Guide to Gift and Estate Tax

Transcription

1 Guide to Gift and Estate Tax A Center for Continuing Education 1465 Northside Drive, Suite 213 Atlanta, Georgia (404) (800) Fax: (404)

2 Published by Erland Education Services (formerly Erland Financial Education Services). No part of these courses may be reproduced, transmitted in any form or by any means, electronic or mechanical, for any purpose, without the express permission of Erland Education Services. Although great effort has been made to ensure this publication contains accurate, timely information, it is provided with the understanding that the author is not engaged in rendering legal, accounting, tax, or other professional service. If professional advice is required, the services of a competent legal advisor should be sought. Copyright Erland Education Services (formerly Erland Financial Education Services) 2008, 2009, 2010, 2011, 2012 Table of Contents

3 CHAPTER ONE: AN INTRODUCTION TO GIFT AND ESTATE TAX... 1 WHAT ARE FEDERAL GIFT AND ESTATE TAXES?... 1 Gift Tax... 1 Estate Tax... 1 Unified Transfer Tax... 2 THE EARLY HISTORY OF GIFT AND ESTATE TAXES... 2 THE MODERN HISTORY OF GIFT AND ESTATE TAXES... 2 Federal Estate Tax of Revenue Act of Revenue Act of Revenue Act of Tax Reform Act of Economic Recovery Act of Tax Reform Act of Taxpayer Relief Act of The Economic Growth and Tax Relief Reconciliation Act of Tax Increase Prevention and Reconciliation Act of The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of CHAPTER 1 - STUDY QUESTIONS... 6 Answers to Chapter 1 Study Questions... 8 CHAPTER TWO: THE ECONOMIC GROWTH AND TAX RELIEF RECONCILIATION ACT OF 2001 AND THE TAX REFORM ACT OF WHAT IS EGTRRA?... 9 APPLICABLE EXCLUSION AMOUNT Unified Credit Applicable Exclusion Amount TAX RATES GENERATION-SKIPPING TRANSFER TAX SUNSET PROVISION THE TAX RELIEF, UNEMPLOYMENT INSURANCE REAUTHORIZATION AND JOB CREATION ACT OF Gift Taxation under TRA Estate Taxation under TRA Generation Skipping Transfers Tax and TRA CHAPTER 2 - STUDY QUESTIONS CHAPTER THREE: AN INTRODUCTION TO GIFTING WHAT IS GIFTING? Gifting Purpose Gift and Estate Taxes Copyright Erland Financial Education Services 3

4 Qualified Disclaimer TYPES OF GIFTS TRANSFERS THAT ARE NOT GIFTS Political Organizations Educational Payments Medical Payments GIFT DEDUCTIONS Charitable Deduction Marital Deduction CHAPTER 3 STUDY QUESTIONS Answers to Chapter 3 Study Questions CHAPTER FOUR: GIFT VALUATION FAIR MARKET VALUE VALUATION FOR SPECIFIC TYPES OF GIFTS Stocks and Bonds Real Property Gift Loans Mutual Funds Life Insurance Annuities Joint Tenancies CHAPTER 4 STUDY QUESTIONS Answers to Chapter 4 Study Questions CHAPTER FIVE: GIFT TAX ANNUAL EXCLUSION Exclusion Amount Present Interest GIFT SPLITTING LIFETIME GIFT EXEMPTION GIFT TAX FILING CHAPTER 5 STUDY QUESTIONS Answers to Chapter 5 Study Questions CHAPTER SIX: CALCULATING GIFT TAXES Estate and Generation Skipping Transfer Tax Rates Retroactive Tax Rate Options Under TRA Example Using Unified Rate Schedule GIFT TAX CALCULATION Taxable Gifts Total Taxable Gifts Net Gift Tax Gift Tax Due Gift and Estate Taxes Copyright Erland Financial Education Services 4

5 EXAMPLE Gifts Made Under the Current TRA 2010 Rules CHAPTER 6 STUDY QUESTIONS Answers to Chapter 6 Study Questions CHAPTER SEVEN: ESTATE TAX AND THE GROSS ESTATE GROSS ESTATE Life Insurance Proceeds Annuities Retirement Accounts Transferred Property Joint Property General Powers of Appointment DEDUCTIONS FROM GROSS ESTATE Funeral Expenses Debts State Death Tax Deduction ADJUSTED TAXABLE GIFTS CHAPTER 7 STUDY QUESTIONS Answers to Chapter 7 Study Questions CHAPTER EIGHT: ESTATE TAX CREDITS UNIFIED TAX CREDIT Changes Made by TRA Adjustment to Unified Credit FOREIGN DEATH TAX CREDIT Statutes and Treaties PRIOR TRANSFERS TAX CREDIT Prior Transfer Property Maximum Credit Amount Percent Allowable CHAPTER 8 STUDY QUESTIONS Answers to Chapter 8 Study Questions CHAPTER NINE: CALCULATING ESTATE TAXES ESTATE TAX CALCULATION ORDER Tentative Taxable Estate Taxable Estate Gross Estate Tax Net Estate Tax Due EXAMPLE Applicable Exclusion Amount under TRA Potential Claw-Back after CHAPTER 9 STUDY QUESTIONS Gift and Estate Taxes Copyright Erland Financial Education Services 5

