CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Estate Planning

© 2012, College for Financial Planning, all rights reserved.

Module 6

Methods of Estate Transfer During Life

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMEstate Planning

Learning Objectives

6–1 Identify the purpose (uses), characteristics, and factors to be considered in using a given inter vivos intrafamily planning technique.

6–2 Analyze a situation to determine the tax implications and/or the advantages and disadvantages of a given inter vivos intrafamily planning technique.

6–3 Evaluate a situation to select the most appropriate property and/or technique to accomplish a client’s inter vivos intrafamily planning objectives.

6–4 Identify the purpose (uses), characteristics, and factors to be considered in using a given inter vivos closely held business transfer technique.

6–5 Analyze a situation to determine the tax implications and/or the advantages/disadvantages of a given inter vivos closely held business transfer technique.

6–6 Evaluate a situation to select the most appropriate transfer technique to accomplish a client’s inter vivos closely held business planning objectives.

6–7 Identify the purpose (uses), characteristics, objectives, and factors to be considered in using a given inter vivos life insurance planning technique.

6–8 Analyze a situation to identify the tax implications and/or the advantages and disadvantages of a given inter vivos insurance planning technique.

6–9 Evaluate a situation to select the most appropriate technique to accomplish a client’s inter vivos insurance planning objectives.

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Questions to Get Us Warmed Up

6-3

Inter Vivos Gifts: Questions

6-4

What is the purpose or goal of the gift?

Who will be the donee?

Should the donor retain an interest in or control over the gifted assets?

What assets will be transferred?

What form will the transfer take? Outright gift … custodial account …trust?

Inter Vivos Gifts: Identity of Donee

Factors if identity of donee is not dictated by desire to help a specific individual or charity:• the competency of the potential donee• the estate tax status of the potential donee• the potential donee’s marginal income tax

bracket• the potential donee’s relationship to the donor

Don’t forget that direct and exclusive payment of medical and tuition expenses is free of both gift tax and GSTT.

6-5

Inter Vivos Gifts: Retained Interest or Control

Possible Consequences:• Income tax — may not shift taxation

(e.g., because of grantor trust rules)• Gift tax—may cause Chapter 14 rules to apply• Estate tax:

o may cause transfer sections (Code sections 2036–2038) to apply

o may cause three-year rule to apply if retained interest is released within three years of death

o may jeopardize marital or charitable deduction

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Inter Vivos Gifts: Gift Leaseback

• fee simple gift of business property

• business owned or controlled by donor leases property from donee

• business gets income tax deduction for lease payments (if reasonable and necessary)

• donor owes gift tax (and possibly GSTT) on FMV of gifted property

• gifted property is removed from donor’s gross estate

• donee assumes donor’s basis in gifted property, must report lease payments as ordinary income, and must include property in gross estate if owned at death

6-7

Inter Vivos Gifts: Reverse Gift

• appreciated property is given to a donee expected to predecease the donor, and is given with expectation that donee will give property back to donor by will

• purpose: donor wants a stepped-up income tax basis

• gift is subject to gift tax and possibly GSTT

• donee must have no legal obligation to bequeath property to donor and must include property in gross estate if owned at death

• donor achieves step-up in basis only if more than one year elapses between completion of the gift and donee’s date of death

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Inter Vivos Gifts: Net Gift

• gift is conditioned on donee assuming a legal obligation of the donor—e.g., a mortgage on gifted property or obligation to pay gift tax on the transfer

• gift tax is paid only on net amount of the gift and donor’s credit status is used

• donor is liable for GSTT if donee is skip party in relation to donor

• if obligation assumed by donee exceeds donor’s adjusted basis in the property, donor realizes gain to extent of excess

• donor’s estate includes taxable gift and resulting credit (if gift tax is actually paid) in estate tax calculation, regardless of tax being paid by donee

6-9

Inter Vivos Gifts: Custodial Accounts

Characteristics• Property is titled in the name of

some competent adult as the custodian for a minor pursuant to state’s adoption of either UGMA or UTMA.

• Separate account must be established for each minor.

• Age of majority (when minor must be given control of property) is set by state law.

