FEDERAL TAXES ON GRATUITOUS TRANSFERS

Transcription

1 ASPEN CASEBOOK SERIES FEDERAL TAXES ON GRATUITOUS TRANSFERS LAW AND PLANNING JOSEPH M. DODGE Steams Weaver Miller Weissler Alhadeff & Sitterson Professor of Law Florida State University College of Law WENDY C. GERZOG Professor University of Baltimore School of Law BRIDGET J. CRAWFORD Professor Pace Law School Wolters Kluwer Law & Business

2 SUMMARY OF CONTENTS Contents Preface 1. Setting the Stage: The Basics of Gratuitous Transfers 2. Overview of the Federal Transfer Taxes 3. Gift Tax Basics 4. The Basic Estate ; 5. Nonprobate Transfers 6. Marital Transfers 7. Long-Term Trusts 8. Gifts with Retained Interests and Powers 9. Advanced Valuation Issues Table of Cases Table of Statutes Table of Regulations Table of Revenue Rulings and Revenue Procs. Table of Private Letter Rulings and Technical Advice Memoranda Revenue Ruling Index xi xxi IX

3 CONTENTS Preface. xxi ]T] SETTING THE STAGE: THE BASICS OF GRATUITOUS TRANSFERS Review of Property Concepts 1 A. History of Law of Gratuitous Transfers 1 B. Glossary of Terms Review of Basic Income Tax Concepts Relating to Gratuitous Transfers 16 A. Gratuitous Receipts Income Exclusions Nondeductibility of Gifts ' Basis of Transferee 17 B. Post-Transfer Income: Trusts and Beneficiaries 18 C. The Estate as an Income Tax Entity Looking at the Big Picture 21 A. Relation of the Transfer Taxes to the Income Tax 21 B. Typology of Wealth (Transfer) Taxes 22 C. Should the Federal Transfer Taxes Be Retained? 23 Gerald Jantscher, Aims Of Death Taxation / 23 OVERVIEW OF THE FEDERAL TRANSFER TAXES 31 $2.1. Prelude 31 $2.2. The Federal Estate Tax, 32 A. Net Estate Subject to Tax 32 B. Rates and Exemptions 32 C. Augmented Gross Estate The Federal Gift Tax 35 A. What is a "Gift" Under the Gift Tax? 35 B. Incomplete Gifts 36 C. The Annual Exclusion 36 D. Gift Tax Computation 36 $2.4. Husband and Wife: The Gift and Estate Tax Marital Deductions 39 A. Husband and Wife as Separate Taxpayers 39 XI

4 xii Contents B. Tax Advantages of Owning Community Property 39 C. The Gift-Splitting Election 40 D. The Marital Deduction The Original Version The Current Unlimited Marital Deduction 40 $2.5. Relation of Estate and Gift Taxes 41 A. Unification of Estate and Gift Taxes 42 B. Transfers Subject to Both Gift and Estate Tax 43 C. Pros and Cons of Gifts Gifts in Excess of the Reduced Gift Tax Exemption The Taxability of the Gift Tax Paid The Bracket Effect The Gift Tax Exclusions Support Obligations Overlapping Transfer Tax Jurisdictions 49 A. State Death Taxes The Credit for State Death Taxes Transition to a Deduction System 50 B. Credit for Foreign Death Taxes 50 $2.7. Credit for Prior Estate Transfers 50 $2.8. The Federal Generation-Skipping Transfer Tax 52 $2.9. The 2001 and the 2010 Acts 55 A. Repeal of Estate and GST Taxes 56 B. The Transition Period, 56 C. Partial Repeal of Stepped-Up Basis 56 D. Deferred Sunset of the 2001 Act 57 GIFT TAX BASICS 6i $3.1. Transfers Subject to Gift Tax 61 A. Transfer of Wealth for Insufficient Consideration Meaning of "Money's Worth" Transfers for Partial Consideration Below-Market Term Loans Sham Loans 66 Revenue Ruling Below-Market Demand Loans 68 B. Non-Gift Wealth Transfers Personal Consumption and Economic Waste Political Contributions Transfers Mandated by Law Divorce-Related Transfers Paying for Education and Medical Care 78 P.L.R

