SECTION F-2064 - A LITTLE MORE EARLY HELP - DEDUCTIONS FROM GROSS ESTATE AND SOME TAX PROCEDURES Table of Contents Table of Contents... -1- Section 2064 - A Little More Early Help - Deductions From Gross Estate And Some Tax Procedures... -2- Examine The Following Comments Carefully... -2- The purpose of these tax texts... -2- Using these tax texts... -2- Viewing Professor Jegen s tax texts and other tax materials... -2- Some more comments about Corel WordPerfect software... -3- Some more comments about Microsoft Word software... -3- Some more comments about Adobe Reader software... -3- So use whichever software pleases you... -4- If you have some problems... -4- Deductions From Gross Estate Some Tax Procedures... -5- Deductions - in general... -5- Expenses and claims... -5- Casualty and theft losses... -8- Charitable contributions... -8- Unlimited estate tax deductions... -12- Deduction for certain interests in a business... -23- Nonresident, noncitizens... -27- Allocation of taxes... -27- Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -1-
Section 2064 - A Little More Early Help - Deductions From Gross Estate And Some Tax Procedures Examine The Following Comments Carefully I. The purpose of these tax texts. These tax texts are used primarily for a beginning income tax course of three to four hours and for other two or three-hour courses dealing with: corporation income tax; gratuitous transfer taxes; tax procedure; and/or state and local taxes. For the assumptions which are used in these tax texts, read Section F-2001 of these tax texts. II. Using these tax texts. In order to view, for no charge, Professor Jegen s Federal and State tax texts and other tax materials, whether or not you are a student, a lawyer, or an accountant, you must go to Professor Jegen s Taxsite, the Internet address for which is as follows. Examine this taxsite carefully, before reading any additional part of these tax texts. http://www.iupui.edu/~taxsite A. Viewing Professor Jegen s tax texts and other tax materials. 1. In order to view all of Professor Jegen s Federal and State tax texts and other tax materials, whether or not you are a student, a lawyer, or an accountant, you must go to Professor Jegen s Taxsite, the Internet address for which is: http://www.iupui.edu/~taxsite 2. There are tax texts, forms, etc. for all viewers, but particularly with respect to students, there are schedules, assignments, and a variety of informative documents about each course which Professor Jegen teaches. 3. After you locate the tax texts (the files) which you wish to read, notice that the name of each file has an extension (ending). A file extension is at the end of the basic file name (with a dot in front of it) which has been assigned to the file, generally, by the drafter of the content of the file. There are some extensions with which you probably already familiar, such as the following three. 4. The extension for WordPerfect document is: wpd. 5. The extension for a Word document is: doc or docx. 6. The extension for a Adobe portable document format is: pdf. 7. To repeat. A file extension is at the end of the basic file name (with a dot in front of the extension) which extension has been assigned to the file, by me for my files or by someone else for their files. 8. You should be familiar with the following, very common, extensions. a. Microsoft Word uses a doc or docx extension. The docx extension is the more recent release of the two. (1) \You may download a Microsoft Office Compatibility pack to ensure that you can view newer documents with the.docx file extension. b. If you use Corel WordPerfect, then you are familiar with the wpd extension. c. Adobe Acrobat uses the pdf extension and to read these files, you must go on line and acquire, free of charge, the Adobe Reader program. (1) For this purpose, you might want to use the following link: http://www.adobe.com/reader 9. The file of extension of pdf stands for portable document format and this type of file is used in competition and as a complement with other types of files, e.g., the doc extension for Microsoft Word and the wpd extension for Word Perfect Documents. One advantage of a pdf file type or commonly referred to as a pdf file is that a file which is a pdf file type may be consistently viewed and printed by computer users who normally use other operating systems or software for wordprocessing, e.g., Word, Works, WordPerfect, StarOffice or OpenOffice. 10. Therefore, it does not matter whether or not you normally use Microsoft Word, Microsoft Works, Corel WordPerfect, Sun StarOffice or OpenOffice, you can consistently view and Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -2-
print files which have a pdf extension by using the Adobe Reader, which is generally referred to as Adobe. 11. Even though an individual normally uses other software (e.g., Word, Works, WordPerfect, StarOffice or OpenOffice) to edit and view or print files, that individual may use the Adobe Reader for pdf files and this allows the drafter of the documents in a make such pdf files available for viewing by more individuals, without having to make more than one file available for each type of wordprocessor software and/or each type of operating system and further ensures that the document is consistently formatted for viewing and printing. A distinct advantage is clearly provided to the authors of such files, however, a recipient of such file also is provided with the advantage that they can read such file regardless of their word processing software or operating system. B. Some more comments about Corel WordPerfect software. 1. Two individuals, Bastian and Ashton, decided to create a word processing program for a minicomputer system in 1979 and began selling WordPerfect in 1980. Corel later purchased the rights to the software and began introducing updated versions. For several years, this software was the most popular word processing software until overtaken by Word during the 1990s. Its popularity was mainly due to the fact that it was available for a wide variety of operating systems and it was highly compatible with many systems. 2. Corel WordPerfect is still number two in sales behind Word and some universities also include the cost of the software in fees and permit students to download WordPerfect Office X5. See the IUware online website at http://iuware.iu.edu. As stated above, the most common file extension of WordPerfect files is.wpd. Kendall Callas states the Corel WordPerfect software is still the most popular word processor for lawyers due to PerfectScript, the programming language that, when combined with macros, allows law firms to more readily create their widely varying legal documents than with other leading word processing programs such as Microsoft Word (microcounsel.com). C. Some more comments about Microsoft Word software. 