6 Answers to Chapter 9 Study Questions CHAPTER TEN: GENERATION-SKIPPING TRANSFER TAX HISTORY OF THE GENERATION-SKIPPING TRANSFER TAX Changes Under TRA WHAT IS THE GENERATION-SKIPPING TRANSFER TAX? Subject to Taxation Made of an Interest in Property Made to a Skip Person GST EXEMPTION GST TAX RATE CHAPTER 10 STUDY QUESTIONS Answers to Chapter 10 Study Questions CHAPTER ELEVEN: GIFTING TO MINORS CUSTODIANSHIPS Uniform Gift to Minors Act and Uniform Transfer to Minors Act Establishing a Custodial Account Age of Termination GUARDIANSHIPS TRUSTS Section 2503(b) Trust Section 2503(c) Trust Section 529 Plans CHAPTER 11 STUDY QUESTIONS Answers to Chapter 11 Study Questions CHAPTER TWELVE: GIFTING TO CHARITIES OUTRIGHT GIFTS Cash Property Appreciated Property CHARITABLE REMAINDER TRUSTS Pooled Income Fund CHARITABLE GIFT ANNUITIES CHARITABLE LEAD TRUSTS LIFE INSURANCE PRIVATE FOUNDATION CHAPTER 12 STUDY QUESTIONS Answers to Chapter 12 Study Questions INDEX Gift and Estate Taxes Copyright Erland Financial Education Services 6

7 Chapter One: An Introduction to Gift and Estate Tax The taxation of transfers of property during life and at death has a long history. This chapter provides an overview of the history of the gift and estate taxes, beginning with the enactment of a federal estate tax in Upon completion of this chapter, you will be able to: Define gift tax and estate tax Identify provisions in the Federal Estate Tax of 1916, the Revenue Act of 1924, the Revenue Act of 1942, the Revenue Act of 1948, the Tax Reform Act of 1976, the Economic Recovery Act of 1981, the Tax Reform Act of 1986, the Taxpayer Relief At of 1997, the Economic Growth and Tax Relief Reconciliation Act of 2001, the Tax Increase Prevention and Reconciliation Act of 2005, and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of What are Federal Gift and Estate Taxes? Gift Tax A gift tax is a tax that is imposed on the transfer of property that an individual makes during his or her lifetime. The federal gift tax is required when property is transferred for less than the full amount of the property s worth; in other words, when the property is gifted. Estate Tax An estate tax is a tax that is imposed on the transfer of property that is made upon an individual s death. This type of transfer usually, but not always, occurs by means of a will. It is important to note that the federal estate tax generally applies to the transfer of every asset that is owned or controlled by an individual at his or her time of death. Guide to Gift and Estate Tax Page 1

8 Unified Transfer Tax While gift taxes and estate taxes are levied individually, they are also combined in a certain sense. This is due to the applicability of one tax schedule to the total of all taxable transfers made through both gifting and the transferring of estates. This essentially means that taxable gifts made during life are added to the taxable transfers made upon death. These gifts and transfers are then subject to a unified transfer tax. The Early History of Gift and Estate Taxes Estate taxes as a concept go very far back in history. For instance, in ancient Egypt evidence is found for a 10% tax on transfers of property at death. It is also known that the Greeks and Romans imposed death taxes on their citizens. The evolution of gift and estate taxes in the United States begins with the imposition of the first estate taxes in 1797 with the adoption of the Death Stamp Tax to raise revenues to pay off naval debts incurred in the face of a tense relationship with the French. This tax was repealed in 1802, and was followed by the 1862 imposition of an inheritance tax, which was also repealed in The Modern History Of Gift and Estate Taxes Federal Estate Tax of 1916 The development of the modern federal gift and estate tax system effectively began in It was in this year that Congress enacted a Federal Estate Tax. This tax was meant to raise revenue and was also supposed to preclude an inordinate wealth concentration through heirs inheritance of property upon an individual s death. This estate tax shared many features of the current federal estate tax, including: Tax measured by the value of a decedent s property at the time of death The value of a decedent s estate was increased by lifetime transfers for tax purposes All property owned jointly by a decedent and another individual was included (according to its full value) in the decedent s gross estate Revenue Act of 1924 In 1924, Congress increased the estate tax rates and enacted a federal gift tax that had the same rate schedule as the estate tax. It was created to stop estate tax avoidance through inter-vivos transfers (i.e. transfers made during an individual s lifetime). Although this gift tax was repealed in 1926, it was reinstated in It was in this year that the federal gift tax Guide to Gift and Estate Tax Page 2

