax exempt) and capital gain and losses (excluded from DNI and allocated to corpus) Gross income: Taxable interest: $65,000 Tax exempt interest: Deductible expenses: Administrative expenses ($14,000) Charitable contributions from gross income: (9000) =*Distributable net income: $42,000* ====> *This means that the first $42,000 of distributions from the trust are taxable income to the recipient(s), with any additional distributions being considered nontaxable distributions of trust corpus* ===> If less than $42,000 is distributed, the amount actually distributed is taxable to the recipient, and any remaining undistributed portion of the $42,000 would be taxable at the trust level *Dividend income is part of the income in determining DNI* *Interest income is part of the income in determining DNI*

Fred and Ethel (brother and sister), residents of a noncommunity property state, own unimproved land that they hold in joint tenancy with rights of survivorship. The land cost $100,000 of which Ethel paid $80,000 and Fred paid $20,000. Ethel died during 2013 when the land was worth $300,000, and $240,000 was included in Ethel's gross estate. What is Fred's basis for the property after Ethel's death? a. $140,000 b. $240,000 c. $260,000 d. $300,000

(c) The requirement is to determine Fred's basis for the property after the death of the joint tenant (Ethel). When property is held in joint tenancy by other than spouses, the property's fair market value is included in a decedent's estate to the extent of the percentage that the decedent contributed toward the purchase. Since Ethel furnished 80% of the land's purchase price, 80% of its $300,000 fair market value, or $240,000 is included in Ethel's estate. Thus, Fred's basis is $240,000 plus the $20,000 of purchase price that he furnished, a total of $260,000.

Which of the following requires filing a gift tax return, if the transfer exceeds the available annual gift tax exclusion? a. Medical expenses paid directly to a physician on behalf of an individual unrelated to the donor. b. Tuition paid directly to an accredited university on behalf of an individual unrelated to the donor. *c. Payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor.* d. Campaign expenses paid to a political organization.

(c) The requirement is to determine which gift requires the filing of a gift tax return when the amount transferred exceeds the available annual gift tax exclusion. A gift in the form of payments for college books, supplies, and dormitory fees on behalf of an individual unrelated to the donor requires the filing of a gift tax return if the amount of payments exceeds the $14,000 annual exclusion contrast, no gift tax return need be filed for medical expenses or college tuition paid on behalf of a donee *because there are unlimited exclusions available for these types of gifts after the annual exclusion has been used.*

Income in respect of a cash-basis decedent a. Must be included in the decedent's final income tax return b. Receives a stepped up basis in the decedent's estate c. Cannot receive capital gain treatment *d. Covers income earned before the taxpayer's death but not collected until after death*

(d) Income in respect to a decedent covers income earned before the taxpayer's death but not collected until after death

On February 1, 2013, Hall learned that he was bequeathed 500 shares of common stock under his father's will. Hall's father had paid $2,500 for the stock in 2008. Fair market value of the stock on *February 1, 2013, the date of his father's death, was $4,000* and had *increased to $5,500 six months later*. The executor of the estate elected the *alternate valuation date* for estate tax purposes. *Hall sold the stock for $4,500 on June 1, 2013,* the date that the executor distributed the stock to him. How much income should Hall include in his 2013 individual income tax return for the inheritance of the 500 shares of stock that he received from his father's estate? a. $5,500 b. $4,000 c. $2,500 d. $0

(d) The requirement is to determine how much income Hall should include in his 2013 tax return for the inheritance of stock which he received from his father's estate. Since the definition of gross income excludes property received as a gift, bequest, devise, or inheritance, Hall recognizes no income upon receipt of the stock. Since the executor of his father's estate elected the alternate valuation date (August 1), and the stock was distributed to Hall before that date (June 1), Hall's basis for the stock would be its $4,500 FMV on June 1. Since Hall also sold the stock on June 1 for $4,500, Hall would have no gain or loss resulting from the sale.

The generation-skipping transfer tax is imposed: a. Instead of the gift tax. b. As a separate tax in addition to the gift and estate taxes. c. Instead of the estate tax. d. On transfers of future interest to beneficiaries who are more than one generation above the donor's generation.

*(B) As a separate tax in addition to the gift and estate taxes. The generation-skipping transfer tax is imposed as a separate tax in addition to the federal gift and estate taxes, and is designed to prevent an individual from escaping an entire generation of gift and estate taxes by transferring property to a person that is two or more generations *below* NOT ABOVE that of the transferor. The tax is imposed at the highest tax rate (40% for 2016) under the transfer tax rate schedule.