1. According to contributors to Wikipedia, Microsoft first introduced Word in 1983 under the name Multi-Tool Word. While it was not well received initially and struggled to compete with the well-established WordPerfect, Word slowly, but steadily gained a greater share of the market. The release of Word software with Macintosh-compatible in 1985 gave Word more credibility and increased distribution. Further, Microsoft offers these programs to college students at a greatly reduced cost and some universities allow current students to download them with the cost already included in technology fees. See the IUware online website at http://iuware.iu.edu. This has assured the promulgation of Word to the next generation of professionals. D. Some more comments about Adobe Reader software. 1. First introduced in 1993 by Adobe, the pdf format has evolved from a proprietary format only being available on Macintosh and requiring a user to purchase software to access such documents to the current state in which the pdf format is near standard format for viewing files and is further an open file format available on all major operating systems. The Adobe software to view the pdf format is available for free from Adobe's site and further since the file format is no longer proprietary there are numerous third party software vendors which provide software to not only view but to create and edit pdf files. In fact you will find features to generate pdf files from most recent major word processing tools. 2. As stated, the Adobe Reader is available to computer users for no charge and a link has been provided on Professor Jegen s taxsite which allows computer users to download the Adobe Reader in order to view and print all pdf files which are located at Professor Jegen s taxsite. Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -3-
If you are wondering how Adobe makes its money, it is due to Adobe s sales and support of pdf authoring and related software (the software which allows an individual to edit a pdf file) and licensing of their technology to other companies. The site at which computer users can download the Adobe Reader (at no charge) is: http://www.adobe.com/prodindex/acrobat/readstep.html E. So use whichever software pleases you. 1. Therefore, it does not matter whether or not you normally use Microsoft Word, Microsoft Works, Corel WordPerfect, Sun StarOffice or OpenOffice, you can reliably view and print files which have a pdf extension by using the Adobe Reader. This allows the author of such files to make such one file available for viewing which can be used by a larger group of computer users without having to make more than one file for each type of wordprocessor software and/or each type of operating system. F. If you have some problems. 1. If you have difficulty opening part or all of some of the files which are on Professor Jegen's taxsite, then you should first download the particular document to your or the law school's hard drive, and then, open the particular file. If you still are unable to open a particular document in whole or in part, then you should speak with one of the individuals who provide student help in the law school computer rooms or contact the University Information Technology Services (UITS) support center at 317-274-4357. Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -4-
Deductions From Gross Estate Some Tax Procedures I. Deductions - in general. While the Internal Revenue Code prescribes the characteristics required for property to be subjected to estate tax and gift tax and requirements for expenses and liabilities to be allowable as deductions or credits in computing such taxes, the determination as to whether or not the prescribed characteristics or requirements exist is generally a matter of state law. A. If there is no state statute or state court decision on point, the federal courts will try to determine how the highest court of the state would answer the question. B. Where the particular estate or its beneficiaries have participated in an adjudication of the question in the state courts, the decision of the state's highest court will probably be determinative; but decisions of lower state courts will be given proper regard along with other factors in answering the relevant state law question. C. There are five sections which allow estate tax deductions. D. Section 2053 allows estate tax deductions for the following four items. 1. Funeral expenses. 2. Administration expenses. 3. Unsecured claims against the estate. 4. Secured claims on property which is includible in the decedent's gross estate. E. Section 2054 - allows estate tax deductions for uninsured casualty and theft losses which occur during the administration of the estate. F. In the case of Section 2053 and Section 2054 deductions, some of these deductions might be deducted, alternatively, on the estate's fiduciary income tax return - - - at the election of the estate's personal representative. 1. Also, in the case of some of the Section 2053 deductions (for example, accrued business expenses, or interest, or state and local taxes to a cash method decedent) may be deducted on both a fiduciary income tax return of the decedent's estate and on the estate tax return of the decedent - - - a double deduction. 2. Medical expenses of decedent owing at his death and deducted on decedent's final income tax return pursuant to Section 213(d) may not be deducted on the estate tax return, not even the amount below the threshold amount required before any income tax deduction is allowed. G. Section 2055 allows an estate tax charitable deduction for transfers to qualified charitable organizations. 1. Generally, the transfer must be made: a. To or for the United States, any state, the District of Columbia, or any political subdivision thereof for public purposes; b. To a corporation which is organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes; c. To a trustee, fraternal society, order, or association operating under the lodge system, provided that the funds are used exclusively for religious, charitable, scientific, literary, or educational purposes; or, d. To or for the use of any veteran's organization incorporated by Act of Congress, or its departments or local chapters or parts, no part of the net earnings of which inures to the benefit of any private shareholder or individual. H. Section 2056 allows estate tax marital deductions, for transfers to (or on behalf of) a surviving spouse. I. Section 2057 allows estate tax deductions, up to $675,000, for certain family-owned business interests. II. Expenses and claims. As stated, Section 2053 allows the basic estate tax deductions for: estate administration expenses; funeral expenses; unsecured claims against the estate; and, secured claims against the estate with respect to property which is includible in the decedent's gross estate. A. Administration expenses include personal representative fees, lawyer fees, and various miscellaneous expenses. 1. Expenditures which are not essential to the proper settlement of a decedent's estate, but Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -5-
