3. The Federal Estate tax basic features

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1. Briefly describe the purpose and basic features of the federal estate tax. purpose: Enacted in 1916, the federal estate tax was created to bring about the redistribution of wealth by placing an excise tax on the right to transfer wealth at death
unified tax system:: a descriptive term for the federal gift and estate tax system after 1976; it denotes that both taxes currently have a common rate schedule, applicable credit amount (through 2003), marital deduction, and charitable deduction
applicable credit amount and applicable exclusion amount: Both are features of the federal unified transfer system; however, the former is a dollar-for-dollar offset against taxes due, while the latter is the amount of taxable property that would result in that amount of tax due. These amounts are currently the same for both the federal gift and estate tax, but will cease being the same beginning in 2004.
as a unified tax system: The federal gift and estate taxes can be described as a unified tax system because, after 1976, the gift tax and the estate tax have the same basic featuresÂ—namely, a tax rate table, applicable credit amount (until 2004), unlimited marital deduction, and unlimited charitable deduction
as progressive: The federal gift and estate taxes can be described as progressive because the tax rate table has multiple brackets, with rates from 18% to 49% in 2003. This means that an additional dollar's worth of taxable property may be taxed at a higher rate than the prior dollar's worth of taxable property. (see Table 3).
6. Identify at least two characteristics of the unified tax system that are not common to testamentary transfers and lifetime gifts.: the annual exclusion allowed for present interest lifetime gifts; there is no comparable provision for transfers at death
gift splitting, which allows the nonowner spouse to treat one-half of the property gifted by the owner spouse as being gifted by the nonowner spouse and therefore subject to his or her annual exclusion amounts and applicable credit amount; there is no comparable provision for transfers at death
taxation of gifts on a tax-exclusive basisÂ—i.e., gift tax is not paid on the dollars used to pay the tax that is due; estate transfers are taxed on a tax-inclusive basisÂ—i.e., estate tax is paid on the dollars that are used to pay the tax that is due
automatic step-up in income tax basis for death-time transfers until 2010 (if included in gross estate) but not for lifetime transfers
b. Basic features: The estate tax imposes a transfer tax on property passing from a decedent at death. It reaches a wide variety of assets beyond the probate estate. Assuming the decedent made no lifetime taxable gifts, taxable transfers up to the amount of the estate tax applicable exclusion amount are insulated from tax by the estate tax applicable credit amount. Unlimited marital and charitable deductions can reduce the tax liability to zero on even very large estates.
3. Identify the differences between the terms in each of the following pairs. inheritance tax and estate tax: Both are death taxes; however, the former is paid by the devisee, legatee, or heir for the right to receive property, while the latter is paid by the decedent's estate for the right to transfer property.
4. Discuss the following terms in relation to the federal gift and estate taxes. as a transfer tax system: The federal gift and estate taxes can be described as a transfer tax system because the taxes are imposed on the right to transfer property either during lifetime (gift tax) or at death (estate tax); contrast this with taxes on income earned (income tax) or the sale of goods (sales tax).
as cumulative: The federal gift and estate taxes can be described as cumulative because all prior taxable gifts must be added to the current year's taxable gifts before calculating the gift tax due, and taxable gifts (adjusted taxable gifts) must be added to the taxable estate before calculating the estate tax due.