• Not a true trust, since minor has both legal and equitable title to assets; however, use of assets for benefit of minor prior to majority is at custodian’s discretion.

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Inter Vivos Gifts: Custodial Accounts

Taxation• Income from custodial assets is taxed

to minor except for income used to discharge a legal obligation of support of the minor’s parent that is taxed to the parent; kiddie tax rules apply; grantor trust rules do not apply.

• Custodial account is a completed gift and is eligible for annual exclusion even though no present interest.

• Donor is subject to GSTT if minor is a skip party in relation to the donor.

• If donor dies while custodian, property contributed by donor is included in donor’s gross estate.

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Inter Vivos Gifts: Section 2503(c) Minor’s Trust

Characteristics• Property is given to an irrevocable trust in which a minor

under the age of 21 years is both the sole income and remainder beneficiary.

• Trust property may be used for the exclusive benefit of the minor beneficiary at the trustee’s discretion.

• Upon reaching age 21, minor beneficiary must be allowed to remove the property from the trust.

• If minor dies prior to age 21, trust property must be paid to minor’s estate or to appointee of the minor.

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Inter Vivos Gifts: Section 2503(c) Minor’s Trust

Taxation• Income is taxed to the minor except income used to

discharge a parental obligation of support that is taxed to the parent.o kiddie tax rules apply

• Donor must pay gift tax on FMV of assets given less one annual exclusion.

• Donor must pay GSTT if minor is skip party in relation to donor.

• If donor dies while trustee or successor trustee, property given by donor will be included in donor’s gross estate.

• Assets will be included in donee’s gross estate if owned at death.

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Inter Vivos Gifts: Qualified Tuition Plan Accounts

Characteristics• account is established (IRC 529) with an approved

sponsor for the benefit of any person, adult or minoro cash contributions only

• account not required to be dispersed at any specified age, and remains under control of contributor

• account beneficiary can be changed, but may be tax consequences

• sponsor may have maximum contribution limito no income limits on contributors

• account balance is usually intended to cover qualified higher educational expenses, but no federal requirementthat balance be used for this purpose

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Inter Vivos Gifts: Qualified Tuition Plan Accounts

Taxation• Contributions are eligible for the gift tax annual exclusion; can

contribute up to five times the maximum annual exclusion in one year (”five year averaging”) gift tax free.

• Contributions are not deductible from federal income, but may be deductible from state income if made to a state sponsored plan.

• Account earnings accumulate income tax free.

• Distributions of earnings for qualified higher educational expenses are excluded from gross income; distributions for nonqualified expenses are included in gross income of the recipient and subject to 10% penalty.

• Account balance is included in beneficiary’s gross estate; account balance included in account owner’s gross estate if no designated beneficiary, or if “five year averaging” is used and contributor dies during five-year term.

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Inter Vivos Gifts: Coverdell Education Savings Accounts

Characteristics• Account established (IRC 530) for a minor (under age

18 unless special needs) with institution qualified for IRAs; contribution is not deductible.

• Is a maximum income limit for individual contributors.

• $2,000 maximum contribution per year; can be made for current year until following April 15.

• Account can be established for beneficiary of IRC 529 plan account.

• Account must be fully distributed when beneficiary turns 30 unless special needs.

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Inter Vivos Gifts: Coverdell Education Savings Accounts

Taxation• Contributions are eligible for annual exclusion; thus, no gift tax, and no

GSTT if beneficiary is a skip party.

• Account earnings accumulate income tax free.

• Distributions of earnings for qualified education expenses (K–12 and postsecondary) are not included in gross income; distributions of earnings in excess of these expenses or for other purposes are included in gross income, and are subject to 10% penalty.

• Only distributions from account because of beneficiary’s death are included in beneficiary’s gross estate.

• Account rollovers are subject to gift tax and GSTT unless new beneficiary is a member of the family of the old beneficiary. Rollover is subject to income tax if account has been rolled over in last twelve months or if rollover is not to a member of the same family.