which are incurred for the individual benefit of beneficiaries (heirs or devisees) are not deductible for estate tax purposes. a. There is a question as to whether or not expenses incurred in administering decedent's estate, such as the costs of selling property, are deductible where the expenses are allowed by state law, but are not necessary to either settle or distribute such estate. 2. A lawyer's fee (including one incurred by a beneficiary) which is not essential to the proper settlement of the decedent's estate is not deductible as an administration expense, even if the expense is approved by a probate court as an expense payable or reimbursable by the decedent's estate. 3. Miscellaneous expenses, including court costs, accountants' fees, appraisers' fees, and other expenses which are necessary for preserving and distributing the decedent's estate, are allowable estate tax deductions. a. Also deductible are the costs of storing or maintaining property of the decedent's estate for a reasonable period of time before the property is distributed. b. Not deductible, of course, are the costs of additions or improvements to the property. 4. If property has to be sold in order to pay the decedent's debts, administration expenses, or taxes, or to maintain the decedent's estate or to make a distribution, then the expenses of the sale are deductible for estate tax purposes. a. Included are brokerage fees, excise taxes on the sale, and other expenses of the sale. 5. Interest expenses which are incurred after the decedent's death are generally allowable as a deduction if the interest expenses are reasonable and necessary for the administration of the estate. a. The interest must be allowable under local law. b. The interest which accrues after death on federal and state income tax deficiencies while the personal representative contests the imposition of the taxes is deductible as an administration expense. c. Interest payable on a loan incurred in order to pay estate taxes is deductible as an administration expense. d. Interest incurred as the result of a federal estate tax or gift tax deficiency is a deductible administration expense. e. If the personal representative elects installment payments for the estate tax, then interest payable on those installments is deductible as an administration expense. f. Interest incurred as the result of a late payment of the federal estate tax or a state death tax is deductible as an administration expense. (1) However, any penalty for failure to pay or failure to file is not deductible as an administration expense even if the deduction is allowable under local law. g. The Internal Revenue Service holds that an administration expense deduction is not allowable for interest which is payable after a decedent's death and which is attributable to an installment obligation incurred by the decedent. (1) If the decedent had lived, then the decedent would have been liable for the interest as well as the principal. (2) But because the interest is not actually and necessarily incurred in the administration of the decedent's estate, the Internal Revenue Service holds that such interest is not allowable as an administration expense. (a) This is questionable - - - at the least. h. Estimates of future payments of interest are not deductible where the obligation may be prepaid. 6. Expenses occasioned by decedent's death and incurred in administering nonprobate assets included in decedent's gross estate are deductible if they meet the following requirements. a. If the expenses would be allowable deductions if incurred in administering property subject to claims. b. If the expenses are paid before the expiration of the period of limitation for Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -6-
assessment of estate tax. B. Funeral expenses are allowable as a deduction from the gross estate if the funeral expenses are actually paid and are allowable out of property which is subject to claims under local law. 1. Deductible expenses include the reasonable costs of a tombstone, monument, mausoleum, or a burial lot, either for the decedent or the decedent's family, and a reasonable expenditure for its future care if allowable by the local law. 2. The cost of transportation of the person bringing the body to the place of burial is deductible. 3. The estate is allowed an estate tax deduction if the estate is primarily liable under local law for the decedent's funeral expenses. 4. However, under local law, a surviving spouse may be primarily liable for the funeral and last illness expenses of the deceased spouse. a. In this case, the estate is allowed an estate tax deduction for these expenses only if the decedent's last will and testament directs that these expenses be paid out of the decedent's estate. 5. The deduction for funeral expenses must be reduced by the value of any wrongful death recovery. Read Rev. Rul. 77-274, 1977-2 C.B. 326. C. Amounts which may be deducted as claims against a decedent's estate are only for enforceable personal obligations of the decedent at the time of death and interest on those obligations, which accrues up to the time of the decedent's death; however, it does not matter whether or not the obligations have, in fact, matured. The amount of the deduction is the amount of the claim. 1. Only interest accrued up to the date of death is deductible, as a claim against the estate, even though the personal representative elects to value the decedent's gross estate at the alternate valuation date. 2. Medical expenses of the decedent are deductible as a claim against the estate. 