9 was established with rates set at three-quarters of the estate tax rates. This rate level was sustained until Revenue Act of 1942 The Revenue Act of 1942 endeavored to fix an inequality in the way that residents of community property states and common-law states were required to pay estate and gift taxes. Before this time, in states that passed community property laws, the estate would usually include one-half of a couple s community property (the property they held together). However, in states that did not pass these community property laws (common-law states), the estate would include all of a couple s property. This led to an unbalanced tax burden on residents of common-law states. But the 1942 Act amended the federal estate tax laws so that a taxable estate would always include all of a couple s community property. Revenue Act of 1948 However, the Revenue Act of 1942 was not seen as the most ideal solution, and so was modified by the Revenue Act of This Act created estate and gift tax marital deductions. The marital deduction applicable to estate taxes allowed a decedent s estate to deduct the value of all property that passed to the surviving spouse. The maximum deduction allowed was one-half of the decedent s adjusted gross estate (adjusted gross estate is the gross estate minus debts, taxes and expenses for administration). This marital deduction only applied to non-community property, thereby equalizing the tax burden that fell to residents of common-law states. The marital deduction that applied to the federal gift tax allowed the individual giving the gift to deduct one-half of a gift made with a spouse to a third party. This deduction also applied to non-community property. A new split gift rule was also created by the 1948 Act, which allowed a non-donor spouse to choose to be treated as if he or she made a gift of one-half the total amount of the gift given by the donor spouse. Tax Reform Act of 1976 The next major change made to rules for federal estate and gift taxes came in 1976, with the Tax Reform Act. The greatest change brought about by this Act was the unification of the gift and estate tax structure. This unification meant that all gift taxes an individual pays are considered when estate taxes are calculated in order to avoid double taxation on one transfer. Guide to Gift and Estate Tax Page 3

10 The Act also created a unified credit that would be applied to gift and estate tax. The unified credit is essentially a dollar-for-dollar reduction in the amount of taxes due. It was created to be used to offset gift tax liability during life or (if unused) to offset estate tax liability at death. Marital deductions were also increased under this Act. For estate tax marital deductions, the deduction was the larger of one-half of the adjusted gross estate or $250,000. The gift tax marital deduction was also increased so that a donor spouse could deduct the full amount of the first $100,000 of an interspousal gift. Another significant change made by the 1976 Act was the tax on generation skipping transfers. These transfers are considered those in which two individuals share the use and ownership of property. Usually these two individuals will be the child (first level beneficiary) of a donor and the grandchild (second level beneficiary) of a donor. Example: Charles is a property donor. He gifts the right to use and benefit from his property to his daughter, Christine. When Christine passes the property on to her son, Carl, he becomes the owner of the property that originally belonged to Charles. A generation-skipping transfer has occurred. Before the 1976 Act, a generation skipping transfer would avoid estate taxes by not charging taxes to the first level beneficiary. However, this tax loophole was closed by requiring that property be taxed as if it passed through the first level beneficiary s estate. Economic Recovery Act of 1981 The Economic Recovery Act of 1981 significantly increased the unified transfer tax credit. It also created a reduction of certain generation skipping transfer tax rates. Most significant, however, were the changes this Act made to the marital deduction. All limits on the gift and estate tax marital deductions were removed, thus creating an unlimited marital deduction. Tax Reform Act of 1986 The Tax Reform Act of 1986 revised the generation-skipping transfer tax to close loopholes. It created a flat tax rate which applied to all generationskipping transfers, even those in which the first-level beneficiary did not receive any interest. The Act also increased the estate tax for those decedents who had excess accumulation in a retirement plan. A Guide to Gift and Estate Tax Page 4

11 kiddie-tax was also created that taxed unearned income over $1200 of children ages 13 and under at the top marginal income tax rate of the children s parents. Taxpayer Relief Act of 1997 The Taxpayer Relief Act of 1997 increased the unified credit amount for the first time since the 1981 Economic Recovery Act. This Act created an increasing credit scale from 2000 to The Taxpayer Relief Act also made the annual exclusion amount and the generation skipping transfer tax subject to adjustment for inflation. The Economic Growth and Tax Relief Reconciliation Act of 2001 The Economic Growth and Tax Relief Reconciliation Act of 2001 made extensive changes to estate and gift tax rules. This Act will be discussed in detail in the following chapter. Tax Increase Prevention and Reconciliation Act of 2005 The Tax Increase Prevention and Reconciliation Act of 2005 increased the applicable kiddie-tax age from 14 to 18. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 This Act postpones the sunset provisions in the Economic Growth and Tax Relief Reconciliation Act relating to tax rates and amends portions of the estate, generation skipping transfer and gift tax laws within that 2001 Act. It will be discussed in greater detail throughout the course. Guide to Gift and Estate Tax Page 5

12 Chapter 1 - Study Questions 1. When property is transferred for less than the full amount of the property s worth, the property is: A. Funded B. Donated C. Gifted D. Bequeathed 2. Estate taxes as a concept may best be described as originating: A. At least as far back in history as Ancient Egypt B. With the English common law system C. At the tail-end of the French revolution D. Upon the signing of the U.S. Constitution 3. The Federal Estate Tax of 1916 shared all of the following features with the current federal estate tax, except: A. Estate tax was measured by the value of a decedent s property at the time of death; B. The value of decedent s estate increased by lifetime transfers for tax purposes; C. All property owned jointly by a decedent and another individual was included (according to its full value) in the decedent s gross estate D. When property was passed to a grandchild, it was required to be taxed as if it passed through the first level beneficiary s estate 4. Before the passing of this Act, an unbalanced tax burden fell on those residents of common-law states. Which Act was the first to amend the federal estate tax laws so that a taxable estate would always include all of a couple s community property? A. Revenue Act of 1942 B. Tax Reform Act of 1976 C. Economic Recover Act of 1981 D. Taxpayer Relief Act of 1997 Guide to Gift and Estate Tax Page 6