During the taxable year, Blake transferred a corporate bond with a face amount and fair market value of $20,000 to a trust for the benefit of her 16-year old child. Annual interest on this bond is $2,000, which is to be accumulated in the trust and distributed to the child on reaching the age of 21. The bond is then to be distributed to the donor or her successor-in-interest in liquidation of the trust. Present value of the total interest to be received by the child is $8,710. The amount of the gift that is excludable from taxable gifts is:

*0.* The requirement is to determine the amount of gift that is excludable from taxable gifts. Since the interest income resulting from the bond transferred to the trust will be accumulated and *distributed to the child in the future upon reaching the age of twenty-one*, the gift (represented by the $8,710 present value of the interest to be received by the child at age twentyone) is a *gift of a future interest and is not eligible to be offset by an annual exclusion.*

Trust vs Estate

*A person's estate is all of their property owned at death.* If they have a Will, that document states who inherits the estate. If they die without a Will, state law determine who will inherit their estate. In both cases, if they have enough assets, a probate court has to supervise the settling of the estate. A trust is a fiduciary relationship in which one party, known as a trustor, gives another party, the trustee, the right to hold title to property or assets for the benefit of a third party, the beneficiary.

Complex vs Simple trusts vs Grantor vs. Revocable

*Complex Trust* may *Accumulate* Current Income, *Distribute* Principal (or Corpus) (can distibute principal and earnings) and Provide for *Charitable Contribution*. -> *Complex Trust* is entitled to $100 Exemption in arriving at its taxable income. => Attribute exclusively of a complex trust = it distibutes corpus ==>Income distributions are optional =========== *Simple Trust* may *Only* make *Distribution from Current Income (Not Corpus or Principal),* *Must Distribute All Current Income* and may NOT make Charitable Contribution. ===> If @ the Year End Simple Trust holds on to the Current Income ----> Then Simple Trust pays the Tax on it. And, If Simple Trust Pass out Current Income to the Beneficiary ----> Then Beneficiary Pays the Tax. ===>Income distributions are mandatory ===>Allowed personal exemption of $300 ============ Either Trust may have more than 1 Beneficiary/Beneficiaries, have a Grantor that is/are Not Individual . ============= *Grantor Trust* -> In Grantor trust, grantor retains control over the trust assets.===> requires that a person transfer property to a trust and *retain* certain powers over the trust -> Any income or deduction of grantor trust is reported on income tax return of grantor. -> A grantor can be a qualified shareholder of an S Corporation ======= *Revocable* Have right to revoke trust meaning have power over trust

Estate Tax (Form 706) The *applicable credit and the amount of gift taxes payable on prior gifts* made (after 1976) *reduce* the amount of calculated *estate tax* to arrive at estate tax payable with the estate tax return (Form 706)

*Filing Requirement for Estate Tax Return:* An Estate must file *Form 706* if the gross value of the estate + historical gifts by the decedent exceed $5,450,000 (Indexed each year) in 2016. The estate and gift tax exemption is $5.45 million per individual That means an individual can leave $5.45 million to heirs and pay no federal estate or gift tax. A married couple will be able to shield $10.9 million from federal estate and gift taxes. The annual gift exclusion remains the same at $14,000. *Filing Deadline:* The Form 706 must be filed within *9 months after the decedent's death* (unless an extension is requested).

For single $14,000 excluded from gift tax each year and for married $28,000 (indexed annually) to anyone.

*Unlimited Exclusion in Gift Tax* -> Payments made directly to Educational Institution===> NO exclusion if payments made for college books, supplies and dormitory fees on behalf of an individual -> Payments made directly to Health Care (Medical). -> Charitable Gifts (Payments to friends in need or to Needy people are *not* deductible)===> The charitable contribution deduction on an estates fiduciary income tax return is allowable *ONLY* if the decedent's *WILL* specifically provides for the contribution ==================>intestate: a person who has died without having made a will. -> Marital Deduction (Spouse), so if you give a engagement ring worth of $20,000 to your fiance, you are only allowed to exclude $14,000 worth of gift tax because you are NOT married yet, but after marriage unlimited amount will be excluded.