3. Deductions for claims founded upon promises or agreements are limited to the extent that the liabilities were contracted for in good faith and for adequate and full consideration in money or money's worth. a. However, a pledge or subscription in favor of a public, charitable, religious, or educational organization is deductible to the extent that the amount would have constituted an allowable estate tax deduction if the item had been a devise. b. Liability under a separation agreement is not contractual, if the agreement has been confirmed by a divorce decree of a court having power to alter the terms of the agreement. 4. Taxes, which are deductible as claims against the estate, include property taxes which accrue before the decedent's death, unpaid income taxes on income received by the decedent during life, and unpaid gift taxes on gifts made by the decedent during life. a. Unpaid state gift taxes are deductible even if, when the taxes are paid, the gift taxes are credited against a state inheritance tax. b. Taxes which are not deductible include income taxes on income received after the decedent's death, property taxes which are not enforceable before death, and estate, succession, or inheritance taxes. c. If a state or a foreign country imposes a death tax on a transfer made by a decedent for charitable purposes, then the estate may elect to take a deduction for the payment of this tax rather than to take the state or foreign death tax credit. (1) The estate tax deduction is allowable only if the decrease in the federal estate tax (because of the deduction) benefits only the charitable organization, or if the federal estate tax is apportioned among all beneficiaries of property included in the estate. (2) When the deduction is claimed, the credit for state death taxes or foreign death taxes, whichever is applicable, is reduced in order to reflect that a portion of such tax is used as a deduction rather than as a credit (against the estate tax). 5. Amounts due on judgments against the decedent, including tort liabilities, are deductible. 6. Amounts paid in settlement of will contest are not deductible as either a claim or an expense Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -7-
of administration. 7. Secured claims for which decedent was individually liable are deducted as debts; while secured claims for which decedent was not personally liable are reductions in the value of the property securing such claims includible in decedent's gross estate. 8. The payment of insurance proceeds to a former spouse are deductible as an indebtedness of the decedent's estate if the decedent was required to name the former spouse as the beneficiary of the policy pursuant to a divorce decree. 9. Generally, a claim that becomes unenforceable because of a creditor's failure to file as required under state law is not deductible. D. Where debts, funeral expenses and probate administration expenses total more than the probate estate, the excess is deductible only to the extent that it is paid prior to the due date for the estate tax return. Read section 2053(c)(2). 1. The due date for the return for purpose of determining the deductibility of such payments is extended by extensions pursuant to Section 6081. Read U.S. Treas. Reg. 20.2053-1(c)(2). III. IV. Casualty and theft losses. Section 2054 allows estate tax deductions for casualty and theft losses which are incurred during the settlement of the estate and which arise from theft or casualties, such as storms or fires. A. But such casualty or theft losses are allowable only to the extent that the losses are not compensated for by insurance or by other third person sources. B. Where the alternate valuation date is elected and estate property suffers a casualty or theft loss during the six months following decedent's death, such loss is considered in determining the value of such property and no deduction is allowed for such loss. C. Casualty and theft losses are deductible for estate tax or for income tax, but not for both. Charitable contributions. Section 2055 allows charitable contribution deductions for estate tax purposes, for the value of property which is includible in the decedent's gross estate and which the decedent transferred during life or by the decedent's last will and testament to or for the use of charitable organizations. Read section 2055. A. The estate tax charitable deduction is virtually unlimited and transfers to the following entities qualify for the charitable contribution deduction, for estate tax purposes. 1. The United States of America, a state, a political subdivision of a state, or the District of Columbia, if the funds are to be used exclusively for public purposes. Read section 2055(a)(1). 2. Any corporation, trust, community chest, fund, or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art, and organizations which foster national or international amateur sports competition, but only if none of the activities involve providing athletic facilities or equipment, and organizations for the prevention of cruelty to children or animals. Read section 2055(a)(2). a. These charitable organizations qualify as long as no part of the organizations's net earnings benefits any private individual. b. And, also, as long as no substantial activity is undertaken to carry on propaganda, or to otherwise attempt to influence legislation or participate in any political campaign on behalf of any candidate for public office. 3. A fraternal society, order, or association operating under the lodge system, if the transferred property is to be used exclusively for religious, charitable, scientific, literary, or educational purposes including the encouragement of art, and the prevention of cruelty to children or animals. Read section 2055(a)(3). a. Participation in a political campaign or attempts to influence legislation by a fraternal society, order, or association disqualifies gifts to such society, order or association for the charitable deduction. 4. Any veterans organization organized in the United States of America or in any of the organization's auxiliary departments or local chapter or posts, as long as no part of the net earnings benefits any private individual. Read section 2055(a)(4). Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -8-