13 5. The greatest change brought about by the Tax Reform Act of 1976 was: A. The creation of a gift tax for inter-vivos transfers B. The unification of the gift and estate tax structure C. The repeal of the estate tax D. The decrease of the marital deduction 6. Prior to which of the following Acts could a generation skipping transfer avoid estate taxes by not charging taxes to the first level beneficiary? A. The Tax Reform Act of 1976 B. The Taxpayer Relief Act of 1997 C. The Economic Growth and Tax Relief Reconciliation Act of 2001 D. The Tax Increase Prevention and Reconciliation Act of The Tax Reform Act of 1986 created a new type of tax on unearned income over $1200 of children ages 13. This tax is called: A. The child-gift tax B. The minor tax C. The juvenile categorization tax D. The kiddie-tax Guide to Gift and Estate Tax Page 7

14 Answers to Chapter 1 Study Questions 1. C. The definition of a gift for tax purposes is property that is transferred for less than the full amount of the property s worth This is not the definition of a taxable gift, because a taxable gift has further conditions. 2. A. Archaelogists have discovered evidence in ancient Egypt of the taxation of the estate. 3. D. Under the federal estate tax laws in effect in 1916, the passing of property to a non-spouse beneficiary who was a generation below the deceased was not taxed; the tax skipped a generation. 4. A. The Revenue Act of 1942 changed the estate tax laws so that property in community property states that belonged to a couple was all included in the estate, which is the way the law treated property in non-community property states. 5. B. The unification of the gift and estate tax structure was the greatest change brought about under the Tax Reform Act of The change eliminated double taxation of a single transfer of property. 6. A. The Tax Reform Act of 1976 included the tax on generation skipping transfers. 7. D. This type of tax is known as the kiddie tax. Guide to Gift and Estate Tax Page 8

15 Chapter Two: The Economic Growth and Tax Relief Reconciliation Act of 2001 and the Tax Reform Act of 2010 What is EGTRRA? The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) provided the largest tax cut in the United States in over twenty years. Signed by President George W. Bush, it gave nearly every American taxpayer some form of tax savings. The Act provided tax relief in four different areas: Retirement Plans Allowable contributions to nearly all kinds of retirement plans were increased under this Act. Marginal Tax Rates The Act added a tax bracket of 10% that replaced one portion of the prior 15% bracket. All tax brackets were then reduced on a phased-in basis. Education Funding Incentives for education funding were provided by the Act. These included taxfree withdrawals from qualified tuition plans, and relaxed inter-plan transfer rules. Estate, Gift, and Generation-Skipping Transfer Taxes The Act provided an estate and generation-skipping transfer tax repeal on January 1, 2010, subject to a sunset provision. Before that time, the limits on tax-free transfers to heirs are increased, while tax rates are reduced. The remainder of this chapter will focus on EGTRRA as it applies to estate, gift and generation skipping transfer taxes and changes to its provisions that were made in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRA 2010). Upon completion of this chapter, you will be able to: Differentiate between the unified credit and the applicable exclusion amount Guide to Gift and Estate Tax Page 9

16 Equate the unified credit to the non-taxable amount of lifetime transfers Describe the provisions of EGTRRA that deal with estate and gift tax, including the sunset provision Identify changes to estate, generation skipping transfers and gift tax provisions made under TRA 2010 Applicable Exclusion Amount Unified Credit Recall that the 1976 Tax Reform Act created a unified credit that is applied to gift and estate tax, and that this credit is essentially a dollar-for-dollar reduction in the amount of taxes due. During an individual s life, when gift taxes are owed, the unified credit may be used against that amount, but any credit used reduces the amount of credit that may be used against gift tax in a later year. Any unified credit that is not used to reduce gift tax may be used to eliminate or reduce estate tax. Applicable Exclusion Amount Instead of referring to the unified tax credit, the dollar amount of the taxable estate that the unified credit makes tax-free is often spoken of in relation to gift and estate tax. This dollar amount is known as the applicable exclusion amount. All transferred amounts that are not subject to federal estate or gift taxes are referred to as the applicable exclusion amount. Although this amount was created prior to EGTRRA, it was changed significantly by this Act. Before EGTRRA, the applicable exclusion amount was the same for both estate and gift taxes (although it did differ when it was being used to calculate taxes for large estates). After the passage of the Act, however, gifts and transfers at death became subject to different applicable exclusion amounts. Applicable exclusion is still used to refer to transfers at death, but the exclusion amount for gifts is now referred to as the lifetime gift exemption. Under EGTRRA, the applicable exclusion amount as it applied to estate taxes increased from 2002 to 2009, and was repealed (along with estate taxation itself) in The unified credit also increased from 2002 to 2009, until it too was repealed in Guide to Gift and Estate Tax Page 10

