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Transcript of McGraw-Hill's Taxation of Business Entities, 2016 Edition
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estate. 2ence, unless 0red has made significant taxable gifts during his life, he is unlikel to have an
estate that is sufficientl large to be sub'ected to the federal estate tax.
. [LO 1] $efine fair market %alue for transfer tax purposes.
$ccording to the regulations, fair market value is the price at which such propert would change hand
between a willing buer and a willing seller, neither being under an compulsion to bu or to sell, and
both have reasonable knowledge of the relevant facts.
. [LO 2] $escribe the re3uirements for a complete gift* and contrast a gift of a present interest !ith a g
a future interest.
$ gift is onl complete with deliver !of control of the gift" and acceptance b the donee. $ present
interest is one that the donee can en'o immediatel such as an unrestricted use of propert or income
contrast, a future interest is one that cannot be en'oed immediatel 3 the en'oment is postponed unti
sometime in the future.
4. [LO 2] $escribe a property transfer or payment that is not* by definition* a transfer for inade3uate
consideration.
$ gift is defined as a transfer for inade#uate consideration. The gift tax is not imposed on paments
associated with sales of goods or services because these transfers occur in a business context where
consideration !mone" is exchanged for the goods or services. That is, there is ade#uate consideratio
4either is the satisfaction of an obligation considered a gift. 0or example, tuition paments for a chil
education would satisf a support obligation and would not be considered a gift.
5. [LO 2] $escribe a situation in !hich a transfer of cash to a trust might be considered an incomplete g
In some instances, a donor ma relin#uish some control over transferred propert, but retain other po
to influence the en'oment or disposition of the propert. If the retained powers are important, then th
transfer will not be a complete gift. 0or example, a transfer of propert to a trust where the grantor
retains the power to revoke the trust will not be a complete gift. In instances where the grantor retains
important powers, the gift will generall be complete once the powers are released or the propert is n
longer sub'ect to the donors control. 0or example, a distribution of propert from a revocable trust w
be a completed gift because the grantor would no longer have the abilit to revoke the distribution.
6. [LO 2] Identify t!o types of transfers for inade3uate consideration that are specifically excluded from
imposition of the gift tax.
5olitical contributions are specificall excluded from the gift tax as are the pament of medical or
educational expenses on behalf of an unrelated individual. To avoid confusing a division of propert w
a gift, a transfer of propert in con'unction with a divorce is treated as nongratuitious !e.g., a transfer
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consideration" if the propert is transferred within three ears of the divorce under a written propert
settlement.
10. [LO 2] 7nder !hat circumstances !ill a deposit of cash to a bank account held in 8oint tenancy be
considered a completed gift9
$ deposit to a 'oint account is viewed as an incomplete gift until the donee withdraws cash from the
account because the donor !depositor" can withdraw the deposit at an time.
11. [LO 2] xplain ho! a purchase of realty could result in a taxable gift.
$ completed gift results when realt is purchased in the name of a donee as sole owner of the propert
tenants in common, or as 'oint tenants with the right of survivorship if the donee does not provide
ade#uate consideration for their ownership interest.
12. [LO 2] $escribe the conditions for using the annual exclusion to offset an other!ise taxable transfer.The annual exclusion can onl offset a gift of present interest. $ gift of a future interest is not eligible f
an annual exclusion. The onl exception is a transfer in trust for a minor !under age -1" where the
propert can be used to support the minor and an remaining propert is distributed once the child
reaches age -1.
1#. [LO 2] List the conditions for making an election to split gifts.
In order to utilie gift splitting, each spouse must be a citien or resident of the nited 8tates, be marr
at the time of the gift and not remarr during the remainder of the calendar ear. In addition, both
spouses must consent to the election b filing a timel gift tax return.
1&. [LO 2] $escribe the limitations on the deduction of transfers to charity.
$s long as a #ualifing charit receives the donors entire interest in the propert, the amount of the
charitable deduction is onl limited to the value of the gift after the annual exclusion.
1. [LO 2] xplain the purpose of adding prior taxable gifts to current taxable gifts and sho! !hether the
prior gifts could be taxed multiple times o%er the years.
&ith a progressive tax rate schedule, adding to the tax base increases the likelihood that a higher
marginal tax rate will appl to the latest increment !transfer". To prevent double taxation of prior gift
the gift tax on prior taxable gifts is subtracted from the total gift tax.
1. [LO #] xplain !hy the gross estate includes the %alue of certain property transferred by the deceden
death* such as property held in 8oint tenancy !ith the right of sur%i%orship* e%en though this property i
not sub8ect to probate.
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The gross estate includes testamentar transfers even though this propert is transferred outside of the
probate court !automaticall through operation of law". &hile he didnt own: the propert at death,
decedent had control of the ultimate disposition of the propert.
14. [LO #] Identify the factors that determine the proportion of the %alue of property held in 8oint tenancy
!ith the right of sur%i%orship that !ill be included in a decedent:s gross estate.