5. A foreign government or its political subdivision when the use of such property is limited exclusively to charitable purposes. B. If, at the date of the death transfer to a qualified charitable organization, the transfer is contingent upon some act or occurrence, a charitable contribution deduction, for estate tax purposes, is allowable only if it is virtually certain that the transfer will become effective and the contingency can be ignored. C. If any person has the power to divert any part of the property or fund for a use or purpose which is not deductible for estate tax purposes, then only the part of the property or fund which is not subject to this power is deductible for estate tax purposes. Read section 2055(d). 1. It is risky to the charitable contribution deduction for the executor of the estate to have any discretion regarding the amounts to be bequeathed to anyone under the terms of the last will and testament. a. If the executor of the estate has the authority to give a discretionary sum of money from the estate to an individual, with the remainder going to a charitable organization, then no charitable contribution deduction may be taken by the estate for the sums that actually went to the charitable organization. (1) The amount that is designated to go to the charitable organization is regarded as uncertain (due to the executor's discretion) and thus, no charitable contribution deduction may be taken. b. If the executor of the estate has the authority to give a discretionary sum of money to more than one charitable organization and one of the charitable organizations does not qualify as a "qualified charitable organization", then all of the devises to the other qualified charitable organizations will be disqualified (for being a sum uncertain.) (1) A will provision which instructs the executor to "divide the residue amongst these five charitable organizations" is an example of a discretionary provision. (2) A will provision which instructs the executor to "divide the residue equally amongst these five charitable organizations" is not a discretionary provision. (3) The courts are willing to listen within reason, to a scrivener's error. c. It is safest to make the amount of the charitable devise definitive. (1) "Definitive" may be an amount specified but uncertain, such as one-third of the residual estate. (2) "Definitive" may be spelled out directly, such as $200,000. 2. There has been much litigation regarding whether or not a transfer is "virtually certain. 3. Essentially, the amount of the charitable contribution must be fixed at the date of death. 4. The charitable deduction is allowed for amounts that are transferred to charitable organizations as a result of a qualified disclaimer. 5. A trust may be reformed if, and only if, it is a split interest trust, i.e., income to A for life, remainder to B, where A or B is a qualified charitable organization. a. The IRS will immediately jump on any attempted reformation of a non-split interest. (1) Some judicious reformation may be possible as long as it is not stated to be a reformation. b. The amount of the devises may not vary more than 5 percent from what they would have been without any reformation. (1) If an organization or individual would have received $100,000, they must receive no less than $95,000 and no more than $105,000 after the reformation. (2) This can require creative arguments, such as arguing that an individual would require at least $ for discretionary medical bills and that the trustee would have paid those funds. c. If you can anchor yourself by showing that the decedent was intending to get the charitable deduction, then you ought to be able to get rid of any wood that doesn't Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -9-
apply. 6. Any death taxes that arise due to a faulty charitable deduction are apportioned among all the devises, not just the one that is faulty. a. Whether the faulty one can be cured or not is determined later. 7. The amount of the charitable deduction is limited to the amount actually available for charitable uses. Thus, if any federal estate taxes or state death taxes are payable out of the amount transferred to the charitable organization the amount of the deduction is the amount of the transferred property reduced by those taxes. D. If the decedent transfers an interest in property for both charitable and noncharitable purposes or if the decedent keeps an interest in the same property transferred to the charitable organization, then an estate tax charitable deduction is allowable for the interest passing to the charitable organization only if the transfer is one of the following. Read section 2055(e)(2). 1. A transfer of an undivided portion of the decedent's entire interest in property. a. The interest may not be transferred in trust. b. The transfer must consist of a fraction or percentage of each interest or right which the decedent owns in the property. c. The transfer must extend over the entire term of the decedent's interest in the property or in other property into which the transferred property is converted. 2. A transfer of a remainder interest in the decedent's personal residence, but not the proceeds to be derived from the sale of the residence. a. The property may not be transferred in trust. b. The property can be any residence used by the transferor, not just the decedent's principal residence. c. The interest in the residence can be stock which the decedent owns as a tenantshareholder in a cooperative housing corporation. d. The interest does not include household furnishings which are not fixtures. 3. A transfer of a remainder interest in the decedent's farm. a. The property may not be transferred in trust. b. A farm includes any land used, by the decedent or by the decedent's tenant, to produce crops, fruit, or other agricultural products, or to sustain livestock. c. A farm includes improvements to the farm. 4. A transfer of a qualified real property interest to a qualified organization exclusively for conservation purposes. a. Conservation purposes are defined as: (1) Preserving land areas for outdoor recreation by the general public, or for its education; (2) Protecting a relatively natural habitat of fish, wildlife, or plants; or, (3) Preserving open space including farm and forest land, if the preservation is: (a) (b) For the scenic enjoyment of the general public; or Under a clearly delineated federal, state, or local government conservation policy that will yield a significant public benefit; or (4) Preserving a historically important land area or a certified historic structure. 5. A transfer of a remainder interest, in trust, in the form of a charitable remainder unitrust, a charitable remainder annuity trust, pooled-income fund, or any other type of charitable remainder interest. a. A charitable remainder unitrust is a trust from which a fixed percentage of the net fair market value of its asset, valued annually, is paid at least annually to one or more persons who are living at the time of the creation of the trust. (1) The percentage must be at least five percent, and not more than 50%. (2) At the death of the beneficiaries or at the end of a term of up to 20 years, the remainder interest is held for the benefit of a qualified charitable organization or paid to the qualified charitable organization. b. A charitable remainder annuity trust is a trust from which a specified amount is paid at least annually to one or more persons who were living at the time the trust was Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -10-