17 For gift tax purposes, the lifetime gift exemption amount remained level from 2002 to Note that gift tax, unlike estate tax, was not repealed in 2010 under EGTRRA. For Gift Tax Purposes For Estate Tax Purposes Year Unified credit Lifetime gift exemption Unified credit Applicable exclusion amount $345,800 $1,000,000 $345,800 $1,000, $345,800 $1,000,000 $555,800 $1,500, $345,800 $1,000,000 $780,800 $2,000, $345,800 $1,000,000 $1,455,800 $3,500, $345,800 $1,000,000 Repealed Repealed Note that for gift tax purposes the unified credit of $345,800 exempts $1,000,000 from gift tax. The unified credit also increased through 2009 for estate taxes, in order to exempt the increasing applicable exclusion amounts from estate tax. Example: Christopher passed away in In that year, his taxable estate is worth $3,500,000. The estate produces $1,455,800 of federal estate taxes. This is equal to the unified credit as it applies to estate taxes; therefore, Christopher s estate pays no federal estate taxes (assuming that the unified credit amount had never been reduced by applying it to any gifts Christopher made during his lifetime). Tax Rates For those amounts over the lifetime gift exemption or applicable exclusion amounts, estate and gift tax rates apply. Under EGTRRA, the top marginal estate and gift rates decreased after In 2010, the estate tax was repealed. Guide to Gift and Estate Tax Page 11

18 Year Top Marginal Tax Rate % % % % % % 2010 Gift tax rate = 35% It should be noted that the 35% gift tax rate applicable in 2010 was equal to the highest marginal federal income tax bracket. This means that those individuals in higher tax brackets have no tax incentive to makes gifts to individuals in lower tax brackets that exceed the annual exclusion amount and the lifetime gift exemption. Generation-Skipping Transfer Tax In addition to the repeal of the estate tax in 2010, EGTRRA also provided a repeal of the generation-skipping transfer tax in that same year. Before that year, the tax rate is reduced together with the highest rate for estate taxes. The exemption amount for the generation-skipping transfer tax is also increased with the increase of the estate tax exemption. Sunset Provision The provisions of EGTRRA were scheduled to sunset on January 1, This meant that the Act s provision would return to the provisions that were applicable before the Act was passed. This sunset will occur unless Congress enacted legislation to continue the provisions of EGTRRA. The following table demonstrates the condition of the estate tax if the Act s provisions had been allowed to sunset: Year Applicable Exclusion Amount Unified Credit Top Marginal Tax Rate 2009 $3,500,000 $1,455,800 45% 2010 Repealed 2011 $1,000,000 $345,800 55% Guide to Gift and Estate Tax Page 12

19 The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 On December 17 th, President Obama signed TRA 2010 into law. This law included the following important provisions related to gift and estate taxation: Gift Taxation under TRA 2010 The $1,000,000 gift exemption amount continues under this law, and is increased for years 2011 and In these two years, there is a $5,000,000 gift exemption, which is subject to adjustment for inflation, and in 2012 became $5,120,000. Then the gift exemption amount returns to $1,000,000 in The gift tax rate in 2011 and 2012 is 35%. In 2013, the gift tax rate is scheduled to return to 55%, as it would have been if Congress had not enacted TRA 2010 and instead had allowed EGTRRA s sunset provisions to apply. Estate Taxation under TRA 2010 TRA 2010 also applies a $5,000,000 estate tax exemption in the years 2011 and 2012 and a top estate tax rate of 35%. This effectively puts the unified credit system back into place for these two years, since both estate and gift taxes are subject to the same top rate and exemption amount. In 2012, the $5,000,000 exemption amount is subject to indexing for inflation and was increased to $5,120,000. Generation Skipping Transfers Tax and TRA 2010 TRA 2010 provides for a $5 million generation skipping transfer exemption and a 0% tax rate for direct skips in this year. In 2011 and 2012, the rate, like the estate and gift tax rate, is 35% and a $5,000,000 generation skipping transfer exemption amount applies in 2011, and a $5,120,000 amount applies in Guide to Gift and Estate Tax Page 13

20 Chapter 2 - Study Questions 1. The Economic Growth and Tax Relief Reconciliation Act was passed during the Presidency of: A. Jimmy Carter B. Ronald Regan C. Bill Clinton D. George W. Bush 2. Which of the following statements best describes the manner in which EGTRRA affected the applicable exclusion amount of gift and estate taxes? A. The Act created the applicable exclusion amount B. The Act eliminated the applicable exclusion amount for the first year after its passage, then reinstated it C. The Act caused gifts and transfers at death to become subject to different applicable exclusion amounts D. The Act caused gifts and transfers at death to become subject to the same applicable exclusion amount 3. Under EGTRRA, in 2010 the unified credit for estate taxes was: A. $345,800 B. $780,800 C. $2,000,000 D. Repealed 4. Under EGTRRA, in 2010 the top marginal gift tax rate was: A. 55% B. 40% C. 35% D. Repealed Guide to Gift and Estate Tax Page 14

21 5. Under TRA 2010, in 2011 and 2012, the top marginal gift and estate tax rate is: A. 55% B. 40% C. 35% D. Repealed Guide to Gift and Estate Tax Page 15

22 Answers to Chapter 2 Study Questions 1. D. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was passed during the presidency of George W. Bush. 2. C. Under EGTRRA, the gift tax lifetime applicable exclusion amount is now $1,000,000. The estate tax applicable exclusion amount reached $3,500,000 in 2009 under EGTRRA s terms. 3. D. The estate tax was repealed in C. In 2010, the top marginal gift tax rate equaled the top marginal income tax rate of 35%. 5. C. Under TRA 2010in 2011 and 2012 the top marginal estate and gift tax rate is 35%. Guide to Gift and Estate Tax Page 16