5 Contents xiii 3.2. Identifying the Donor 81 A. Transfers by Entities and Fiduciaries 82 B. Indirect Transfers 82 Revenue Ruling C. Constructive Transfers Allowing Another to Dispose of One's Property Refusing to Accept a Gratuitous Transfer 87 Commissioner v. Estate of Vease When Does a Gift Occur? 95 A. Completion of Gift ' ' What Is an Incomplete Transfer? Completion of Incomplete Transfers Jointly-Held Powers 99 B. Binding Agreement to Make Future Transfers 102 Estate ofdimarco v. Commissioner Valuation of Gifts ' 109 A. The Willing-Buyer Willing-Seller Test 110 B. Can the Gift Itself Affect Its Value? 112 Revenue Ruling C. Actuarial Tables Construction and Use of the Tables Retained-Interest Gifts 116 D. Defined-Value Clauses The Annual Exclusion 122 A. General Outline of the Annual Exclusion 122 B. Exclusion for Present-Interest Gifts Under 25O3(b) 123 Maryland Nat'l Bank v. United States 125 C. Gifts to Minors 129 D. Crummey Trusts 131 THE BASIC ESTATE HI $4.1. Property Passing by Will or Intestacy 142 A. What Is "Property" of the Decedent Under 2033? 142 B. Interests that Expire by Reason of the Decedent's Death 146 C. Interests that Spring into Existence at the Decedent's Death 147 D. Amounts Payable to the Decedent's Estate 148 E. Property Owned by Another 150 F. The Role of State Law in Tax Disputes 152 $4.2. Negative Assets: The Deductions Under $$2053, 2054, and A. Overview 157 B. Claims Against the Decedent Arising Before Death Estate Tax Treatment Income Tax Treatment The $691(c) Income Tax Deduction 162

6 xiv Contents C. Claims Against the Estate (Other than Death Taxes) Arising After Death 162 D. Death Taxes Income Taxation of Estates 167 $4.4. Estate Tax Valuation 172 A. Estate Tax Valuation Date 173 B. Additional Valuation Rules 174 C. Special Statutory Valuation Rules Special Valuation Real Estate Qualified Conservation Easements 177 D. The Effect of the Decedent's Death on Valuation 182 Estate of McClatchy v. Commissioner 182 E. Buy-Sell Agreements 187 Holman v. Commissioner Estate Tax Procedure 196 A. Returns 196 B. Payment 197 C. Burden of the Estate Tax 197 { ] NONPROBATE TRANSFERS. 199 $5.1. Revocable Trusts Jointly-Held Property 202 A. Effect of State Law 202 B. Gift Tax Treatment of the Creation and Termination of Joint Tenancies Creation of Joint-Ownership Property Creation of Joint Bank and Brokerage Accounts Termination of Joint Ownership During life C. Estate Tax Treatment of Joint-Ownership Arrangements Non-Spousal Joint Tenancies Spousal Joint Tenancies Joint Tenancies Created by Third Parties Valuation of Included Portion Income Tax Basis 210 D. Avoiding J Surrender Within Three Years of Death Terminations and Transfers to Avoid 2040(a) Commercial Annuities 213 A. Nature and Function of Commercial Annuities 213 B. Gift Tax Treatment of Commercial Annuities 214 C. Estate Tax Treatment of Commercial Annuities 214 D. Annuity-Insurance Combinations 216 Estate of Montgomery v. Commissioner 216 E. Valuation of Lottery Payments Included Under $

7 Contents xv 5.4. Survivor Benefits Under Employee Plans 220 A. Characteristics and Income Tax Treatment of Employee Plans and Survivor Benefits Qualified Plans Individual Retirement Accounts Nonqualified Plans Income Tax Treatment of Survivor Benefits 223 B. Estate Tax Treatment of Survivor Benefits Survivor Benefits Under Estate of Bahen v. United States Survivor Benefits Outside of 2039' Effect of Community Property Laws Gift Tax Treatment of Employee Survivor Benefits Statutory Survivor Benefits Life Insurance 231 A. Nature of Life Insurance^ Economics of Life Insurance Distinguishing Life Insurance from Other Survivor Benefits Income Tax Treatment of Life Insurance 234 B. Nontax Uses of Life Insurance Revocable Insurance Trusts Using Life Insurance to Pay Estate Obligations 236 C. Section 2042(2) Possible Approaches History of 2042(2) Meaning of "Incidents of Ownership" 241 Estate of Skifter v. Commissioner 241 D. Avoiding Incidents of Ownership Gift Tax Treatment Mechanics of Gifts of Life Insurance 250 Commissioner v. Estate of Noel " Irrevocable Life Insurance Trusts Transfers Within Three Years of Death Taking Out Insurance on Another's Life 252 E. Effect of Premium Payments Payment by the Insured on a Policy Owned by Another 256 Estate of Leder v. Commissioner Can the Payment of Premiums Be a "Transfer" of the Proceeds Outside of 2035? Effect of Premium Payments by the Non-Insured Owner 259 MARITAL TRANSFERS Purpose and Effect of the Marital Deduction 263 A. Background 263 B. Qualification Requirements 265