created. (1) The amount must be at least five percent, and not more than 50%, of the initial fair market value of the property placed in trust. (2) At the death of the last income beneficiary, or at the end of a term of up to 20 years, the remainder interest must be held for the benefit of a qualified charitable organization or paid to the qualified charitable organization. c. A pooled-income fund is a trust maintained by a charitable organization to which transferors transfer property and contribute the remainder interest in the property to a charitable organization. (1) The transferor creates an income interest, either for the transferor's life or for the life of one or more beneficiaries living at the time of the transfer, in the property contributed by the transferor. (2) And, the transferor contributes the remainder interest in the property to the charitable organization. 6. A transfer of an income interest, in trust or otherwise, in the form of a guaranteed annuity interest or unitrust interest. a. A guaranteed annuity interest is the right, under the instrument of transfer, to receive a determinable amount for a specified term or for the life or lives of an individual or individuals. (1) The amount must be paid at least annually. (2) The individual or individuals receiving the interest must be living at the date of the transfer. (3) A guaranteed annuity interest, not in trust, must be paid by an insurance company or by an organization regularly engaged in issuing annuity contracts. b. Unitrust interest means the right, given in the instrument of transfer, to receive payment of a fixed percentage of the net fair market value, determined annually, of the property that funds the unitrust. (1) The amount must be paid at least annually. (2) A unitrust interest, not in trust, must be paid by an insurance company or by an organization which is regularly engaged in issuing interests and which otherwise meets the requirements of a unitrust interest. 7. The decedent is entitled to a charitable contribution deduction for estate tax purposes for the transfer to a qualified organization of a work of art, even if the decedent does not transfer the copyright to the charitable organization, because the work of art and the work of art's copyright are treated as separate properties. Read section 2055(g)(4). a. The term "work of art" means any tangible personal property for which there is a copyright under federal law. b. A qualified organization is any religious, charitable, scientific, educational, or other organization described in Section 501(c)(3) which is not a private foundation. c. The use of the property transferred must be related to the charitable organization's exempt purpose or function. 8. The donor is not entitled to an immediate charitable contribution deduction for gift tax purposes (or income tax purposes) for the transfer to a qualified organization of a work of art, if he retains a life estate. a. The immediate value of a work of art, severed from its copyright/commercial value, is in its artistic value, the aesthetic value of looking at the work of art. b. The value of the work of art, therefore, still rests entirely with the donor. c. Nothing of value is transferred. (1) The donor receives no income tax deduction. (2) The donor owes no gift tax. d. When the donor dies and the work of art is transferred to the qualified charitable organization, the donor's estate may take a charitable deduction for estate tax purposes. Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -11-
E. The deduction for charitable contributions by nonresident noncitizens is governed by the same rules which apply to citizens or residents of the United States of America. 1. However, charitable contributions to, or for the use of, a trust, community chest, fund, foundation, or fraternal order or society operating under the lodge system are deductible, for estate tax purposes, only if the charitable contributions are to be used within the United States of America exclusively for tax exempt purposes. 2. If the charitable contributions are made to or for the use of a corporation, then the corporation must be one created or organized under the laws of the United States of America or of any state or territory thereof. V. Unlimited estate tax deductions. Section 2056 allows almost unlimited estate tax deductions for the value of property which is includible in the decedent's gross estate, for estate tax purposes, and which property passes, or has passed, to the decedent's surviving spouse as the beneficial owner. A. In order for a transfer of property (or interest therein) to qualify for the estate tax marital deduction the following conditions must be met at the time when the decedent dies. 1. The spouses must be married to each other. 2. The spouse making the death transfer must be a United States citizen or resident. 3. The decedent's surviving spouse must either be a citizen of the United States of America or, if the decedent's surviving spouse is not a United States citizen, then the property (or interest therein) must pass to the surviving spouse through a "qualified domestic trust". Read section 2056(d) and Section 2056A. a. A trust is a "qualified domestic trust" if the following conditions are met. (1) The trust agreement must require at least one of the trustees to be either United States citizens or domestic corporations. (2) The decedent's surviving spouse must be entitled to all of the trust's net income, which net income must be payable to the decedent's surviving spouse either annually or in more frequent intervals. (3) The trust must meet the requirements which are imposed by the applicable U.S. Treasury Regulations in order to assure collection of the estate tax which is imposed by Section 2056A. (4) The election, under Section 2056A, must be made on the decedent's estate tax return. (a) Such election is irrevocable. b. The estate tax, under Section 2056A, is imposed on the following. (1) Distributions from a qualified domestic trust (other than distributions of the trust's net income). (2) The value of property in the qualified domestic trust on the death of the surviving spouse. (3) The value of property in the qualified domestic trust when the trust ceases to be qualified. c. The amount of the estate tax, which is imposed under Section 2056A, is the amount by which the normal estate tax on decedent's estate would increase if the taxable amount were added to decedent's gross estate for the normal estate tax purposes. 