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Inter Vivos Gifts: Revocable Living Trusts

Characteristics• property is titled in the name of a

revocable inter vivos trust to avoid probate and plan for incapacity

• can be used as a pourover trust for assets after death

Taxation• income taxed to grantor under grantor

trust rules• no gift tax upon creation because no

completed gift; completed gift upon distribution to other than grantor; if recipient is skip party to grantor, GSTT will apply to distribution in excess of maximum annual exclusion; distributions are not subject to three-year rule

• assets are included in grantor’s gross estate under Code Section 2038 (transfer section)

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Inter Vivos Gifts: Section 2503(b) Mandatory Income Trust

Characteristics• title to property is placed in

the name of an irrevocable trust that is required to pay out all income at least annually

• trust may have any number of income and remainder beneficiaries who can be minors or adults

• trust term may be for any length of time, subject only to any applicable rule against perpetuities

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Inter Vivos Gifts: Section 2503(b) Mandatory Income Trust

Taxation• Income is taxed to income

beneficiaries whether distributed or not.

• FMV of property given to trust is subject to gift tax (and GSTT if beneficiaries are skip parties).o But grantor is entitled to annual

exclusion in an amount not to exceed the lesser of the number of income beneficiaries times the maximum annual exclusion, or the present value of the income interest.

• Trust assets are removed from grantor’s gross estate unless grantor has retained a right of reversion in the remainder that is subject to Code Section 2037.

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Question 1

All of the following are correct statements regarding a gift leaseback transaction except: a. The donor will be subject to gift tax on the fair

market value of the gifted property (less applicable annual exclusions).

b. The donor is subject to capital gains tax on the difference between the fair market value of the gifted property and his basis in the property.

c. The business can take an income tax deduction for the necessary and reasonable expense of renting the gifted property.

d. The donee must report the lease payments as ordinary income.

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Question 2

All of the following are differences between the Uniform Gifts to Minors Act (UGMA) and the Uniform Transfers to Minors Act (UTMA) excepta. restrictions on the type of property that can

be gifted.b. restrictions on whether transfers can

be made during life and/or at death. c. restrictions on how many minors can

be the beneficiaries of an account.

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Question 3

All of the following are consequences of a donor retaining an interest in or control over gifted property except a. if the gifted property is placed in trust, the

grantor may still be taxed on the income even if the trust is irrevocable.

b. if the gifted property is an interest in a closely held business, the Chapter 14 rules may apply in computing the value of the gift.

c. the donor may be subject to income tax on any capital gain.

d. the gifted property may still be included in the donor’s gross estate.

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Question 4

All of the following are correct statements regarding a reverse gift transaction except a. the property involved has a high basis in

relation to its fair market value.b. the primary purpose of this transaction is for

the donor to get a stepped-up basis in the asset that is gifted.

c. the donee cannot have a legal obligation to leave the property to the original donor at the donee’s death.

d. the property will receive a step-up in basis only if more than one year elapses between completion of the gift and the date of death.

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Question 5

All of the following are correct statements regarding a net gift transaction except a. the donee may be asked to pay the gift tax

due on the gift.b. the taxable gift is included in the donee’s

estate tax calculation as an adjusted taxable gift.

c. if the obligation assumed by the donee exceeds the donor’s adjusted basis in the property, the donor will realize gain to the extent of the excess.

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Question 6

All of the following are correct statements regarding a Section 2503(b) mandatory income trust excepta. this trust can have beneficiaries who are

adults.b. this trust must disperse its assets when the

income beneficiary reaches age 21.c. this trust is irrevocable.d. this trust can have multiple

beneficiaries.

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Question 7

All of the following are correct statements regarding a Section 2503(c) minor’s trust excepta. this trust must disperse its assets when the

minor beneficiary turns age 30.b. this trust can have only one beneficiary.c. a donor to this trust is entitled to an annual

exclusion.d. a grantor to this trust may have to include

trust assets in his gross estate.