The amount includible for propert held as 'oint tenanc with the right of survivorship depends upon t
marital status of the owners. 0or propert 'ointl owned b a husband and wife with the right of
survivorship, half of the value of the propert is automaticall included in the estate of the first spouse
die. 0or other propert held in 'oint tenanc with the right of survivorship b unmarried co;owners, t
proportion of the value included in the decedents gross estate is the proportion of the consideration th
the decedent provided to ac#uire the propert. In the extreme cases, the entire value of propert is
included in the gross estate !where the decedent provided the entire purchase price of the propert" or
none of the value !where the decedent didnt provide an of the consideration for the purchase".
15. [LO #] (arold o!ns a condo in (a!aii that he plans on using for the rest of his life.
(o!e%er* to ensure his sister -aude !ill o!n the property after his death* (arold deeded the remainde
the property to her. (e signed the deed transferring the remainder in ;uly 2006 !hen the condo !as !
)20*000 and his life estate !as !orth )4*000. In ;anuary 2011 (arold died* at !hich time the condo
!as !orth )#00*000.
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referred to as the 8ection 7*- rate and is published monthl b the Treasur. The value of the income
interest is merel the difference between the value of the remainder and the total value of the propert
21. [LO #] xplain !hy the fair market %alue of a life estate is more difficult to estimate than an income
interest.
The calculation of a value of a life estate is a bit more complicated that an income interest because the
time dela for the future pament of the remainder is unknown. To estimate this dela, the calculation
based upon the number of ears the life tenant is expected to live. To facilitate the calculation, the
regulations provide a table where the discount rate is calculated b including the life tenants age and
expectanc.
22. [LO #] $escribe a reason !hy transfers of terminable interests should not 3ualify for the marital
deduction.
If terminable interests #ualified for the marital deduction, then propert would pass from the first spou
!upon death or gift" to the second spouse without transfer tax !because of the marital deduction". The
interest would then terminate and the propert would pass from the second spouse to the eventual own
without transfer tax because upon termination the second spouse had no propert to transfer. 2ence,
terminable interests #ualified for the marital deduction, no transfer tax would be imposed on the transf
of this propert.
2#. [LO #] ,rue or 'alse> Including taxable gifts !hen calculating the estate tax sub8ects these transfers t
double taxation. xplain.
0alse. The ob'ective of adding previousl taxed transfers to the taxable estate is to allow the estate ta
base to reflect all transfers, both intervivos and testamentar. nder a progressive tax rate schedule san ad'ustment is designed to increase the marginal tax rate on the estate. $d'usted taxable gifts are n
however, sub'ect to tax in the estate formula. To prevent double taxation of prior taxable gifts, the
tentative estate tax is reduced b a credit for the taxes that would have been paable on the ad'usted
taxable gifts under the current tax rate schedule.
2&. [LO #] =eople sometimes confuse the unified credit !ith the exemption e3ui%alent. $escribe ho! th
terms differ.
The unified credit is the tax calculated on an amount of transfers that /ongress intended to pass witho
imposition of either transfer tax !gift or estate". The amount of cumulative taxable transfers that can b
made without exceeding the unified credit is called the applicable exemption amount !previousl the
exemption e#uivalent".
2. [LO &] $escribe a reason !hy a generation/skipping tax !as necessary to augment the estate and gift
taxes.
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Bonors discovered that transfers across multiple generations avoided the imposition of an gift or est
taxes until the termination of the remainder interest. 0or example, a gift of a terminable interest to a
with the remainder to a grandchild spans two generations. &hen this childs interest terminates, no gestate tax is imposed even though the child had the full use of the propert perhaps throughout his !or
lifetime. The strateg here could be expanded to multiple generations with remainder interest transfer
far into the future. Indeed, some states now allow perpetual trusts that in the absence of a generation
skipping tax would allow grantors to avoid all transfer taxes save the initial transfer to the trust.
2. [LO &] xplain !hy an effecti%e !ealth transfer plan necessitates cooperation bet!een la!yers*
accountants* and in%estment ad%isors.
$n integrated team is essential to a successful wealth transfer plan because transfer and income taxes
onl represent one piece of the pule. Cawers are critical to constructing propert rights to achieve
and nontax ob'ectives while investment advisors provide the economic input necessar for long;term
plans. Dbviousl accountants provide much of the necessar tax expertise.
24. [LO &] $escribe ho! to initiate the construction of a comprehensi%e and effecti%e !ealth plan.
&ealth planning tpicall begins with understanding the individuals goals and ob'ectives. These
ob'ectives include immediate goals, such as assuring a stead source of income, and longer;term goal
such as providing for a specific division of assets or providing educational support for dependents. E
wealth plans will likel have significant tax and nontax conse#uences. &hen considering tax factors,
however, an effective wealth transfer plan should also anticipate the economic and legal ramifications
that will accompan an transfer of wealth.
25. [LO &] List t!o 3uestions you might pose to a client to find out !hether a program of serial gifts !ou
be an ad%antageous !ealth transfer plan.
The most obvious #uestion would be whether the client could afford to make gifts given the level of inc
expected to be necessar to support the client in the future. $nother important #uestion involves the
health(age of the client and the past and expected rate of appreciation for the proposed gift propert.
8erial giving is less beneficial for clients who might be expected to die soon and for propert that has
substantiall appreciated in the past.
