Annual Advanced ALI-ABA Course of Study Planning Techniques for Large Estates November 17-21, 2003 San Francisco, California Estate Administration: A Review of Income, Gift, and Estate Tax Planning Issues By Steve R. Akers Bessemer Trust Company Dallas, Texas 2003 Bessemer Trust Company, N.A.. All rights reserved.
TABLE OF CONTENTS ESTATE ADMINISTRATION: A REVIEW OF INCOME, GIFT, AND ESTATE TAX PLANNING ISSUES Steve R. Akers Bessemer Trust 300 Crescent Court, Suite 800 Dallas, TX 75201 (214) 981 9407 akers@bessemer.com I. INTRODUCTION... 1 II. INCOME TAX PLANNING... 1 Page A. Decedent's Final Return... 1 1. File Decedent's Final Income Tax Return... 1 2. Consider Filing Joint Return... 1 3. Determine How to Report Series E Bond Interest... 2 4. Treatment of Deductions on Final Return... 3 5. Partnership and S Corporation Income... 4 6. Net Operating Losses... 5 7. Installment Sale in Year of Death... 5 8. Executor s Liability for Decedent s Unpaid Income Taxes... 5 B. Planning Considerations for Estate's Fiduciary Income Tax Return, Form 1041... 8 1. Consider Fiscal Year... 8 2. Administrative Expense Deductions... 9 3. Take Advantage of Double Deduction Items... 15 4. Plan on Paying Substantial Administration Expenses in Last Year to Pass Deductions to Beneficiaries... 15 5. Pay Estate Income Tax Liabilities... 16 6. Consider Utilization of Depreciation and Depletion Deductions (By Estates or Trusts) and Establishment of Depreciation or Depletion Reserve (By Trusts Only)... 16 C. Funding and Distribution Planning... 17 1. General Rules Regarding Income Tax Effects of Distributions... 17 a. General Rules... 17 b. Exceptions: Specific Bequest Exception and Separate Share Rule... 19 c. Income in Respect of a Decedent... 29 d. Distribution of Appreciated Property in Satisfaction of Pecuniary Bequest... 30 e. Distribution of IRD to Satisfy Pecuniary Bequest Accelerates Recognition of IRD... 31 f. Election to Treat Revocable Trust as Part of Grantor s Estate... 32 i
g. Deemed Holding Period of Inherited Property... 41 h. Beneficiaries Must Report Inconsistencies with Fiduciary Return... 42 2. Consider Making Distributions to Shift Income and Defer Tax Payment. 42 3. Consider Timing of Distribution to Avoid Inequities... 42 4. Trust Distributions for the First 65 Days May Be Treated as if Made in Prior Year... 44 5. Election to Treat Estimated Payments by Estate or Trust as if Made by Beneficiary... 44 6. Carefully Document Distributions to Charity That Are Made From Income So That Charitable Income Tax Deduction Will Be Allowed... 44 7. Consider Election to Treat Distributions to Charity as if Made in Prior Year... 45 8. Consider "Trapping" Distributions to Trust... 45 9. Do Not Distribute IRD in Satisfaction of Pecuniary Bequest... 46 10. Distribute Right to IRD to Marital Deduction Share... 46 11. Consider Distributing Right to IRD to Charitable Bequest... 46 12. Consider Planning Considerations in Distribution of Installment Note... 47 13. Consider Whether to Recognize Gain on Distributions in Kind... 49 14. Consider Whether Making In-Kind Distribution Will be Treated as a Taxable Transaction... 50 15. Income Allocation in Funding Bequests... 52 16. Payment of Interest on Pecuniary Bequests... 52 17. Income Tax Planning for Payment of Widow's or Family Allowance; Spouse s Elective Share... 53 18. Consider Throwback Rule and Multiple Trust Rule... 54 19. Consider Allocating General Administration Expenses Against Specific Classes of Income... 55 20. Summary of Techniques for Consideration in Light of Compressed Income Tax Brackets for Estates and Trusts... 55 21. Basis Issues... 56 22. Equitable Recoupment... 57 D. Executor's Commissions... 58 1. Consider Tax Effects of Payment of Executor's Commissions... 58 2. Comply with Requirements for Valid Waiver of Commissions... 59 III. GIFT TAX PLANNING... 60 A. Filing Requirement... 60 B. Consider Splitting Gifts With Surviving Spouse... 60 1. Gift-Splitting of Decedent s Gifts... 60 2. Gift-Splitting of Decedent s Spouse s Gifts... 60 3. Debt Deduction for Gift Tax... 61 IV. ESTATE TAX PLANNING... 61 A. Alternate Valuation Date... 61 1. General Rule... 61 2. Mechanical Requirements for Making Alternate Valuation Election... 61 ii