8 xvi Contents 1. The "Passing" and "Taxable Transfer" Requirements The Terminable Interest Rule The PAT and QTIP Trust "Income" Requirement Gift Tax Treatment of Transfers of Interests in PATs and QTIP Trusts 277 C. The Amount Deductible Marital Deduction Planning 287 A. Aims of Marital Deduction Planning Why Marital Deduction Planning Is Mostly a "Tax Game" "" Exemption Amounts and the Two-Track Estate Plan Allocating Values Between Marital and Non-Marital Transfers Shifting Post-Death Wealth to the By-Pass Trust 293 B. Post-Mortem Adjustments 294 C. Generation-Skipping Tax Planning Involving Spouses Drafting the Marital Deduction Transfer 296 A. Formula Clauses The Problem of Coordination Types of Formula Clauses ' 298 B. Pecuniary, Fractional-Share, and Hybrid Formula Transfers Pecuniary Formula Fractional-Share Formula Transfer Hybrid Formula Clause 305 Revenue Procedure C. Funding Marital Deduction Transfers 306 LONG-TERM TRUSTS Powers i of Appointment 313 A. Nontax Definition and Role of Powers of Appointment 313 B. Powers of Appointment Under C. Powers of Appointment Under 2041 and Transfer Tax Meaning of Power of Appointment Estate and Gift Tax Consequences of General Powers of Appointment Transfer Tax Definition of "General Power of Appointment" 318 Revenue Ruling 7/ Revenue Ruling Jointly-Held Powers 322 Revenue Ruling D. Effect of Action or Inaction by the Donee of a General Power "Possession" of a General Power 326

9 Contents xvii 2. Exercise or Release of General Power Lapse of General Power Income Tax Effects of Possessing an Inter Vivos General Power Tax Consequences of Exercising a Special Power of Appointment 3 34 A. Exercise of Special Power as Gift 335 Estate of Regester v. Commissioner 335 B. The "Delaware Tax T.rap" Giving Content to the Generation-Skipping Transfer Tax 339 A. Review of Major GST Tax Features 339 B. Additional Rules for Identifying Generation-Skipping Transfers Effective Date of the Tax Effect of Reverse QTIP Election on the Identity of the Transferor Marital and Charitablt Transfers Special Rules Concerning Beneficiary Status 343 C. Rules Relating to the Amount of a Generation-Skipping Transfer Exclusions Valuation Transmission Costs Effect of the GST Tax on the GST Tax Base (and the Gift Tax Base) 348 D. Implications of Tax Base Rules for Planning 349 E. Effect of the Exemption Amount on Planning Operation of the Exemption Amount Effect of the Estate Tax on the Exemption Amount Leveraging the Exemption Allocating the GST Tax Exemption Estate-Includible Completed Gift Transfers Effect of Having Two or More Transferors ' 3 54 F. Powers of Appointment and the GST Giving a General Testamentary Power of Appointment to Beneficiaries Effect of the Exercise of a Special Power of Appointment 355 F. Basis Adjustments 356 G. Postscript: The Perversion of the Concept of a GST Tax: How the Present Tax Encourages the Making of Generation-Skipping Transfers Income Taxation of Subchapter J Trusts and Their Beneficiaries 360 A. Overview 360 B. Trust Net Income 361 C. How Trust Income Is Shifted to Beneficiaries 361 D. Allocation of Income Among Beneficiaries 363 E. The Conduit Principle 365