26. [LO &] ? client in good health !ants to support the college education of her teenage grandchild. ,he
client holds %arious properties but proposes to make a gift of cash in the amount of the annual exclusio
xplain to the client !hy a direct gift of cash may not be ad%isable and !hat property might ser%e as a
reasonable substitute.
Transfers to support the education of a teenager should probabl be made in trust because the donee w
be able to spend an amounts given directl. =ather than cash, the gift could consist of propert that i
expected to appreciate rapidl in value thereb allowing the appreciation to escape the transfer tax.
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#0. [LO &] ?n elderly client has a life insurance policy !orth )&0*000 that upon her death pays )20*000
her sole grandchild @or his estateA. ,he client retains o!nership of the policy. Outline for her the cost
and benefits of transferring o!nership of the policy to a life insurance trust.
The benefit of the transfer is that the value of the polic !)-*," would not be sub'ect to the estate t
upon the clients death if the client lives for at least three ears after the transfer. The cost is that the
transfer of the polic would constitute a taxable gift !to the extent that the value exceeds the annual
exclusion" and might be sub'ect to the generation skipping tax. In addition, in order to complete the
transfer the client would need to give up !among other rights" the right to change the beneficiar of th
polic.
#1. [LO &] $escribe the conditions in !hich a married couple !ould benefit from the use of a bypass
pro%ision or a bypass trust.
The couple must expect to have an estate whose tax will exceed the unified credit upon the death of thelast spouse. In addition, the couple must have sufficient assets to provide for the support of the surviv
spouse after transferring assets through the bpass of the first spouse to die.
#2. [LO &] 7nder !hat conditions can an executor or trustee elect to claim a marital deduction for a trans
of a terminable interest to a spouse9
The FTI5 option provides an exception to the general prohibition against claiming a marital deductio
for a transfer of a terminable interest. The conditions are that the !surviving" spouse is entitled to all
the income from the propert paable at least annuall and no person has the power to appoint an pa
of the propert to anone other than the !surviving" spouse until the death of the surviving spouse. 0o
intervivos transfer, the spouse must include the value of the propert in her taxable gifts and for a
testamentar transfer the executor must include the value of the propert in the estate of the surviving
spouse.
##. [LO &] xplain ho! a transfer of property as a gift may ha%e income tax implications to the donee.
$lthough a gift is not taxable income to the donee, there is no step;up in the tax basis of the transferre
propert. 2ence, if the donee sells the propert, an appreciation !including appreciation up to the da
the gift" will be taxed to the donee.
PROBLEMS
#&. [LO 2] Ba3uel transferred )100*000 of stock to a trust* !ith income to be paid to her nephe! for 15 y
and the remainder to her nephe!:s children @or their estatesA. Ba3uel named a bank as independent tru
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but retained the po!er to determine ho! much income* if any* !ill be paid in any particular year. Is th
transfer a complete gift9 xplain.
=a#uel has retained sufficient control that the transfer of the income interest to her nephew is incompl
3 the gift to the nephew will be completed as income is actuall distributed to him. 2owever, the porti
of the transfer representing the remainder interest is a complete gift because =a#uel can no longer con
this portion of the propert.
#. [LO 2] ,his year erry:s friend* $e!ey* !as disabled. erry paid )1*000 to $e!ey:s doctor for me
expenses and paid )12*00 to State 7ni%ersity for college tuition for $e!ey:s son. (as erry made
taxable gifts* and if so* in !hat amounts9
Goth paments were complete gifts, but both are exempt from the gift tax as long as the paments were
made directl to the college or doctor.
#. [LO 2] ,his year $an and -ike purchased realty for )150*000 and took title as e3ual tenants in comm
(o!e%er* -ike !as able to pro%ide only )&0*000 of the purchase price and $an paid the remaining
)1&0*000. (as $an made a complete gift to -ike* and if so* in !hat amount9
Ban has made a complete gift to Eike of )*, !)9,H)1,J*KL ; )+," and the gift is
eligible for an annual exclusion of )1+,.
#4. [LO 2] Last year Cate opened a sa%ings account !ith a deposit of )1*000. ,he account !as in the n
of Cate and $errick* 8oint tenancy !ith the right of sur%i%orship. $errick did not contribute to the
account* but this year he !ithdre! )*000. (as Cate made a complete gift* and if so* !hat is the amou
of the taxable gift and !hen !as the gift made9
4o gift was made at the time of the deposit, but a complete gift of )*, was made once Berrick mad
the withdrawal.
#5. [LO 2] Darry transfers )1*000*000 to an irre%ocable trust !ith income to Bobin for her life and the
remainder to -aurice @or his estateA. "alculate the %alue of the life estate and remainder if Bobin:s ag
and the pre%ailing interest rate result in a ,able S discount factor for the remainder of 0.24.
The remainder is valued at )-7, !)1 million J.-7". $ccordingl, the value of the life estate is
)7, !)1,, less )-7,".