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Question 8

Which of the following statements regarding qualified tuition plans (§529) are correct?I. Contributions are completed transfers.II. Contributions are entitled to the annual

exclusion.III. An account can have more than one named

beneficiary.IV. Contributions can be made in cash or

property.a. I and II onlyb. II and III onlyc. III and IV onlyd. I, II, and IV only

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Question 9

Which of the following statements regarding Coverdell education savings accounts (§530) are correct?I. Contributions can be made in cash only.II. Account assets can be used only for qualified

higher education expenses.III. Distributions are at the discretion of the

trustee/custodian.IV. Contributions for a prior year may be made until

April 15 of the subsequent year.a. I and II onlyb. III and IV onlyc. I, III, and IV onlyd. I, II, III, and IV

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Question 10

All of the following statements are true of both revocable and contingent trusts excepta. both trusts are revocable.b. trust assets remaining at the grantor’s death

will be included in the grantor’s gross estate.c. trust assets remaining at the grantor’s death

will avoid probate.d. both trusts are funded immediately after they

are established.

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Inter Vivos Gifts: Crummey Trusts

Characteristics• Property is titled in the name of an irrevocable inter

vivos trust in which some or all of the beneficiaries have been given a Crummey power.

• Trust can have any number of beneficiaries who can be minors or adults.

• Distribution of income is discretionary.

• Trust term may be for any length of time, subject only to any applicable rule against perpetuities.

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Taxation• Income may be taxed to:

o grantor under grantor trust ruleso to holders of a Crummey power under Section 678;o to income beneficiaries if distribution is made; oro to the trust if the foregoing does not account for all income, and

remaining income is accumulated, depending on terms of the trust.

• FMV of property given to trust is subject to gift tax (and possibly GSTT) but grantor is entitled to annual exclusion in an amount equal to the lesser of the present interests created by the Crummey powers granted, or the number of powers granted times the maximum annual exclusion.

• Trust assets are removed from the grantor’s gross estate unless three-year rule or transfer sections apply.

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Tax implications to holder of Crummey power:• Code Section 678 makes holder liable for trust

income to the extent of the power, whether exercised or not.

• Lapse of Crummey power will subject holder to gift tax on the lapsed amount that exceeds greater of 5 and 5.

• Any amounts subject to exercise of the power at death must be included in holder’s gross estate.

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Inter Vivos Gifts: Grantor-Retained Trusts

Characteristics• Property is given to an irrevocable inter vivos trust to last for a term

certain; grantor must also retain a beneficial interest in the trust.• Interests commonly retained by the grantor are

o all income from trust assets (GRIT).o an annuity interest (GRAT).o a unitrust interest (GRUT).o the right to use a personal residence (QPRT).

• Remainder interest is given to beneficiaries specified by the grantor.

• Purpose is to remove asset from grantor’s gross estate while allowing grantor to retain benefit of the asset during trust term and/or transfer remainder interest gift tax free if GRAT is “zeroed out.”

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Inter Vivos Gifts: Grantor-Retained Trusts

Taxation• Grantor is taxed on income to extent of interest

retained.o Excess income, if any, is accumulated and taxed to the trust.

• FMV of property given to trust less present value of the retained interest is subject to gift tax (and possibly GSTT) for all but a GRIT.o FMV of all property given to a GRIT is

subject to gift tax because of Section 2702 (Chapter 14 rules).

• Asset is removed from grantor’s gross estate unless grantor dies during trust term,

• in which event Section 2036 (transfer section) requires inclusion.

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Inter Vivos Sales: Bargain Sale

Characteristics• An asset is sold for less than FMV.

o Difference will be held to be a gift.

Taxation• If sales price exceeds seller’s adjusted basis, seller will have

capital gain to extent of excess.

• If buyer also assumes an existing indebtedness, seller can also have capital gain if indebtedness exceeds basis.

• Gift tax and possibly GSTT on gift portion, but donor is entitled to annual exclusion.

• Asset is removed from seller/donor’s gross estate, but sale proceeds, if not consumed at death, are included.

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Inter Vivos Sales: Installment Sale

Characteristics• Purchase price not paid at time of sale is paid in a

fixed number of future installments, at least one of which must be in a tax year other than the year of sale.

• Reporting of gain on an installment basis is allowed automatically unless seller elects otherwise.

• Sale of marketable securities and depreciable property to a controlled entity is not eligible for installment reporting of gain.