4. The value of the interest (at either the decedent's death or at the alternate valuation date) must be included in the decedent's gross estate for estate tax purposes. 5. The interest transferred from the decedent must "pass" to (or for the initial and exclusive benefit of) the decedent's surviving spouse. 6. The interest transferred to the decedent's surviving spouse must not be a "nondeductible terminable interest". 7. The decedent's surviving spouse must not disclaim the interest which is to be transferred to the decedent's surviving spouse. B. A property interest which "passes" to the decedent's surviving spouse includes any interest which is taken by the decedent's surviving spouse in any one of the following ways. Read section 2056(c). 1. Such interest is devised to the decedent's surviving spouse. Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -12-
a. This property (or interest therein) is includible in the decedent's gross estate under Section 2033, and, in general, the interest is transferred to the decedent's surviving spouse by the decedent's last will and testament or under the laws of descent and distribution. 2. Such interest is taken by the surviving spouse as a dower or curtesy interest or as the statutory interest in place of dower or curtesy, if elected. a. This property (or interest therein) is includible in the decedent's gross estate under Section 2033. 3. Such interest is assigned to the decedent's surviving spouse due to a court decision in a will contest. a. However, such an assignment is considered as passing from decedent to the decedent's surviving spouse only to the extent that the bona fide rights of the decedent's surviving spouse required the assignment. Read U.S. Treas. Reg. 20-2056(e)-2(d)(2). b. If the decedent's surviving spouse assigns or surrenders an interest to another individual in settlement of a will contest or controversy, then such assigned or surrendered interest does not pass from the decedent to the decedent's spouse. Read U.S.Treas. Reg. 20-2056(e)-2(d)(1). 4. Such interest has been transferred from the decedent to the decedent's surviving spouse at any time. a. An example of this is the case in which the decedent establishes, during the decedent's life, an irrevocable trust, with the net income to the decedent's child for the child's life, and with the remainder to the decedent's spouse, but (despite the fact that the decedent might have made a taxable gift for gift tax purposes) the decedent retains, until the decedent's death, one or more powers over the trust's principal which causes the entire trust estate of the trust to be includible in the decedent's gross estate for estate tax purposes under either Section 2036 or Section 2038 (for example, the decedent retains the power to change the beneficiaries to other individuals). (1) In such a case, the entire trust estate of the trust (determined at the decedent's date of death or at the alternate valuation date) is includible in the decedent's gross estate, for estate tax purposes, but the decedent is entitled, for estate tax purposes, to an estate tax marital deduction for the value (at the decedent's death or at the alternate valuation date) of the remainder interest in the trust, assuming that such remainder interest was still owned by the decedent's surviving spouse at the decedent's death. b. Another example of this type of passing is the case in which the decedent gives to the decedent's spouse a life insurance policy which insures the life of the decedent and which life insurance policy names the decedent's spouse as the life insurance beneficiary and the decedent dies within three years of the gift of the life insurance policy to the decedent's spouse. (1) In such a case, the gift of the life insurance policy to the decedent's spouse qualifies for the gift tax exclusion and for the gift tax marital deduction. (2) Then, the life insurance proceeds are includible in the decedent's gross estate, for estate tax purposes, under Section 2035, and the decedent is entitled to an estate tax marital deduction for the amount of such life insurance proceeds. 5. Such interest has been transferred to the decedent's surviving spouse as a tenant by the entirety or as a surviving joint tenant with rights of survivorship with the decedent. a. An example of this type of passing is the case in which the decedent acquires title to some land, puts the title to the land in the decedent's and the decedent's spouse's names, as tenants by the entireties, as a gift to the decedent's spouse, and dies with the title to the land in the decedent's and the decedent's spouse's names as tenants by the entireties. Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -13-
(1) In such a case, 50% of the value of the land (at the date of the decedent's death or at the alternate valuation date) is includible in the decedent's gross estate, for estate tax purposes, under Section 2040, and such includible 50% qualifies for the estate tax marital deduction. 6. Such interest is transferred to the decedent's surviving spouse due to the exercise or failure to exercise or the release of a power of appointment. a. An example of this type of passing is the case in which the decedent exercises, by the decedent's last will and testament, a testamentary general power of appointment in favor of the decedent's surviving spouse. (1) In such a case, the amount of funds so passing to the decedent's spouse qualifies for the estate tax marital deduction. 7. Such interest transfers to the decedent's spouse in the form of life insurance proceeds under a life insurance policy which is owned by the decedent at the decedent's death and under which the decedent's spouse is the beneficiary. a. Similar types of transfers would be under any other type of contract, for example, under a qualified retirement plan, which is includible in the decedent's gross estate and which is payable to the decedent's surviving spouse. Read U.S. Treas. Reg. 20.2056(e)-1(a)(6). C. In a nutshell, the following interests which pass to the decedent's surviving spouse do not qualify for the estate tax marital deduction. 1. A property interest which is not includible in the decedent's gross estate. 2. A property interest which is transferred to the decedent's surviving spouse in order to satisfy a claim against the decedent's estate. 