10 xviii Contents =013 GIFTS WITH RETAINED INTERESTS AND POWERS 5.1. Estate Tax f A. Overview 1. Brief History of Elements Required for Inclusion Under B. The Interests and Powers that Trigger Prototypical Situations 2. Holding the String at Death 3. Assigning or Releasing the String Within Three Years of Death United States v. Allen 4. Contingent Interests and Powers 5. Relations Among C. The Neutering of the Concept of a Taxable Retained Power 1. Jointly-Held Powers 2. The Helmholz Doctrine 3. Vicarious Powers Estate of Wall v. Commissioner 4. Powers of Independent Significance Estate of Tully v. United States 5. Administrative Powers Old Colony Trust Co. v. United States 6. The Power to Control Business-Entity Distributions 7. Dispositive Powers Limited by Standards United States v. Powell D. The "Retention" of an "Interest" (or Power) Under 2036 and Meaning of "Retention" in Connection with Outright Transfers Estate oflinderme v. Commissioner ' 2. Retention in Trusts for the Benefit of the Settlor Commissioner v. Irving Trust Company Estate of Skinner v. United States 3. Indirect Retention by a Settlor Through the Rights of the Settlor's Creditors Outwin v. Commissioner, 4. Retaining an Interest Vicariously: Trusts for the Support of the Settlor's Dependents Estate of Chrysler v. Commissioner 5. Transfers to a Trust Created by Another United States v. Estate of Grace 6. Effect of Interest Retained on the Amount Includible 7. Can Inter Vivos Transfers Avoid Both Gift and Estate Tax?

11 Contents xix E. The Requirement that the Retained Interest (or Power) Be "in" the Property Transferred Segregation into Separate Funds 421 Fidelity-Philadelphia Trust Co. v. Smith Private Annuities 423 Fabric v. Commissioner 423 F. The Requirement of a Transfer for Less than Full Consideration * Inter Vivos Transfer by the Decedent Transfers for Consideration in Money or Money's Worth 434 United States v. Righter 436 Estate of D'Ambrosio v. Commissioner Section 2702 and Its Impact on Retained-Interest Gifts 446 A. Section Basic Operating Rule Why 2702 Was Enacted Prerequisites for Applying Explicit Exceptions to B. GST Tax Treatment of Retained-Interest Transfers 449 C. Applying the Adjusted Taxable Gift Exclusion Split-Interest Charitable Transfers 454 A. Background 454 B. General Qualification Rules 456 C. Charitable Remainder Trusts The Charitable Remainder Annuity Trust (CRAT) The Charitable Remainder Unitrust (CRUT) The Pooled Income Fund GST Tax Issues Income Taxation of the Charitable Remainder Trust Direct Charitable Annuities 460 D. Charitable Lead Trusts Qualification Estate and Gift Tax Deduction Generation-Skipping Tax Treatment Income Tax Treatment 461 E. Non-Trust Partial Interests Income Tax Treatment of Transfers with Retained Interests and Powers How Should Transfers with Retained Interests and Powers Be Treated Under the Transfer and Income Taxes? 469 A. Revocable Transfers 469 B. Transfers with Retained Reversions 469 C. Transfers with Retained Income Interests 470 D. Retained-Power Transfers 472 E. Income Tax Rules 472

12 xx Contents p] ADVANCED VALUATION ISSUES 473 $9.1. The Byrum Case Section 2701 and Entity Estate Freeze Transactions 477 A. Status of Entity Estate Freezes Under 2036(a) 478 Estate ofboykin v. Commissioner 478 B. Entity Estate Freezes Under $9.3. Family Limited Partnerships 484 A. Use offlps (and Other Entities) to Obtain Valuation Discounts 484 Estate of Kelley v. Commissioner 485 B. Status of FLPs Under 2036(a) 488 C. The Bona Fide Sale Exception Under 2036(a) 490 Estate of Thompson v. Commissioner 490 Estate of Bongard v. Commissioner 493 D. Indirect Gifts of FLP Assets and the Step-Transaction Doctrine Section 2704: Voting and Liquidation Rights and Restrictions 506 A. Section 2704(a): Lapsing Redemption and Voting Rights 506 B. Section 2704(b): Transfers Subject to Restrictions on Liquidating the Entity 509 Kerr v. Commissioner 510 Table of Cases 513 Table of Statutes 525 Table of Regulations 535 Table of Revenue Rulings and Revenue Procs. 539 Table of Private Letter Rulings and Technical Advice Memoranda 543 Revenue Ruling Index 553