3. Make Alternate Valuation Election if it Produces Lower Estate Tax... 62 4. Consider Making Sufficient Disclaimers to Cause a Small Amount of Tax to be Payable... 62 5. Consider Effects of Sales and Distributions on Alternate Values... 63 B. Special Use Valuation... 64 1. General Effect of Special Use Valuation... 64 2. Qualification Requirements... 64 3. Special Use Value... 71 4. Consider Whether to Make Special Use Valuation Election... 71 5. Carefully Consider Estate Tax Apportionment if Special Use Valuation Election is Made... 72 6. Minority Interest Discount With Special Use Valuation... 72 7. Planning Considerations to Leverage Benefit of Special Use Valuation... 72 C. General Valuation Considerations... 73 1. Penalty Considerations... 73 2. Mechanical Valuation Requirements... 74 3. Make Appropriate Valuation Adjustment... 75 4. No Necessity of Aggregating With QTIP Assets for Valuation Purposes... 96 5. Valuation of S Corporation Stock; Whether to Tax Affect S Corp Earnings in Determining Value Based on Capitalization of Earnings Approach... 100 D. Administration Expense and Debt Deductions... 101 1. Decide Whether to Claim Administrative Expense Deductions for Estate or Income Tax Purpose... 101 2. Deductibility of Post-Death Interest Expenses... 102 3. Allocating Post-Death Interest Expenses Against Estate Income... 117 4. Possibility of Allocating Administrative Expenses (Other Than Post-Death Interest) Against Estate Income... 118 5. Deduction of Administrative Expenses Attributable to QTIP Trust or Other Non-Probate Assets... 118 6. Sales Expenses Deducted Even If Sufficient Non-Probate Assets to Pay Administration Expenses... 120 7. Residence Maintenance Expenses... 120 8. Maintenance Expenses of Ongoing Business... 121 9. Valuation of Disputed Claims Against Estate... 121 E. Marital Deduction Planning... 125 1. QTIP Planning Considerations... 125 2. Funding Issues... 138 3. Consider Rights of Election Against Will to Increase Marital Deduction... 146 4. Planning Considerations for Non-Citizen Surviving Spouse... 147 F. Charitable Deduction Planning... 158 1. Consider Deductibility of Charitable Bequests... 158 2. Consider Statutory Reformation of Split-Interest Trust... 160 3. Consider Judicial Proceeding to Compromise the Interest of Non-Charitable Beneficiaries to Obtain Charitable Deduction... 163 4. Consider Disclaimers of Non-Charitable Interests in Non-Deductible iii
Split-Interest Bequests... 164 G. Qualified Family-Owned Business Interest Deduction... 164 1. Brief Synopsis... 164 2. Amount Of Deduction... 167 3. Requirements For Business Interests to Constitute Qualified Family-Owned Business Interests... 171 4. Qualifying Estates... 174 5. Recapture Provisions... 183 6. Planning Considerations... 187 7. Effective Date... 189 H. Filing of Estate Tax Return and Payment of Estate Tax... 189 1. General Filing and Payment Requirements Extension of Time to Pay Tax Attributable to Closely-Held Business Under 6166... 189 2. Extension of Time to Pay Tax Attributable to Closely-Held Business Under 6166... 192 3. Discharge of Personal Liability of Executor for Estate Tax... 207 4. Transferee Liability of Beneficiaries... 208 V. DISCLAMER PLANNING... 209 A. General Requirements... 209 B. Nine Months Time Limit Requirement... 210 1. Date of Taxable Transfer... 210 2. Time Limit Strictly Enforced... 211 3. Under Age Twenty-One Rules... 211 4. Joint Tenancy Property... 212 5. Application of Time Limit to Transfers Preceding Adoption of Gift Tax... 212 6. No Substantial Compliance Approach; Person Dies Before Signing Disclaimer... 212 7. Income Tax Effect of Disclaimers... 213 C. Planning Flexibilities with Partial Disclaimers... 213 1. Regulation 25.2518-3... 213 2. Separate Interests... 213 3. Cannot Disclaim for Certain Number of Years... 213 4. Severable Property... 213 5. Power of Appointment is Treated as a Separate Interest... 214 6. Can Disclaim Specific Assets From Trust... 214 7. Disclaimer of Specific Pecuniary Amount Allowed... 214 8. Formula Disclaimers are Permitted... 215 9. Partial Disclaimers With Executor Having Authority to "Pick and Choose... 217 D. Passing Without Any Direction By Disclaimant... 217 1. Splintering of Interests in Will... 217 2. Disclaimant as Fiduciary... 217 3. Disclaimant Cannot Hold Power of Appointment... 218 4. Disclaimant as Director of Foundation Receiving Disclaimed Assets... 218 iv