• Payments may be secured or unsecured.

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Inter Vivos Sales: Installment Sale

Taxation• Buyer’s basis is purchase price actually paid.• For payments made after seller’s death, buyer gets

income tax deduction for estate tax paid on IRD• Cost recovery recapture, if any, is due in full in the year

of sale (increases seller’s basis).• Payments are composed of three elements:

1. return of basis (tax free); 2. gain (taxed as capital gain); and 3. interest (ordinary income).

• Reporting of gain may be accelerated under second disposition rule.

• Present value of remaining payments is included in seller’s gross estate.

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Characteristics

• Normal installment sale except all unmatured payments will be canceled at seller’s death.

• The possibility that the seller may die prior to due date of all installments must be taken into consideration to avoid gift tax. This result is avoided by increasing the purchase price and/or interest rate—known as a SCIN premium.

Inter Vivos Sales: SCINs

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Inter Vivos Sales: SCINs

Taxation • Seller’s estate must recognize gain in

payments canceled at death if between related parties and FMV of asset on date of cancellation (or face amount of note, if less) exceeds the seller’s basis in the obligation.

• If SCIN premium was not paid, transaction becomes a bargain sale, subject to gift tax on seller.

• There are no estate tax consequences to the seller.

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Inter Vivos Sales: Private Annuities

Characteristics• A type of installment sale in which payments are

determined by using the actuarial lifetime of the seller and the applicable federal discount rate for the month of sale.

• Payments continue for actual lifetime of seller, whether that is more or less than his or her actuarial lifetime.

• If seller is willing to accept smaller payments, survivorship payments can be made over two or more lifetimes, such as a husband and wife.

• Installment reporting of gain is not available whether payments are secured or unsecured.

6-41

Inter Vivos Sales: Private Annuities

Taxation• Payments are reported by seller under annuity

rules (return of basis and ordinary income until basis has been fully recovered, at which time all additional payments are ordinary income).

• No gift tax unless asset is sold for less than FMV.

• Asset is excluded from seller’s gross estate even if seller dies before end of actuarial lifetime; no amount for future payments is included in gross estate of seller absent survivorship payments.

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Inter Vivos Sales: Sale-Leaseback

Characteristics• Business-related property is sold, then

seller’s business leases property from buyer.

Taxation• Seller recognizes gain (reported on

installment basis if sale price exceeds seller’s basis).o Business gets income tax deduction

for lease payments if reasonable and necessary.

o Buyer reports lease payments as ordinary income.

• No gift tax unless asset is sold for less than FMV.

• Asset sold is not in seller’s gross estate.

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Question 11

All of the following are correct tax implications of a Crummey trust except a. the holder of the Crummey power will likely

have to include some portion of the trust assets in his gross estate if he dies during the trust term.

b. if the holder of the Crummey power exercises it to withdraw trust assets, the grantor of the trust will not be entitled to an annual exclusion.

c. there are no gift tax consequences if the holder of the Crummey power exercises it to take trust assets for himself or herself.

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Question 12

All of the following statements regarding qualified personal residence trusts (QPRT) are correct except a. the grantor retains the right to live in the

residence during the trust term. b. the Chapter 14 valuation rules require the

grantor to pay gift tax on the entire value of the residence at the time the trust is funded.

c. the grantor will be subject to gift tax only on the present value of the remainder interest.

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Question 13

All of the following statements regarding self-canceling installment notes (SCINs) are correct except a. the self-canceling provisions of a SCIN must

be paid for with a SCIN premium to avoid gift tax.

b. the seller will not have to include any payments canceled at death in his or her gross estate.

c. the purchaser’s basis in the asset purchased is limited to the payments that are actually made to the seller prior to death.

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Question 14

All of the following statements regarding split interest transactions (SPLITs) are correct except a. the two parties buy their interests in the asset

at different times. b. the life interest holder is entitled to all income

from the asset during her lifetime. c. although this transaction involves a sale, it is

subject to one of the Chapter 14 rules if the two parties are related.

d. the life interest holder may have to include some part of the value of the asset in her gross estate.