23 Chapter Three: An Introduction to Gifting Transfers of property during life made for less than the property s full value are gifts. Such transfers are subject to taxation under federal gift taxation rules. This chapter provides an introduction to gifting and the issues surrounding gifting under the federal rules. Upon completion of this chapter, you will be able to: List purposes of making gifts and types of gifts Explain the purpose of a qualified disclaimer Identify transfers that are not considered gifts for the purpose of gift taxation Describe the charitable and marital deductions from taxable lifetime transfer amounts What is Gifting? For the purposes of gift taxes, a gift is simply a transfer of property, made from a donor to a donee, without the expectation of receiving something of equal or greater value in return. Gifting Purpose Why would a donor want to make a particular gift? There are as many reasons for this as there are types of assets gifted, but there are several common gifting factors. By gifting, taxation may be reduced. When property makes significant income, the gifting of that property reduces income taxes. Also, for property that is increasing in value at a rapid rate, transferring that property during life as a gift can eliminate the amount of estate taxes that would be levied against that property if it were transferred at death. Guide to Gift and Estate Tax Page 17

24 Often a gift is given simply because the donor wants to see the donee enjoy the gifted property. Charities are common donees, as are churches and other religious organizations. Qualified Disclaimer In order for a transfer to be considered a gift, a donee must accept it. When a donee refuses to accept a gift, he has made a qualified disclaimer. This disclaimer means that the property that would have been gifted will be treated as if it had never been transferred to the donee, and as if the donor had never made the gift. A qualified disclaimer is one that is in writing, and is irrevocable and unqualified. It must be delivered to the donor, the donor s legal representative, the person holding legal title to the property or the person in possession of the property no later than nine months after the later of the date in which the transfer was made or the donee turns 21. Also, the donee cannot have accepted interest or any benefits of the property, and may not have any determination in the subsequent location of the property in order for the disclaimer to apply. Types of Gifts Gifts can be made of many different types of property, including: Real property Money Forgiveness of debts Forgiveness of loan interest Interest-free or reduced-interest loans Transfer of property to a trust The assignment of the benefits of an insurance policy Certain property settlements in a divorce case An amount of an annuity given up in exchange for the creation of a survivor annuity Exercise or release of general powers of appointment (those powers in which the holder may appoint the specific property to himself, his creditors, his estate, or the creditors of his estate) Guide to Gift and Estate Tax Page 18

25 Transfers That Are Not Gifts There are certain kinds of transfers that are not considered gifts for the purpose of gift taxation. These include transfers to political organizations, payments that qualify for an educational exclusion, and payments that qualify for a medical exclusion. Political Organizations When transfers are made to a political organization for the use of that organization, a gift is not considered to have been made. Under the IRS s definition, a political organization is a party, committee, association, fund or other organization (whether or not incorporated), organized and operated primarily for the purpose of accepting contributions or making expenditures, or both, for an exempt function. Educational Payments Gift tax does not apply to tuition a donor pays on behalf of a donee to a qualifying domestic or foreign educational organization. Under the IRS definition, a qualifying education organization normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its education activities are regularly carried on. Note that this educational exclusion for gift taxation does not apply to payments made for books, room and board, or any other expense that is not tuition. Medical Payments Amounts paid by a donor to a person or individual who provided medical care for a donee are not considered gifts. According to the IRS, medical care includes expenses incurred for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body, or for transportation primarily for and essential to medical care. Note that this definition also includes amounts paid for medical insurance on behalf of a donee, but does not include amounts that are reimbursed by a donee s insurance company. Gift Deductions There are two specific types of gifts that, while being distinguished as gifts, do not incur gift tax. These are the gifts to charity, and gifts to spouses. Guide to Gift and Estate Tax Page 19

26 Charitable Deduction Gifts made for charitable, public, or other similar purposes are generally not subject to gift tax. Rather, such gifts receive a charitable deduction for the full amount of the gift. Gifts to charity include donations of real property (such as real estate, clothing or vehicles), money, securities, and the like. Gifts qualifying for the charitable deduction include transfers made to or for the use of: The United States, a state or political subdivision of a state or the District of Colombia, for exclusively public purposes; Any corporation, trust, community chest, fund, or foundation organized and operated only for religious, charitable, scientific, literary or education purposes; Any corporation, trust, community chest, fund, or foundation organized and operated to prevent cruelty to children or animals; Any corporation, trust, community chest, fund, or foundation organized and operated to foster a national or international sports competition; A fraternal society, order, or association operation under a lodge system, if the transferred property is used only for religious, charitable, scientific, literary or education purposes; Any war veteran s organization organized in the United States. Marital Deduction Generally, gifts that are made between spouses fall under the unlimited marital deduction, meaning that they are not subject to gift tax. In order to qualify for the deduction, the couple must generally be legally married at the time the gift is made and the donor spouse must be a citizen of the United States. Note also that if the donee spouse is not a citizen of the United States, the unlimited marital deduction will not apply to certain gifts. It is important to point out that gifts of terminable interest do not generally fall under the marital deduction. Gifts of terminable interest are those in which someone other than the donee spouse will have an interest in the property following the termination of the donee spouse s interest (such as is found under a life estate). However, gifts of terminable interest may be deducted if all of the following requirements are satisfied: 1. The donee spouse is entitled to all of the income from the entire interest for life; Guide to Gift and Estate Tax Page 20