Annual *Estate* Income Tax Return (Form 1041)= Fiduciary income tax return Estates= Anytime (the government lets you die "anytime")

1. Estate required to file income tax return when the annual *income exceeds $600*===> Because $600 is an Exemption Amount for Estate. 2. *No standard deduction is allowed* 3. Estate may elect either Calendar Year *OR* Fiscal Year 4. An Estate is exempt from making estimated payments for the first 2 tax years after person death (After 2 years MUST make estimated payments).

Present Interest Gift Vs Future Interest Gifts

A Present Interest Gifts Qualifies for the Annual Exclusion A Future Interest Gifts Does NOT Qualify for the Annual Exclusion (or a Present Interest without Ascertainable Value) a) Present Interest Gifts: -> Outright gifts or cash or property -> Bonds or Notes even though interest in not payable until maturity -> unrestricted transfer of life insurance policy -> Life Estates (Ownership of the Right to Use Property presently) b) Future Interest Gifts: -> Reversions (Gifting Assets, but later getting the property back) -> Remainders (Distributed at some future point) -> Present Interest without ascertainable value. -> Accumulation of Income by Trustee

A trust has distributable net income of $14,000 and distributes $20,000 to the sole beneficiary. What amounts are taxable to the trust and to the beneficiary? Trust Beneficiary a. $14,000 $0 *b. $0 $14,000* c. $14,000 $20,000 d. $0 $20,000

A trust acts as a conduit and receives a distribution deduction if it distributes its income to a beneficiary, who then is taxed on the income. The maximum deduction that a trust can receive for distributions is limited to its DNI, which also represents the maximum amount that can be taxed to the beneficiary. The income distribution deduction that a trust can take is the lesser of the actual distribution to beneficiary or distributable net income (DNI is the amount they can take but if they distribute less than the DNI, that you would have to take the lesser distributed amount) If DNI is $14,000 and the distribution to the beneficiary is $20,000, the income distribution deduction is $14,000. This, in effect, shifts the taxation of $14,000 from the trust to the beneficiary. *Remaining of 20,000 NOT income to trust....If less than 14,000 DNI was distributed than remainng of 14,000 would be income to trust!!!*

*Form 1041* (U.S. Income Tax Return for Estates and Trusts) *due date*

April 15 Extension: September 30 The requirement is to determine when a fiduciary income tax return for a decedent's estate must be filed. The executor of a decedent's estate that has only US citizens as beneficiaries is required to file a fiduciary income tax return (Form 1041) if the estate's gross income is $600 or more. The return is due on or before the 15th day of the fourth month following the close of the estate's taxable year.

Bell, a cash basis calendar year taxpayer, died on June 1 of the current year. Prior to her death, Bell incurred $2,000 in medical expenses that were paid in the current year. If the executor files the appropriate waiver, the medical expenses are deductible on: *a. Bell's final income tax return.* b. The estate tax return. c. The estate income tax return. d. The executor's income tax return.

Choice "a" is correct. The requirement is to determine the correct treatment of medical expenses paid by the executor of Bell's estate if the executor files the appropriate waiver. The executor may elect to treat medical expenses paid by the decedent's estate for the decedent's medical care as paid by the decedent at the time the medical services were provided. To qualify for this election, the medical expenses must be paid within the one-year period after the decedent's death, and the executor must attach a waiver to the decedent's Form 1040 indicating that the expenses will not be claimed as a deduction on the decedent's estate tax return. Here, since Bell died during 2012, and the medical services were provided and paid for by Bell's estate during 2012, the medical expenses are deductible on Bell's final income tax return for 2012 provided that the executor attaches the appropriate waiver.

If the executor of a decedent's estate elects the alternate valuation date and none of the property included in the gross estate has been sold or distributed, the estate assets must be valued as of how many months after the decedent's death? *a. 6* b. 12 c. 9 d. 3

Choice "a" is correct. Rule: The alternate valuation date is the earlier of the date of distribution or six months after the date of death For estate tax purposes, the value of one's gross estate is usually determined on the date of death. However, instead of valuing the gross estate at the date of death, the executor may choose to value the gross estate at an alternative date. This date is six months after the date of death of the decedent if the property is not otherwise sold, distributed, or disposed of within those six months.

Fred and Amy Kehl, both U.S. citizens, are married. All of their real and personal property is owned by them as tenants by the entirety or as joint tenants with right of survivorship. Assuming the tax law in effect for 2014, the gross estate of the first spouse to die: a. Includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration. b. Includes one-third of the value of all real estate owned by the Kehls, as the dower right in the case of the wife or courtesy right in the case of the husband.