#6. [LO 2] ,his year ;im created an irre%ocable trust to pro%ide for ,ed* his #2/year/old nephe!* and ,ed
family. ;im transferred )40*000 to the trust and named a bank as the trustee. ,he trust !as directed to
income to ,ed until he reaches age #* and at that time the trust is to be terminated and the corpus is to
distributed to ,ed:s t!o children @or their estatesA. $etermine the amount* if any* of the current gift an
the taxable gift. If necessary* you may assume the rele%ant interest rate is percent and ;im is unmarr
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The )7, transfer to the trust is a current gift but onl the income interest #ualifies for an annual
exclusion. The remainder interest is valued as follows?
=emainder interest @ )7, ( !1 A .6" @ )7, ( !1.191" @ )*,77+
The income interest is )7, ; )*,77+ @)11,--6. Gecause the annual exclusion exceeds the income
interest, the income interest of )11,--6 is completel offset b the annual exclusion. The total taxable
is the amount of the remainder, )*,77+.
&0. [LO 2] ,his year "olleen transferred )100*000 to an irre%ocable trust that pays e3ual shares of incom
annually to three cousins @or their estatesA for the next eight years. ?t that time* the trust is terminated
the corpus of the trust re%erts to "olleen. $etermine the amount* if any* of the current gifts and the tax
gifts. If necessary* you may assume the rele%ant interest rate is percent and "olleen is unmarried. <
is your ans!er if "olleen is married and she elects to gift/split !ith her spouse9
The )1, transfer to the trust is a current gift onl to the extent of the income interest !the corpus
returns to /olleen". In other words, /olleen has not transferred the reversion interest because it will
return to her. The reversion interest is valued as follows?
=eversion interest @ )1, ( !1A.6" @ )1, ( !1.*9+" @ )6-,7+ !rounded"
The income interest is )1, ; )6-,7+ @)7,-6 !rounded". Gecause the income interest is paid
currentl and to three donees, the gift will #ualif for three )1+, annual exclusions. In other words
/olleen made three gifts of )1-,+- each. 2ence, /olleen did not make an taxable gifts with this
transfer because the annual exclusions completel offset each gift. If /olleen is married and elects to
split, then the gifts would be evenl split between the spouses.
&1. [LO 2] Sly is a !ido!er and !ants to make annual gifts of cash to each of his four children and six
grandchildren. (o! much can Sly transfer to his children this year if he makes the maximum gifts
eligible for the annual exclusion9
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F420 rate !as .& percent.
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4atalie. $fter appling the annual exclusion, neither Eart nor his spouse made a taxable gift to %mi
but each of them made a taxable gift of )6, to 4atalie.
&. [LO 2] ,his year ;eff earned )50*000 and used it to purchase land in 8oint tenancy !ith a right of
sur%i%orship !ith -ary. (as ;eff made a taxable gift to -ary and* if so* in !hat amount9
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/urrent taxable gifts ) -,+6, 5rior taxable gifts A1,,
/umulative taxable gifts ) 1-,+6,Tax on cumulative taxable gifts ) +,9+,-
Cess? /urrent tax on prior taxable gifts !)1 million" ; ,9+*,Tax on current taxable gifts ) 99+,+nified credit on current taxable gifts !)-.6+ million" ; 99+,+
Nift tax due )
4ote that /ase is in the top marginal gift tax rate and that the gift of )-,+6, times +K e#uthe gift tax on current gifts of )99+,+. $t the end of -1*, /ase would still have an unusedexemption e#uivalent of )1.9++ million !*.+ million less )1 million used in -1 less -.+6 milused in -1*".
2elen will owe no transfer taxes on her gift. 2er gift will not result in an tax because in -1* shas a )*.+ exemption e#uivalent available. $fter application of the -1* exemption e#uivalent 2elen will have )-,9++, of exemption e#uivalent remaining !)*.+ million ; )-.+6 million".
0. [LO #] ,om (ruise !as an entertainment executi%e !ho had a fatal accident on a film set.
,om:s !ill directed his executor to distribute his cash and stock to his !ife* Gaffie* the real estate to h
church* ,he 'irst "hurch of -ethodology* and the remainder of his assets !ere to be placed in trust fo
three children. ,om:s estate consisted of the follo!ing>
?ssets>=ersonal assets ) 500*000"ash and stock 2&*000*000
Intangible assets @film rightsA 41*00*000Beal estate 1*000*000
) 111*#00*000Liabilities>
-ortgage ) #*200*000Other liabilities &*100*000
) 4*#00*000
a. ,om made a taxable gift of )5 million in 2011. "ompute the estate tax for ,om:s estate.
4ote that the applicable exemption amount in -11 was )* million, so Tom would have paid
)1,-, of gift tax on the -11 gift. Toms estate will owe estate tax of )-*,-, calculate
follows?
Nross %state ) 111,,
Earital Beduction ; -+,,
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/haritable Beduction ; 1*,,
Bebts ; 7,,
Taxable %state ) 6*,, 5rior taxable gifts A ,,
/umulative taxable transfers ) 7,,
Tentative tax ) -9,1+*,
/urrent tax on ad'usted taxable gifts ; 1,-,
Nross estate tax ) -7,9+*,
nified /redit -,117,
%state Tax Bue ) -6,,
Toms estate is taxed at the highest estate tax rate. 2ence, the estate tax due + percent of the
cumulative transfers in excess of the exemption e#uivalent and the previousl taxed gift. !)7
million ; )*.+ million 3 million @ )6+.*7 million" )6+.*7 million x + ; )-*.- million.