27 2. The income is paid at least yearly; 3. The donee spouse has the unlimited power, while alive or by will, to appoint the entire interest in all circumstances; and 4. No part of the entire interest is subject to another person s power of appointment. Guide to Gift and Estate Tax Page 21

28 Chapter 3 Study Questions 1. A donee refuses to accept a gift in writing under irrevocable provisions. He has made a(n): A. Approved refusal B. Qualified disclaimer C. Rejection D. Denunciation 2. Making a gift may reduce: A. Income taxes only B. Estate taxes only C. Both income and estate taxes D. Neither income nor estate taxes 3. All of the following are considered to be transfers that are gifts, except: A. A transfer made to a political organization for that organization s use B. The transfer of property to a trust C. The assignment of the benefits of an insurance policy D. The exercise or release of general powers of appointment 4. Gifts that qualify for the charitable deduction do not include transfers made to or for the use of any corporation, trust, community chest, fund, or foundation organized and operated: A. Only for religious, charitable, scientific, literary or education purposes B. To prevent cruelty to children or animals C. To foster a national or international sports competition D. For exclusively public purposes Guide to Gift and Estate Tax Page 22

29 5. Bill and Melinda are a married couple. In order for Bill to give Melinda a gift that falls under the unlimited marital deduction, Bill may not be: A. Younger than Melinda B. More than 10 years older than Melinda C. A citizen of any country other than the U.S. D. A former convict Guide to Gift and Estate Tax Page 23

30 Answers to Chapter 3 Study Questions 1. B. A qualified disclaimer is made when a gift is refused in writing. The disclaimer must also be irrevocable and unqualified. 2. C. Making a gift reduces income taxes if the gift is qualified as a charitable deduction. By reducing the size of the estate, it also reduces potential estate taxes. 3. A. A transfer made to a political organization for that organization s use is not considered a gift, but a transfer of property to a trust, the assignment of the benefits of an insurance policy and the exercise of or release of general powers of appointment are all transfers that are considered gifts. 4. D. Transfers that are made to or for the use of any corporation, trust, community chest, fund or foundation organized and operated for exclusively public purposes do not qualify for a charitable deduction. Transfers to such entities do qualify for a charitable deduction if made only for religious, charitable, scientific, literary or education purposes, to prevent cruelty to children or animals, or to foster a national or international sports competitions. 5. C. In order for a gift from a spouse to qualify under the unlimited marital deduction, the spouse must be a citizen of the U.S. Guide to Gift and Estate Tax Page 24

31 Chapter Four: Gift Valuation The tax on a gift is based on its fair market value. The determination of fair market value can be different based on the type of property gifted. This chapter explains the valuation of commonly gifted property. Upon completion of this chapter, you will be able to: Define fair market value Describe the basic valuation rules for stocks and bonds, real property, mutual funds, life insurance, annuities and joint tenancies Fair Market Value The value of a gift is the fair market value of that item on the date it is transferred. Fair market value is the price at which property would be bought by a willing buyer or sold by a willing seller, when neither the buying nor selling is forced, and when both buyer and seller have reasonable knowledge of all facts relevant to the transaction. The fair market value of an item is never determined by a forced sales price. It is also never determined by the sale price of the transferred item in a market that is not the market in which it is most commonly sold to the public. Valuation for Specific Types of Gifts Stocks and Bonds The fair market value of a stock or bond is the mean between the highest and lowest selling prices that are quoted on the date the stock or bond is valued. However, if the only available prices are the closing selling prices, then the fair market value is the mean between the quoted closing selling price on the date of valuation and on the trading day before the date of valuation. If there were no sales on the date of valuation, then a special calculation is required: Guide to Gift and Estate Tax Page 25

32 1. Find the mean between the highest and lowest selling prices on the nearest trading date before and the nearest trading date after the date of valuation; then 2. Prorate the difference between the mean prices to the date of valuation; then 3. Add or subtract (based upon applicability) the prorated part of the difference to or from the mean price figured for the nearest trading date before the date of valuation. When stock of close corporations or inactive stock is involved in a gift, such stock must be valued on the basis of: Worth, Earnings, Earning and dividend capacity, and Other relevant factors Real Property For real property, the best way to find the gift valuation is to use the price paid for the property in an arm s length transaction on or before the date the gift is valued. An arm s length transaction is a transfer that is made in the ordinary course of business, and is subject to no conflict of interest. Such a transaction is always considered to be conducted at fair market value. If an arm s length transaction cannot be found to use as a valuation method, then the comparable sales method may be used. Under this type of valuation method, the gifted property is compared with several similar properties that have been sold. Differences in the date of the sale, the size, condition, and location of the properties must all be taken into consideration, and appropriate adjustments then made. Gift Loans A gift loan is considered to be a loan under which the interest charged is less than the applicable federal rate. A loan is also a gift loan if the sum of the amount loaned is greater than the present value of payments due. For gift loans meeting the former definition, the amount of the gift is the amount of interest that would have been payable if it was accumulated at the applicable federal rate. For the latter definition, the gift total is the amount of the loan over the present value of the payments. Guide to Gift and Estate Tax Page 26