Choice "a" is correct. The gross estate of the first spouse to die includes 50% of the value of all property owned by the couple, regardless of which spouse furnished the original consideration, as they are considered to have owned the property as joint tenants with right of survivorship.

Carter purchased 100 shares of stock for $50 per share. Ten years later, Carter died on February 1 and bequeathed the 100 shares of stock to a relative, Boone, when the stock had a market price of $100 per share. One year later, on April 1, the stock split 2 for 1. Boone gave 100 shares of the stock to another of Carter's relatives, Dixon, on June 1 that same year, when the market value of the stock was $150 per share. What was Dixon's basis in the 100 shares of stock when acquired on June 1? a. $5,000 b. $5,100 c. $15,000 d. $10,000

Choice "a" is correct. This question combines the rules of estate taxation and gift taxation. Carter's investment in the stock was $50 per share when he died. Upon Carter's death, the stock received a step-up in basis to the fair market value at the date of death (or six months later, if the alternate lower valuation date was elected). Therefore, the stock's basis was $100 per share when it was transferred to Boone. [Note that no capital gain was reportable for the step-up in basis from $50 to $100; however, Carter's estate included the stock at its fair market value of $100/share for estate tax purposes and likely paid a large amount of estate tax on that.] Further, regardless of how long Carter owned the stock (i.e., it could have only been owned for one day), it was automatically deemed long-term property upon Carter's death. So, Boone had 100 shares of stock at a basis of $100/share when Boone received the inheritance. Then, there was a 2-for-1 stock split on April 1 of the following year. This transaction caused Boone to now have double the amount of shares (or, 200 shares) at half the basis per share (or, $50/share). [Note that the total basis remains unchanged (i.e., $100 x 100 shares = $10,000 and $50 x 200 shares = $10,000).] When Boone gifted the stock to Dixon (note: it would not have mattered if Dixon had not been a relative), the donee (Dixon) received the stock at the carryover basis of the donor (Boone). The 100 shares gifted to Dixon were shares from after the stock split; therefore, they have a basis of $50 per share, or a total basis of $5,000 for the 100 shares. [Note that Boone still has 100 shares at a basis of $50 as well.]

Ordinary and necessary administration expenses paid by the fiduciary of an estate are deductible: a. On both the fiduciary income tax return and on the estate tax return by adding a tax computed on the proportionate rates attributable to both returns. b. Only on the fiduciary income tax return (Form 1041) and never on the federal estate tax return (Form 706). *c. On the fiduciary income tax return only if the estate tax deduction is waived for these expenses.*

Choice "c" is correct. Administration expenses paid by the fiduciary of an estate are deductible on the "fiduciary income tax return" only if the estate tax deduction is waived for those expenses. Rule: To deduct administration expenses, a statement must be filed with the income tax return stating that those deductions have not been taken on the decedent's estate tax return.

*Distributable Net Income (DNI)* *Charitable bequests to qualifying organizations and funeral expenses of the decedent are both allowable deductions in determining the taxable estate* *DNI = taxable to the beneficiary = treated as distribution of principal* *DNI= the upper limit on the amount of income that a beneficiary has to include in income from a trust distribution*

Estate (Trust) Gross Income (Includes all capital gains) <Estate (Trust) Deductions> = Adjusted Total Income + Adjusted Tax Exempt Interest <Capital Gains>===> *(attributable to corpus)!* = *Distributable Net Income (DNI)*===> DNI will be "Taxed" When its Distributed *!*Capital Gains Attributable to CORPUS are NOT included in DNI

LLC Taxation (Limited Liability Company)

Limited Liability Companies (LLC) are "Corporation" for Legal Purposes, but for Tax Purposes they are "partnerships". LLC Members are *NOT* personally liable for the obligation of the business. LLC with at least 2 owners is taxed as "Partnership" UNLESS an election is made to have the LLC Taxed as a "Corporation" which is very rare. Company with 1 owner CANNOT be LLC if not elected as corporation, but rather it will be Sole proprietorship.

Estate's initial taxable period

May be either a calendar year, or a fiscal year beginning on the date of the decedent's death

Mackenzie is the grantor of a trust over which Mackenzie has retained a discretionary power to receive income. Kelly, Mackenzie's child, receives all taxable income from the trust unless Mackenzie exercises the discretionary power. To whom is the income earned by the trust taxable? A. To the trust to the extent it remains in the trust. B. To Kelly as the beneficiary of the trust. *C. To Mackenzie because he has retained a discretionary power.* D. To Kelly and Mackenzie in proportion to the distributions paid to them from the trust.