'ill out lines 1 through 12 in part 2 of 'orm 40 for ,om:s estate.
1 Total gross estate less exclusion (from Part 5—Recapitulation, item 12) . . . . . . . . . .1
2 Tentative total allowable euctions (from Part 5—Recapitulation, item 22) . . . . . . . . .2
3a Tentative taxable estate (before state eat! tax euction) (subtract line 2 from line 1) . . . . .
3a b "tate eat! tax euction . . . . . . . . . . . . . . . . . . . . . .
. 3b c Taxable estate (subtract line #b from line #a) . . . . . . . . . . . . . . . .
. . 3c
4 $%uste taxable gifts (total taxable gifts (wit!in t!e meaning of section 25) mae b' t!eeceent
after ecember #1, 1*+, ot!er t!an gifts t!at are incluible in eceents gross estate (section 2&&1(b)))
4
5 $ lines #c an - . . . . . . . . . . . . . . . . . . . . . . . . .5
6 Tentative tax on t!e amount on line 5 from Table $ in t!e instructions . . . . . . . . . .6
7 Total gift tax pai or pa'able wit! respect to gifts mae b' t!e eceent after ecember #1, 1*+. nclue gift
taxes b' t!e eceents spouse for suc! spouses s!are of split gifts (section 251#) onl' if t!e eceent was
t!e onor of
t!ese gifts an t!e' are incluible in t!e eceent,s gross estate (see instructions) . . . . . . . . .7
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P a r t 2 — T a x C o m p u t a t i o n
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8 /ross estate tax (subtract line * from line +) . . . . . . . . . . . . . . . . . .8
9 0aximum unifie creit (applicable creit amount) against
estate tax
111,300,00
46,300,0
65,000,0
65,000,0
8,000,00
73,000,0
29,145,8
1,028,0
28,117,80
(see instructions) . . . . . . . . . . . . . . . .
9
10 $%ustment to unifie creit (applicable creit amount). (T!is a%ustment
ma' not excee +,&&&. "ee instructions.) . . . . . . . .10
2,117,800
11 $llowable unifie creit (applicable creit amount) (subtract line 1& from line ) . . . . . . .11
12 "ubtract line 11 from line (but o not enter less t!an 3ero) . . . . . . . . . . . . .12
2,117,80
26,000,0
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1. [LO #] (al and
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The value of the trust assets would be included in Terrs estate because she retains control
over the income !the abilit to force the trustee to distribute income" and has a contingent
right of reversion.
. [LO #] Last year Bobert transferred a life insurance policy !orth )&*000 to an
irre%ocable trust !ith directions to distribute the corpus of the trust to his grandson* $anny*upon his graduation from college* or to $anny:s estate upon his death. Bobert paid
)1*000 of gift tax on the transfer of the policy. arly this year* Bobert died and the
insurance company paid )&00*000 to the trust.
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a. The exemption e#uivalent for gifts in -* was )1 million so =oland paid no gift taxwith the -* transfer. =olands executor would calculate the estate tax as follows?
$d'usted taxable gifts ) 1,,Taxable estate A *,*,
/umulative taxable transfers ) 6,*,
Tax on cumulative taxable transfers ) -,*+*,Nift tax paid or paable on prior gifts ; Tax on taxable estate ) -,*+*,nified credit ; -,117
%stimated estate tax due ) +-,
4ote that the top estate tax rate is + percent of the cumulative transfers in excess ofthe exemption e#uivalent !)6.* million ; )*.+ million @ )1.7 million and )1.7million x +K @ )+-,".
b. 4ote that because the exemption e#uivalent in -* was onl )1 million, =oland paid gift tax on the -* transfer. =olands executor would calculate the credit for prior taxable gifts at the current rate and calculate the unified credit for the -*exemption e#uivalent at the current tax rate. The credit for prior taxable gifts!)-," would be calculated as follows?
/urrent tax on prior taxable transfers !)1.* million" ) *+*,nified credit under current rate
!)1 million -* exemption e#uivalent" ; +*,/redit for prior taxable gifts ) -,
The estate tax would be calculated as follows?
$d'usted taxable gifts ) 1,*,Taxable estate A *,*,/umulative taxable transfers ) 7,,
Tax on cumulative transfers ) -,7+*,/redit for prior gifts at current rate ; -,
Tax on taxable estate ) -,*+*,nified credit ; -,117,
%stimated estate tax due ) +-,
4ote that this solution is e#uivalent to the prior problem. 2ere the estate tax paable is + percent of the cumulative transfers in excess of the exemptione#uivalent and the previousl taxed gift !)7 million ; )*.+ million ; )*, @)1.7 million".
c. If =oland died within ears of the )1 million gift, the estate would be grossed up bthe amount of an gift tax paid on the gift because the gift was made within three ears of the decedents death. 2owever, if the gift did not exceed =olands unusedexemption e#uivalent, then no gift tax would be due.