33 Mutual Funds When considering gifted open-ended mutual funds, the fair market value is usually the public redemption price (this is the bid price or net asset value) of the shares on the date the gift is given. When no affirmative public redemption price is shown to be in effect when the gift is made, then the applicable public redemption price will be considered to be the last public redemption price as quoted by the company for the date the gift was made. Life Insurance The value of a gift of life insurance is the gross premium paid by the donor, if the policy is gifted immediately after it is purchased. However, if a policy is paid up when it is gifted then the value of the gift is the single premium amount that would be charged by the insurance company for a comparable contract. If an insurance policy has a cash surrender value, and the donee plan to cash out the policy (rather than keeping it as an investment), then the fair market value of the policy is the cash surrender value. If the donee plans to keep the policy as an investment, then the fair market value would be the replacement cost of the policy. For an insurance policy that is not paid-up (i.e. that still has premiums payable), the value is usually the lesser of either total premiums paid or the interpolated terminal reserve. This is the reserve adjusted to the date of the gift, plus the value of the unearned amount of the premium, and is available from the insurer. Annuities The value of an annuity contract is the cost of that contract, if it is gifted immediately after it is purchased. If the contract has been in force for a while, then the gift amount is the cost to purchase, at the time of the gift, an annuity that provides the same payment provisions. When the owner of an annuity names another person as an annuitant on his annuity contract, no gift if considered to have been made until the owner directs annuity payments to begin to the new annuitant. This holds true unless naming of the new annuitant as payee and the beginning date of the payments are irrevocable. If the naming of the annuitant (or other payee) is irrevocable, then the gift is seen as being made at the time the annuitant was named. Guide to Gift and Estate Tax Page 27

34 Joint Tenancies If an individual purchases property with his own assets and holds the title to that property with a donee (who is not a spouse) as joint tenants with rights of survivorship, then if either that individual or the donee gives up those rights by severing interest, a gift will have been considered to have been made to the donee for half the value of the property. However, no gift will consider to have been made if both tenants made equal contributions to the property. If the tenants made contributions of unequal amounts, then the value of a gift from the greater-contribution tenant is the amount by which that tenant s contribution is greater than the average of the contribution amounts. Example: Richard, a joint tenant with Jenna, contributes ¼ of the property, while Jenna contributes ¾ of the property. The gift from Jenna to Richard is ¼, or the amount that is greater than the average (½) of the two contribution amounts. If an individual creates a joint bank account for himself and a donee, then that individual is said to have made a gift to the donee only when that donee takes withdrawals from the account for his own benefit. The gift amount is any withdrawal that the donee took without any duty to repay the donor. If an individual purchases a U.S. savings bond that is registered as payable to himself or a donee, then a gift is considered to have been made when the donee cashes the bond without any duty to repay the donor. Guide to Gift and Estate Tax Page 28

35 Chapter 4 Study Questions 1. The price at which property would be bought by a willing buyer or sold by a willing seller, when neither the buying nor selling is forced, and when both buyer and seller have reasonable knowledge of all facts relevant to the transaction, is referred to as: A. The current value B. The fair market value C. The transfer value D. The purchase price 2. The fair market value of a stock or bond is the highest and lowest selling prices that are quoted on the date the stock or bond is valued. A. the mean between B. the average of C. the difference between D. the multiplication of 3. For real property, the best way to find the gift valuation is to use the price paid for the property in an arm s length transaction: A. Before the date the gift is valued B. On the date the gift is valued C. On or before the date the gift is valued D. fter the date the gift is valued 4. For an insurance policy that is not paid-up (i.e. that still has premiums payable), the gift valuation is usually the lesser of either total premiums paid or the: A. Interpolated terminal reserve B. Immediate gross-factor premium C. Cash surrender assessment D. Factorable rate equivalent 5. When the owner of an annuity names another person as an annuitant on his annuity contract, if the naming of an annuitant is irrevocable, then the gift is seen as being made: A. At the time the owner directs annuity payments to begin to the new annuitant Guide to Gift and Estate Tax Page 29

36 B. At the time the new annuitant spends over $1,000 of the annuity payments C. At the time the owner passes away D. At the time the annuitant was named 6. Mary and Joe (who are not spouses) make equal contributions to the purchase of a piece of land. If they hold the title to that property as joint tenants with rights of survivorship then: A. A gift has been made to Mary for half the property s value B. A gift has been made to Joe for half the property s value C. A gift has been made to Joe for the full amount of the property s value D. No gift is considered to have been made to either Mary or Joe Guide to Gift and Estate Tax Page 30

37 Answers to Chapter 4 Study Questions 1. B. This is the definition of fair market value. 2. A. The mean between the highest and lowest selling price of a stock or bond on the date the stock or bond is valued is the stock s or bond s fair market value. 3. C. An arm s length transaction is a transfer made in the ordinary course of business, and is subject to no conflict of interest. Using the price paid for real estate on or before the date the gift as valued in an arm s length transaction is the fair market value of the property. 4. A. The lesser of total premiums paid or the interpolated terminal reserve is the value for a gift of life insurance. 5. D. If an irrevocable annuitant is named on an annuity contract, a gift is considered to be made at the time the annuitant is named. 6. D. When two people have made equal contributions to the purchase of the property and hold property as joint tenants with rights of survivorship, no gift has been made by either party. Guide to Gift and Estate Tax Page 31