Rule: IRC sections 671-679 control the taxation of grantor trusts when the grantor of the trust retains the beneficial enjoyment or substantial control over the trust property or income. In that case, the grantor is taxed on the trust income. The trust is disregarded for income tax purposes. The grantor is taxed on the income if he/she retains (1) the beneficial enjoyment of the corpus or (2) the power to dispose of the trust income without the approval or consent of any adverse party

During the current year, a trust reports the following information: dividends $10,000 interest from corp bonds $12,000 tax exempt interest from state bonds - $4,000 capital gain (allocated to corpus) - $2,000 trustee fee (allocated to corpus) - $6,000 What is the trust's accounting income? a. $26,000 b. $22,000 c. $34,000 d. $28,000

The answer is $26,000 (dividends 12,000 + interest from corporate bonds $12,000 + tax exempt interest from state bonds $4,000) The capital gain and trustee fee are not included in the trust's income since tey are both allocated to corpus.

The corpus of a trust is ::: *"Allocable to Corpus"* means it's not taxable to beneficiary

The corpus of a trust is the sum of *money or property that is set aside to produce income for a named beneficiary.*

Form 1041 vs for 706

The estate have 2 types of tax 1) Estate income tax return which is from 1041 which must be filed if the *estate has income of 600 or more*.It must be filed on or before 15th April(extension available) .this tax is imposed on the income which is earned by the Estate. 2) Estate tax(Form 706). This is the *tax* which is *imposed when the actual estate is transferred to the beneficiary* .Estate tax is also called as transfer tax. Estate tax must be filed within 9 months after the death of the decedent(don't confuse it with the Estate valuation date, which is 6 months!).

Gift Tax

The gift tax is a transfer tax payable by who give the gifts. Its main purpose is to make the donor liable for the tax that would have been payable as estate tax at the donor's death. For single $14,000 excluded from gift tax each year and for married $28,000 (indexed annually) to anyone.

What is the due date of a federal estate tax return (Form 706), for a taxpayer who died on May 15, year 2, assuming that a request for an extension of time is not filed? a. September 15, year 2. b. December 31, year 2. c. January 31, year 3. *d. February 15, year 3.*

The requirement is to determine the due date for a federal estate tax return for a taxpayer who died May 15 of year 2. The federal estate tax return (Form 706) must be filed within *nine months* of the decedent's date of death, unless an extension of time has been granted. Here the return is due February 15, year 3. Died May 15.....6, 7, 8, 9, 10, 11, 12, 1, 2= 9 mos

Due date for filing the gift tax return

The return is due on or before the 15th day of the furth month following the close of the tax year in which the gift was made. Form 709 is an annual return and its due date is April 15

The Simone Trust reported distributable net income of $120,000 for the current year. The trustee is required to distribute $60,000 to Kent and $90,000 to Lind each year. If the trustee distributes these amounts, what amount is includible in Lind's gross income? a. $0 b. $60,000 *c. $72,000* d. $90,000

The total amount to be distributed to beneficiaries cannot exceed the DNI of the trust i.e. 120k. Thus even though the trustee is required to distribute 60k and 90k distributions will be made in the following proportion: Kent = 60k/(90k+60k)*120k = 48k Lind = 90k/(90k+60k)*120k = 72k

Annual *Trust* Income Tax Return (Form 1041) Trusts= Year end ( I "trust" you will remember Decmber 31 is year end)

Trust are subject to income tax and are considered separate tax paying entities. Trust are classified as either simple or complex. 1. All Trusts EXCEPT Tax-Exempt Trusts MUST use *Calendar year for filing.* 2. A Trust may deduct amounts distributed to beneficiaries up to the DNI LESS adjusted Tax-Exempt Interest.

ESTATE PROPERTY INHERITED (USE FMV, NOT BASIS)

Use FMV at death or Alternate Valuation Date (6 mo. later) ===> If Alt. date is chosen but sold before 6 mo. window, use FMV at date sold Property inherited is LTCG property regardless of how long you hold it after receipt

Estate tax

When someone in your family dies and the property of the deceased transfers to you, the federal government imposes an estate tax on the value of all that property.