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6. [LO #] Drad and ?ngelina are a !ealthy couple !ho ha%e three children* 'red*
Dridget* and Lisa. ,!o of the three children* 'red and Dridget* are from Drad:s pre%ious
marriages. On "hristmas this year Drad ga%e each of the three children a cash gift of
)10*000 and ?ngelina ga%e Lisa an additional cash gift of )&0*000. Drad also ga%e stock!orth )&0*000 @ad8usted basis of )10*000A to the ?ctor:s uild @an H? charityA.
a. Drad and ?ngelina ha%e chosen to split gifts. "alculate Drad:s gift tax. ?ssume that?ngelina has no pre%ious taxable gifts* but Drad reported pre%ious taxable gifts of )2million in 2006 !hen he used )#&*500 of unified credit and paid )*000 of gifttaxes.
a. Gefore gift splitting Grad has made personal gifts totaling )7, !)1, to threechildren and )+, to charit". &ith gift splitting Grads personal gifts arereduced to )*, but he must include half of $ngelinas gift and this increases his gifts to )**,. Grad is allowed to claim annual exclusions for the gifts to his three
children !limited to the amount of the gift for 0red and Gridget" and an additionalannual exclusion for the charitable gift. The remainder of the charitable gift#ualifies for a charitable deduction.
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Donees Brad Angelina
0red ) *, ) *,
Gridget ) *, ) *,
Cisa from Grad ) *, ) *,
Cisa from $ngelina ) -, ) -,
$ctors Nuild ) -, ) -,
Total Nifts ) **, ) **,
$nnual %xclusions !)*A)*A)1+A)1+" ; , ; ,
/haritable Beduction ; 6, ; 6,
Total Taxable Nifts ) 11, ) 11,
Grad would then calculate his gift tax as follows? 5revious taxable gifts !-9" ) -,,
/urrent taxable gift 11,
/umulative taxable transfers ) -,11,
/urrent tax on cumulative transfers ) 7*,-
/urrent tax on prior taxable gifts ; 7+*.
/urrent tax on current taxable gifts ) +,+
nified credit used this ear ; +,+Nift tax due
4ote that Grads gift is taxed at the highest gift tax rate !)11, x +K @ )+,+",and he will have an unused exemption e#uivalent of ),+19, available for futureuse !)*.+ million less )- million less )11 thousand".
b. 'ill out parts 1 and & of 'orm 406 for Drad.
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Part 1—Git! "ub#ect $n%& to Git Tax' /ifts less political organi3ation, meical, an eucational exclusions. (see instructions)
( temnumber
)
4 onees name an aress4 Relations!ip to onor (if an')4 escription of gift4 f t!e gift was of securities, give 6"P no.4 f closel' !el entit', give 78
C *
onors a%ustebasis of gift
+
ateof gift
9alue at
ate of gift
G
:or splitgifts, enter
1;2 of column :
-
8et transfer (subtract
col. / fromcol. :)
1 .+* / chi% 10,000 1225 10,000 5,000 5,000
).*G+T / chi% 10,000 1225 10,000 5,000 5,000
"( / chi% 10,000 1225 10,000 5,000 5,000
(CT$." G* 10,000 1225 40,000 20,000 20,000
/ifts mae b' spouse —complete only if you are splitting gifts with your spouse and he/she also made gifts."( / chi% 40,000 1225 40,000 20,000 20,000
Tota% o Part 1' $ amounts from Part 1, column < . . . . . . . . . . . . . . . . . . . . . . a 55,000
:orm *& Page 3
Part 4—Taxab%e Git .econci%iation
1 Total value of gifts of onor. $ totals from column < of Parts 1, 2, an # . . . . . . . . . .
2 Total annual exclusions for gifts liste on line 1 (see instructions) . . . . . . . . . . . . .
3 Total inclue amount of gifts. "ubtract line 2 from line 1 . . . . . . . . . . . . . . .
*euction! (see instructions)
4 /ifts of interests to spouse for w!ic! a marital euction will be claime, base
1 55,000
2 38,000
3 17,000
6,000
on item numbers of "c!eule $ . .
5 7xclusions attributable to gifts on line - . . . . . . . . . . . .
6 0arital euction. "ubtract line 5 from line - . . . . . . . . . . .
7 !aritable euction, base on item nos. 4 less exclusions .
4
5
6
7 6,000
8 Total euctions. $ lines + an * . . . . . . . . . . . . . . . . . . . . .
9 "ubtract line from line # . . . . . . . . . . . . . . . . . . . . . . . .
10 /eneration=s>ipping transfer taxes pa'able wit! t!is :orm *& (from "c!eule , Part #, col.