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Question 15

All of the following statements regarding private annuities are true except a. a private annuity involves a sale transaction. b. in most instances, the value of the property involved

in the transaction will be eliminated from the gross estate of the annuitant.

c. if the annuitant dies before the end of his actuarial lifetime, the present value of the future payments he or she would have received is included in his or her gross estate.

d. if someone other than the original annuitant will receive payments as a result of the transaction after the original annuitant’s death, the original annuitant’s gross estate must include the present value of such payments.

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Question 16

Which of the following statements regarding remainder interest transactions (RITs) are correct?I. The life and remainder interest holders purchase

their interests at the same time.II. Since this is a sale transaction, it is not subject to

gift tax.III. The life interest holder is entitled to all income of

the property.IV. The property will be in the life interest holder’s

gross estate.a. I and II onlyb. III and IV onlyc. I, II, and IV onlyd. II, III, and IV only

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Business Transfer: Buy-Sell Agreements

Purpose

• to assure a closely held business owner of a market for his or her interest in the event of:o total disabilityo retiremento death

• to prevent closely held business interests from being transferred to third parties who may be unsatisfactory

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Procedure• Each owner obligates himself to sell his interest in certain

circumstances to each of the other owners (cross-purchase) or to the business entity (entity or stock purchase).

• In a cross-purchase, every owner obligates himself to purchase his pro rata share of any offered interest.

• In an entity purchase, the entity obligates itself to purchase any offered interest.

• The agreement establishes a formula for computing the purchase price; if triggering event is death, estate tax value is often used.

• Parties are obligated to purchase insurance in order to meet agreement obligations.

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Taxation• Premiums paid on insurance are not deductible by payor or

income to the insured; in a cross purchase transaction, buyer will have basis in interest purchased equal to purchase price.

• No gift tax if interest is purchased at FMV.

• If interest is not purchased at FMV, Code Section 2703 (Chapter 14 rules) may require selling party to pay gift or estate tax on difference if more than 50% of business is family owned.

• At death of owner, his or her gross estate will include FMV of business interest and replacement cost of policies on other owners, if cross purchase.

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Business Transfer: Recapitalization

Purpose• to allow additional owners of the

business, and give them financial incentive to eventually purchase owner’s remaining interest and run the business

• to maintain control of business until retirement

• to maintain preference in payment of income and liquidation

• to freeze value of business for estate tax purposes

• if business interests are given (rather than sold), to take advantage of valuation discounts

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Procedure• May require change in entity to

accommodate multiple owners.

• Causes creation of multiple classes of ownership interests:o voting vs. nonvoting (to maintain

control)o preferred vs. nonpreferred (to

maintain preference for income)o fixed value vs. non-fixed value

(to freeze value)

• Nonvoting, nonpreferred interests are either sold or given to family members.

• Voting and preferred interests are retained by original owner.

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Taxation• Change of entity and recapitalization

can usually be done without causing realization of gain by owner.

• Old owner can receive compensation for services provided to the business that are a deductible expense.o Both old and new owners will be

entitled to share of income distributed by business.

• Interests that are gifted are subject to gift tax as modified by Code Section 2701 (Chapter 14 rules); annual exclusion and valuation discounts may apply.

• Business interest retained by old owner until death will be included in gross estate at FMV.

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Question 17

Goals that a business owner can reasonably expect to achieve in a preferred stock recapitalization include all of the following excepta. maintaining control of the business. b. eliminating the value of the business from

his or her gross estate.c. maintaining a preference in payment of

income from the business.d. freezing the value of his retained interest.

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Question 18

A buy-sell agreement can be used to transfer a closely held business interest in which of the following circumstances? a. when one of the owners diesb. when one of the owners retiresc. when one of the owners is disabledd. all of the above

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Question 19

In a cross-purchase buy-sell agreement funded with life insurance involving two business owners, each business owner is the owner and beneficiary of a life insurance policy on the life of the other owner. True False

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Question 20

An estate freeze transaction can be achieved through a preferred stock recapitalization of an S corporation. True False

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Question 21

All of the following statements regarding a preferred stock recapitalization freeze transaction are correct except a. if shares are gifted to other family members,

the donor may be able to claim discounts for minority interest and lack of marketability.

b. if shares are gifted to other family members, they are valued as of the date of completion of the recapitalization.

c. if shares are gifted to other family members, the Chapter 14 rules may apply.