E. Disclaim to Avoid Inclusion in Beneficiary's Estate... 219 F. Disclaim to Avoid Creditor's Claims... 219 G. Disclaimer Opportunities Involving Surviving Spouse... 221 1. Disclaim Outright Disposition Into QTIP Trust... 221 2. Consider Partial Disclaimer to QTIP Trust... 221 3. Disclaimers to Allow QTIP Treatment... 221 4. Disclaimer by Trustee of Power to Make Distributions to Beneficiaries Other Than Spouse But May Be Questionable Unless Beneficiary Consents... 223 5. Disclaimer of All Interests Under Will, so Property Passes by Intestacy to Spouse... 224 6. Disclaimer of Insurance on Surviving Spouse s Life... 224 7. Disclaimer of Property Passing by Intestacy to Persons Other Than Spouse... 224 8. Disclaimer of Qualified Plan Benefits Having QTIP Trust as Beneficiary, so Benefits Pass Outright to Spouse to Get Benefit of Rollover IRA... 224 H. Partial Disclaimer After Some Benefits Have Been Accepted; Expectation of Future Benefit as Acceptance... 225 1. General Rule... 225 2. Community Property... 227 3. Other Jointly Owned Assets... 228 4. Expectation of Future Benefit as Acceptance... 229 I. Disclaimers of Joint-Tenancy Property... 232 1. Overview... 232 2. Bank Accounts, Brokerage Accounts, or Other Similar Interests... 232 3. Joint Tenancies of Other Property... 234 J. Disclaimers for Generation Skipping Transfer Tax Purposes... 236 1. Disclaim to Utilize First Spouse's Million Dollar Exemption Amount... 236 2. Disclaim to Create Direct Skips... 236 3. Disclaim Right to be Reimbursed for Estate Taxes from QTIP Trust... 237 4. Disclaimer by Children to Utilize Decedent s Exemption Amount... 237 5. Disclaim to Limit Generation-Skipping Transfer to Exemption Amount... 237 K. Effects Upon Disclaimer of Non-Ascertainable Standard For Distribution Power Held By Disclaimant... 237 1. Disclaimer to Avoid Having General Power of Appointment... 237 2. Requirement that any Retained Power to Direct Enjoyment of Disclaimed Interest be Limited by an Ascertainable Standard... 238 L. Be Careful with Tax Apportionment Issues with Respect to Disclaimed Assets... 238 M. Disclaimers of Pre-1932 Interests... 239 VI. GENERATION-SKIPPING TRANSFER TAX - BRIEF SUMMARY OF PLANNING OPPORTUNITIES... 239 A. Disclaimer Planning Opportunities... 239 B. Effects Upon Disclaimer of Non-Ascertainable Standard For Distribution v
Power Held By Disclaimant... 239 1. Disclaimer to Avoid Having General Power of Appointment... 239 2. Disclaim to Utilize $1,000,000 Exemption Amount By Creating Direct Skips... 239 C. GST Exemption Allocation... 239 1. General Rules... 239 2. Consider Allocating GST Exemption to Lifetime Transfers That May Result in Generation-Skipping Transfers... 240 3. Consider Allocating GST Exemption to Testamentary Transfers Likely to Result in Generation-Skipping Transfers... 241 D. Funding Considerations... 241 1. General Rule-Use Estate Tax Values... 241 2. Exception for Allocating GST Exemption to Pecuniary Lead Gifts... 241 3. Residual Transfers After Payment of Pecuniary Amount... 241 E. Reverse QTIP Considerations... 242 1. Make Reverse QTIP Election... 242 2. Split QTIP Trust into Separate Trusts for Making Reverse QTIP Election... 242 3. Consider Predeceased Ancestor Exception in Determining Whether to Make the Reverse QTIP Election... 242 VII. ALLOCATING ADMINISTRATION EXPENSES AGAINST INCOME OR UNDER REGULATIONS, TREATMENT OF ESTATE MANAGEMENT EXPENSES... 243 A. Hubert-Supreme Court Decision... 243 1. Facts... 243 2. Summary of Supreme Court Decision... 243 B. Final Regulations... 246 1. Overview... 246 2. Estate Management Expenses... 247 3. Estate Transmission Expenses... 247 4 Reduction of Marital or Charitable Deduction for Estate Management Expenses Attributable to Property Passing to Beneficiaries Other Than Spouse or Charity... 247 5. Special Rule Where Estate Management Expenses Are Deducted on the Estate Tax Return... 248 6. Effective Date of Regulation... 248 7. Planning Considerations Under Final Regulations.. 248 C. Retain Flexibility to Utilize Estate Tax Deduction Under Section 642(g)... 256 vi