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0. [LO &] ;ones is seriously ill and has ) million of property that he !ants to
lea%e to his four children. (e is considering making a current gift of the property @rather
than lea%ing the property to pass through his !illA. ?ssuming any taxable transfer !ill be
sub8ect to the highest transfer tax rate* determine ho! much gift tax ;ones !ill o!e if he
makes the transfers no!. (o! much estate tax !ill ;ones sa%e if he dies after three years*
during !hich time the property appreciates to ).5 million9
There are two critical assumptions here. 0irst because the top transfer tax rate applies to
all transfers !currentl and for future transfers", it would appear that Mones has alread
used his exemption e#uivalent. 8econd, Mones survives at least three ears !otherwise, the
gift tax on an current transfer would be included in his estate". nder these assumptions
a current gift of )6 million will result in a taxable gift of )*,9++, !after four annual
exclusions" and a gift tax of )-,77,6. In contrast, the same propert transferred via the
estate will trigger )-,7-, in estate taxes. The difference in the amount transferred
!)+-,+" represents the )--,+ savings from the annual exclusions !)*6, x +K"
and the )-, of estate tax on the ), of appreciation. Gelow is the calculationof the tax savings and the net amount transferred to the children under both scenarios.
Current Gift Transfer at death
/urrent value of propert ) 6,, ) 6,, Cess gift tax on transfer !+K" ; -,77,6Oalue transferred via gift ) ,6--,+ $ppreciation during interim A , A ,Oalue transferred via estate ) 6,, %state tax at +K ; -,7-,
$fter tax value transferred ) +,+--,+ ) +,,
Tax savings and extra valuetransferred ) +-,+
1 [LO &] ?ngelina ga%e a parcel of realty to ;ulie %alued at )210*000 @?ngelina purchased
the property fi%e years ago for )55*000A. "ompute the amount of the taxable gift on the
transfer* if any. Suppose se%eral years later ;ulie sold the property for )21*000.
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Boug made a current gift of )-, and a taxable gift of )6, !after the annual
exclusion. Tina will not recognie an income upon receipt of the stock, and she takes a
carrover basis of )-1, and long;term holding period for income tax purposes. 0or
purposes of calculating a loss, Tinas basis in the stock is limited to the lesser of carrover
basis !)-1," or fair market value on the date of the gift !)-,". 2ence, upon the
sale Tina recognies a loss of )*.
#. [LO &] Boberta is considering making annual gifts of )1&*000 of stock each to each of her
four children. She expects to li%e another fi%e years and to lea%e a taxable estate !orth
approximately )5*000*000. She re3uests you 8ustify the gifts by estimating her estate tax
sa%ings from making the gifts.
If the estimate of =obertas taxable estate is accurate and if the estate tax rates and annual
exclusions do not change, =oberta would be able to use her annual exclusion of )1+, to
gift awa )*6, !)1+, J +" of propert each ear without incurring an tax. 2ence,
she would transfer a total of )-, !)*6, J * ears" that would save )11-, in
transfer taxes !at +K". In addition, each transfer would eliminate the appreciation on the propert between the time of the gift and =obertas death. 0or example, if the propert
appreciates at a * percent compound rate of return, the first gift of )*6, would
eliminate an additional )1*,+7- of appreciation
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b. ince lea%es )10 million to -illie and the remainder to charity.
c. ince lea%es )10 million to -illie and the remainder to his son* =aul.
d. ince lea%es )10 million to -illie and the remainder to a trust !hose trustee isre3uired to pay income to -illie for her life and the remainder to =aul.
a. If all the propert in Oinces estate #ualifies for the marital deduction, then therewould be no taxable estate and there would be no estate tax due upon Oinces death. If Eillie dies with a taxable estate of )1* million, her estate would owe an estate taxof ).- million
b. Dnce again, if the propert left to Eillie #ualifies for the marital deduction and if the propert be#ueathed to charit #ualifies for the charitable deduction, then therewould be no taxable estate and there would be no estate tax due upon Oinces death.
c. $ssuming that the propert left to Eillie #ualifies for the marital deduction, thetransfer to 5aul would be less than the exemption e#uivalent, so no estate tax wouldbe due.
d. The solution is identical to !c" above because the amount left in trust is a terminableinterest that would not #ualif for a marital deduction.
. (ank is a single indi%idual !ho possesses a life insurance policy !orth )#00*000 that !ill
pay his t!o children a total of )500*000 upon his death. ,his year (ank transferred the
policy and all incidents of o!nership to an irre%ocable trust that pays income annually tohis t!o children for 1 years and then distributes the corpus to the children in e3ual shares.
a. "alculate the amount of gift tax due @if anyA on the gift. ?ssume that (ank has madeonly one prior taxable gift of ) million in 2011.
b. "alculate the amount of cumulati%e taxable transfers for estate tax purposes if (ankdies this year but after the date of the gift. ?t the time of his death* (ank:s probateestate is )10 million di%ided in e3ual shares bet!een his t!o children.
a. 2ank will owe no gift taxes calculated as follows?
Nift of life insurance polic ) ,
annual exclusions !two children" ; -,/urrent taxable gifts ) -7-,
5rior taxable gifts A *,,/umulative gifts ) *,-7-,
Tax on cumulative taxable transfers ) -,*+,6less /urrent tax on prior taxable gifts !)* million" ; 1,9+*,Tax on current taxable gifts ) 1,
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nified credit !)*.+ million" ) -,117,less used unified credit !)* million" ; 1,9+*,
nused unified credit ; 17-,Nift tax due )
b. Gecause 2ank made the transfer of the life insurance within three ears of his death,
his estate will include the life insurance proceeds !)," as well as an gifttaxes paid on that transfer. 2ence, 2anks cumulative taxable transfers will becalculated as follows?