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Question 22

All of the following statements regarding buy-sell agreements are correct except a. in a cross-purchase buy-sell agreement, the actions

of the purchasing owners can be made optional rather than mandatory.

b. in a cross-purchase buy-sell agreement, each owner agrees to sell his or her interest in the business to the other owners under certain stated conditions.

c. in an entity purchase buy-sell agreement, each owner agrees to purchase his or her proportionate share of any interest redeemed by the business entity from any other owner.

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Life Insurance: Incidents of Ownership

The right to • name and change the policy beneficiary

• cash in, surrender, or cancel a policy

• receive policy dividends

• borrow against policy cash value

• pledge the policy as collateral for a loan

• assign any of the foregoing rights or the policy

• revoke an assignment

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Life Insurance: Transfer for Value Rule

• Makes life insurance death benefits subject to income taxation if ownership of the policy was transferred for a value, or if value was paid to the owner of the policy to be irrevocably named as beneficiary.

• If rule applies, beneficiary recovers amount paid and subsequent premium payments tax free, but excess is subject to income tax.

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Life Insurance: Transfer for Value Rule

ExceptionsTransfers for value that are not subject to the rule:• to the insured• to a partner, partnership, or corporation in which

the insured is a shareholder or officer• to a transferee whose adjusted basis is

determined in whole or in part by reference to the transferor’s adjusted basis

• transfers between spouses incident to a divorce

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Inter Vivos Gifts: ILIT

Characteristics• Ownership of life insurance policy is given to irrevocable inter

vivos trust with term that usually lasts until death of grantor’s spouse; beneficiary of policy is changed to trustee.

• If other property is also given to the trust (to generate income to pay premiums), trust is said to be “funded.”

• If trust is not funded, beneficiaries are usually given Crummey powers.

• Trustee is usually given power to purchase assets from or to make loans to estates of grantor or grantor’s spouse.

• Income and remainder beneficiaries of the trust are named by grantor.o It is usually a bypass trust so that trust assets are

not included in gross estate of grantor’s spouse.

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Income Taxation• If trust is unfunded, there will usually be no income until

death benefits are paid and invested.• If trust is funded, income that is, or may be, used to pay

policy premiums on grantor or grantor’s spouse is taxed to grantor under grantor trust rules.

• After receipt of death proceeds, taxation of income will depend on trust provisionso if distribution of income is discretionary

(common), and no beneficiary is given a general power of appointment, income will be taxed to beneficiaries only if distributed, and accumulated income will be taxed to trust.

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Gift Taxation• Replacement value of policies and FMV of other

property given to trust is subject to gift tax and possibly GSTT (less applicable annual exclusions if beneficiaries have Crummey powers).

• Future contributions of premium payments are additional gifts, but are allowed annual exclusions if beneficiaries are given sufficient Crummey powers.

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Estate Taxation• Policy death benefits are removed from grantor’s gross

estate unless three-year rule applies; if other assets are given, these assets are also removed from grantor’s gross estate.

• If three-year rule requires inclusion of death proceeds in gross estate, grantor usually cannot take marital deduction as ILIT is usually a bypass trust.

• Trusts are usually written as bypass trusts so that the trust assets will not be included in gross estate of grantor’s spouse.

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Life Insurance: Group Term

Characteristics• Insurance is offered as a benefit by an

employer to its employees on a nondiscriminatory basis, such as two times annual salary.

• Employer pays premiums; employee has the right to designate beneficiary.

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Life Insurance: Group Term

Taxation• Premium payments are deductible by employer.• Premiums for first $50,000 of coverage are not income

to the employee; cost of excess coverage is taxable income to employee based on IRS Table I rates.

• Death benefits are included in employee’s gross estate unless all incidents of ownership are assigned more than three years prior to death.