3. A property interest with respect to which a deductible loss occurs during the administration of the decedent's estate to the extent of such loss. 4. A property interest which is a nondeductible terminable interest. 5. A property interest which is disclaimed by the decedent's surviving spouse. D. As stated, in order for property passing from a decedent to a surviving spouse to qualify for the estate tax marital deduction, the recipient spouse must be married to the decedent at the time of the decedent's death. 1. Thus, the estate tax marital deduction is not allowable with respect to transferred property if the decedent is not married to the transferee at the time of death even though the transferee is the decedent's spouse at the time of the transfer. E. As stated, an estate tax marital deduction is not allowable if the surviving spouse properly disclaims the property interest, which is commonly referred to as a "qualified disclaimer". Read section 2518. 1. The disclaimed interest is considered as passing to the person who is entitled to receive that interest as a result of the disclaimer. a. However, if a surviving spouse receives an interest in property as a result of a qualified disclaimer by another person, that interest is considered as passing directly from the decedent to the surviving spouse and qualifies for the estate tax marital deduction. (1) If the decedent devises the decedent's entire estate to the decedent's child, but the child disclaims the property so devised to the child, and, as a result, the property is transferred, by the applicable probate law, to the decedent's surviving spouse, then the transfer of such property to the decedent's surviving spouse qualifies for the estate tax marital deduction. F. The estate tax marital deduction is allowable only to the extent of the net value of the property (or interest therein) which passes to the decedent's surviving spouse. Read section 2056(b)(4). 1. Specifically, Section 2056(b)(4) provides that in determining the value of the property which passes to the decedent's surviving spouse and which qualifies for the estate tax marital deduction, such value must be reduced by the amount of any federal or state death taxes, all liabilities which are secured by such property, and by all other obligations which the decedent's surviving spouse incurs (as the result of such passing) under the last will and testament, trust agreement, or law provisions which govern the passing of such property to Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -14-
the decedent's surviving spouse. 2. Thus, if any death taxes are charged, by law or by the decedent's last will and testament or trust agreement, against the surviving spouse in connection with the passing of any property which qualifies for estate tax marital deduction, the amount of such death taxes reduces the value of the estate tax marital deduction. 3. If a property interest which passes to the decedent's surviving spouse is subject to a mortgage or other encumbrance, or if another type of obligation is imposed on the decedent's surviving spouse (for example, another type of debt of the estate which the estate requires the decedent's surviving spouse to pay) in connection with the passing of a property interest to the decedent's surviving spouse, then the value of the interest (which otherwise qualifies for the estate tax marital deduction) must be reduced by the amount of the mortgage or other obligation. 4. Further, a property interest passes to the decedent's surviving spouse when the decedent's estate pays, pursuant to the decedent's last will and testament, a debt of the decedent's surviving spouse for which the decedent had no liability. a. In such a case, the amount so paid by the decedent's estate qualifies for the estate tax marital deduction. 5. Further, whenever the decedent's surviving spouse receives a devise with a condition that the decedent's surviving spouse relinquish certain other property, the value of the conditional devise is the amount by which the value of the conditional devise exceeds the value of the relinquished property. 6. However, if the decedent's last will and testament or local law requires the decedent's estate to discharge the debt from other assets of the decedent's estate or to reimburse the surviving spouse for the debt, then the payment or reimbursement constitutes an additional interest passing to the decedent's surviving spouse and which interest qualifies for the estate tax marital deduction. 7. In addition, the estate tax marital deduction is reduced by the amount of death taxes, etc. which are payable from the interests which are granted to the decedent's surviving spouse, even if the personal representative of the decedent's estate pays such taxes, etc. from other property of the estate. G. Certain interests in property which pass from a decedent to the decedent's surviving spouse are referred to as "terminable interests". Read section 2056(b). 1. Such interests are interests which will terminate or fail after the passage of time or upon the occurrence or nonoccurrence of some event or contingency. a. Examples of interests which can be nondeductible terminable interests are: life estates, annuities, estates for terms of years, and patents. b. Another example is an interest which will terminate if "Peter dies before Sue". c. Another example is a devise in the decedent's last will and testament which provides that the decedent's surviving spouse is devised the decedent's "tangible personal property providing that the decedent's surviving spouse survives the decedent by 30 days". 2. Some terminable interests are deductible terminable interests and some terminable interests are nondeductible terminable interests. 3. A terminable interest is nondeductible if: a. Another interest in the same property passes from the decedent to a person (other than the decedent's surviving spouse or the estate of the decedent's surviving spouse) for less than adequate and full consideration in money or money's worth; and, b. Because such interest so passes to such other person, the other person (or that person's heirs) may possess or use any part of the property after the surviving spouse's interest ends or fails. (1) A nondeductible terminable interest exists if a decedent devises real property to the decedent's surviving spouse for life, with the remainder interest being devised to the decedent's children. (a) In general, the life interest which passes to the decedent's surviving Copyright 1986 Through 2010, Professor Jegen s Taxsite F-2064 EH Deductions From Gross Estate -15-