5robate estate ) 1,, Cife insurance proceeds A ,Nift taxes on transfer within ears of death A
Nross estate ) 1,, 5rior taxable transfers A *,-7-,/umulative taxable transfers ) 16,7-,
4ote that 2anks estate will be allowed a credit for the transfer tax on the ),
value of the insurance polic. To do otherwise would sub'ect the transfer of theinsurance polic to double tax 3 once under the gift tax and again under the estatetax.
4. ;ack is single and he made his first taxable gift of )1*000*000 in 2005. ;ack made no
further gifts until 2006* at !hich time he ga%e )1*40*000 to each of his three children and
an additional )1*000*000 to State 7ni%ersity @a charityA. ,he annual exclusion in 2006 !as
)1#*000. Becently ;ack has been in poor health and !ould like you to estimate his estate
tax should he die this year. ;ack estimates his taxable estate @after deductionsA !ill be
!orth ).& million at his death.
The solution begins with the estimation of Macks cumulative taxable transfers as follows?
Nross estate ) *,+,
5rior taxable transfers !-" 1,,
5rior taxable transfers !!)1,7*, ; )1," x " A *,-11,
/umulative taxable transfers ) 11,611,
4ext, it is necessar to calculate the amount of credit for prior taxable transfers. The -
transfer was offset b Macks unified credit !)1 million exemption e#uivalent" but none of
the taxable transfer in -9 was offset b the exemption e#uivalent because Mack used the
exemption e#uivalent in -. 2ence, Mack made a )*.-11 million taxable transfer in
-9. The credit for prior taxable transfers is calculated using the current rate schedule
as follows?
Tax on taxable transfers !)6.-11 million" ) -,+,-
less unified credit !)1 million" ; +*,
/redit for current tax on prior taxable gifts ) -,+,+
The calculation of the estate tax proceeds as follows?
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Tax on cumulative taxable transfers of )11,611, ) +,*9,-
less credit for current tax on prior taxable gifts ; -,+,+
Tax on taxable estate ) -,**,
less nified credit !)*.+ million" ; -,117,
%state tax due ) ,
4ote that Macks estate would be in the top marginal tax rate but that onl a portion of the
gross estate of )*.+ million would be sub'ect to transfer tax because Mack could use the
remaining )+.+ million of exemption e#uivalent to offset the tax !he onl used )1 million
of exemption e#uivalent in - and none in -9". 2ence, onl )97, of the estate is
sub'ect to tax !)*.+ million ; )+.+ million". $t the highest tax rate, this generates
), of tax !)97, times +K".
5. -ontgomery has decided to engage in !ealth planning and has listed the %alue of his
assets belo!. ,he life insurance has a cash surrender %alue of )120*000 and the proceeds
are payable to -ontgomery:s estate. ,he trust is an irre%ocable trust created by
-ontgomery:s brother 10 years ago and contains assets currently %alued at )500*000. ,heincome from the trust is payable to -ontgomery:s faithful butler*
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remainder interest in the trust at his death. 2ence, onl the value of the remainder isincluded in his estate. The remainder is valued b identifing the discount factor given the P7*- interest rate !*.+K" and the age of the life tenant !7 ears". Thevalue !)1-,6" is obtained b multipling the discount factor !.1*+* from %xhibit-*;+" times the value of the trust assets !),". 2ence, the value of
Eontgomers estate is calculated as follows? $uto )-,
5ersonal effects 7*,
/hecking and savings accounts -*,
Investments -,*,
=esidence 1,+,
Cife insurance proceeds 1,,
=eal estate investments *,1-*,
Trust !), x .1*+*" 1-,6
Oalue of estate at date of death )1,+9,6
a. Eontgomers estate tax is calculated as follows?
$d'usted taxable gifts ) Taxable estate A 1,+9,6/umulative taxable transfers ) 1,+9,6Tax on cumulative transfers ) +,1+,-+Nift taxes paid or paable on prior transfers ;
Tax on taxable estate ) +,1+,-+nified credit ; -,117,
%stimated estate tax due ) -,-*,++
b. Eontgomers estate tax is calculated as follows?
$d'usted taxable gifts ) 1,,Taxable estate A 1,+9,6/umulative taxable transfers ) 11,+9,6Tax on cumulative transfers ) +,*+,-+Nift taxes paid or paable on prior transfers ;
Tax on taxable estate ) +,*+,-+nified credit ; -,117,
%stimated estate tax due ) -,+-*,++
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c. Eontgomers estate tax is calculated as follows?
Nross estate ) 1,+9,6/haritable deduction ; -,*,
Taxable estate ) 7,99,6
$d'usted taxable gifts A 1,,/umulative taxable transfers ) ,99,6Tax on cumulative transfers ) ,*+,-+Nift taxes paid or paable on prior transfers ;
Tax on taxable estate ) ,*+,-+nified credit ; -,117,
%stimated estate tax due ) 1,+-*,++