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Life Insurance: Split Dollar

Characteristics• Split dollar insurance involves a written agreement

between employer and employee that specifies coverage to be provided, responsibility of each party for payment of premiums, and rights of each party to policy benefits upon surrender of the policy (termination of employment) or death of the employee who is the insured.

• If employer owns the policy, it is endorsed to allow the employee to designate a beneficiary of benefits allocated to him; if employee owns the policy, he or she makes a collateral assignment to the employer to secure employer’s interest in policy benefits.

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Life Insurance: Split Dollar

Taxation• Premium payments made by employer are not deductible.

• Employee likely to have taxable income.

• Death benefits are income tax free to beneficiary unless transfer for value rule applies.

• Since employee has right to name beneficiary, death benefits controlled by the employee are included in his or her gross estate, unless placed in ILIT more than three years prior to death.

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Life Insurance: Key Person

Characteristics• Purchased by a business on life of a key

employee to compensate for anticipated loss of business income when employee dies.

• Employer is owner and beneficiary and pays all premiums.

• Insured employee is often an equity owner, and is therefore indirectly benefited by death proceeds.

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Life Insurance: Key Person

Taxation• Premium payments are not deductible by employer.

• Premium payments are not income to employee.

• Death proceeds are income tax free to employer unless corporate alternative minimum tax applies.

• Death proceeds are not included in employee’s gross estate (unless payable to a beneficiary designated by the employee and the employee is also a controlling owner).

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Life Insurance: Salary Increase or Selective Pension Plan

Characteristics• Employer purchases and pays all premiums on

life insurance on valued employee as incentive for employee to remain with employer.

• Employee is the owner of the policy and designates the policy beneficiary.

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Life Insurance: Salary Increase or Selective Pension Plan

Taxation• Premium payments are deductible by employer if

total compensation to the employee is reasonable.• Premium payments are taxable income to the

employee.• Death benefits are included in employee’s gross

estate unless irrevocably assigned more than three years prior to death.

• If policy is assigned, employee is subject to gift tax on replacement cost and any subsequent premium payments.

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Question 23

All of the following are correct statements regarding a second-to-die (or “survivorship”) life insurance policy excepta. this policy cannot be placed in an

irrevocable life insurance trust (ILIT). b. premiums are generally lower than

the cost of two separate policies. c. it may be possible to secure such a

policy even if one of the proposed insureds is not otherwise insurable.

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Question 24

Which of the following will cause the life insurance policy (owned by the insured) death benefit to be included in the gross estate of the insured? I. having an incident of ownership in the policy at

deathII. having the estate of the insured as the named

beneficiaryIII. the insured gave up an incident of ownership in

the policy within three years of deatha. I and II onlyb. I and III onlyc. II and III onlyd. I, II, and III

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Question 25

All of the following are correct statements regarding a first-to-die life insurance policy except a. it can be used to fund a buy-sell agreement. b. it can be used for debt reduction. c. premiums are generally more than the

combined premiums on separate policies.d. the death benefit will be paid at the death of

the first insured to die

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Question 26

The cost of coverage for the first $50,000 in death benefit from a group term life insurance policy is not considered taxable income to the employee. True False

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Question 27

All of the following statements regarding group term life insurance are correct except a. this benefit is usually offered only to certain

employees who are highly valued by the company.

b. the death benefit from this type of policy will be included in the employee’s gross estate unless it is placed in an irrevocable life insurance trust (ILIT), and the three-year inclusionary rule does not apply.

c. the insured gets to designate a beneficiary for all death benefits.

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Question 28

All of the following statements regarding split dollar life insurance offered to an employee as a benefit are correct except a. this benefit is usually offered only to certain

employees of the company.b. an actual written agreement is entered into

between the company and the employee. c. the death benefit received by the employer

is subject to income tax.

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Question 29

Which of the following statements regarding ILITs are correct?I. ILITs can either be funded or unfunded.II. Funding with an existing policy may cause

the three-year rule to apply.III. The main purpose of an ILIT is to remove

policy death benefits from the grantor’s gross estate

IV. Most ILITs are also bypass trusts.a. I and II onlyb. III and IV onlyc. II, III, and IV onlyd. I, II, III, and IV

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CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Estate Planning

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