5. Identify at least four characteristics of the unified tax system that are common to both testamentary transfers and lifetime gifts: the use of the same progressive tax rate schedule
a single applicable credit amount (until 2004) that offsets taxes dueÂ—first on taxable gifts and then on the taxable estate, until it is exhausted; its use is mandatory until exhausted
an unlimited marital deduction for qualifying gifts or estate transfers between spouses
an unlimited charitable deduction for qualifying gifts or estate transfers to qualified charities
the calculation is cumulative
Identify types of death taxes that may be paid to a state.: Types of state death taxes that may be imposed are: (1) estate tax, or (2) inheritance tax
8. Describe how bequests are treated for income tax reporting purposes by those receiving them.: For purposes of income tax reporting, property received by bequest is not considered income to the recipient
9. Describe how persons receiving property by bequest (until 2010) determine their income tax basis for such property.: A beneficiary's income tax basis for property received by reason of the decedent's death until 2010 is the value of the property shown on the decedent's final estate tax return, or if no return is filed, the property's fair market value on the date of death
10. What is meant by a step-up in basis? When is it allowed?: A step-up in basis means that assets owned by a decedent receive a new federal income tax basis in the hands of the new owner, equal to the property's value for federal estate tax purposes. In other words, most property that is included in a decedent's gross estate receives a step-up in basis. There are three significant exceptions, notably (1) income in respect of a decedent, (2) property acquired by a decedent by gift within a year of death and subsequently left to the donor or the donor's spouse (a reverse gift), and (3) the surviving spouse's community property share. The first two exceptions do not receive a step-up in basis, while the last exception receives a step-up even though it is not part of the deceased spouse's gross estate. This step-up in basis will be automatic until 2010. Beginning in 2010, and continuing in any year thereafter in which the estate tax is repealed, a step-up in basis can be achieved only by an affirmative allocation of increased basis (not to exceed the property's fair market value at death) by a decedent's personal representative
12. What valuation dates can be used for the federal estate tax?: The valuation date is either the date of death or the date six months after the date of death. The latter date is called the alternate valuation date. It is available by election and, if elected, must be applied to all properties in the gross estate. Some assets decline in value by their nature (e.g., an annuity). The natural decline in the value of such assets is not considered when alternate valuation is elected. This type of asset must be valued as of the date of death, even though other assets are valued on the same alternate valuation date. If property is sold to a disinterested third party between the date of death and the alternate valuation date, and alternate valuation has been elected, the property sold is valued at the sale price
14. Identify five factors necessary for an estate to qualify real estate for the special use valuation under Code Section 2032A.: It must have been held in qualified use for five out of the eight years prior to death by the decedent or a member of the decedent's family.
The value of qualified real and personal property must equal at least 50% of the decedent's gross estate after both are reduced by applicable secured debts and mortgages.
The value of qualified real property alone must equal at least 25% of the decedent's gross estate after both are reduced by applicable secured debts and mortgages.
The property must pass to a qualified heir.
There must have been material participation by the decedent or a member of the decedent's family for five out of eight years preceding the decedent's date of death
18. Describe how co-owned interests are valued for federal estate tax purposes. tenancy in common: tenancy in common: the fair market value of the donor's or decedent's fractional interest on the date of transfer
among nonspouses: For estate tax purposes, the deceased tenant's share based on his or her proportional contribution to the acquisition and improvement costs of the propertyÂ—100% is presumed to be includible in the deceased's gross estate unless his or her estate can prove contribution by the other joint tenants
Under what circumstances must a federal estate tax return be filed?: A federal estate tax return must be filed in all cases where a decedent's gross estate exceeds the maximum estate tax applicable exclusion amount for the year of death, or where a decedent's adjusted taxable gifts after 1976 plus the decedent's gross estate exceed the maximum estate tax applicable exclusion amount.
25. Who is liable for the federal estate tax: The executor of the decedent's estate is personally liable for the federal estate tax, which ordinarily is paid from the decedent's assets. However, if collection of the tax from the estate and the executor fails, recipients of the decedent's assets can be personally liable for the tax to the extent of the value received
13. Identify 12 factors that affect the valuation of real property included in the gross estate.: the nature and condition of the property (physical qualities and defects)
the size and location of the property
actual and potential use of the property (based on consideration of trends)
how suitable the property is for actual or intended use
zoning restrictions
the size, age, and condition of the buildings
the market value of comparable property within the area
the value of net income received from the property
the probate court valuation
comparable sales of property
the replacement cost
unusual facts about/uniqueness of the property
16. Describe how life insurance on the life of a deceased insured is valued for federal estate tax purposes: It is measured by the value of the death benefit (i.e., the face value reduced by any loans or other charges against the policy).
joint tenancy with right of survivorship between spouses: one-half of the fair market value (Note: The amount contributed by each spouse is irrelevant unless the joint tenancy was created prior to 1977 and decedentÂ’s estate elects to prove that decedent paid more than half of the initial contribution; in this event, the estate can include more than half of the asset to give the surviving spouse a step-up in basis on whatever is included in the gross estate.)
22. When is a federal estate tax return due?: A federal estate tax return is due nine months after the decedent's date of death. However, it is possible to secure an extension of time to file.
Who is required to file the estate tax return, and where is it filed?: The executor of the decedent's estate is required to file the return within nine months of the decedent's death. If there is no executor, any and all persons in possession of the decedent's property are required to file a return regarding the property in his or her hands. The return is filed with the IRS service center designated in the estate tax return instructions.
32. List at least five categories of assets included in the gross estate: The most common categories of assets included in the gross estate are: (1) probate or solely owned property, (2) life insurance proceeds, (3) jointly owned property, (4) survivorship benefits in pension plans or annuities, and (5) general powers of appointment.
26. Aaron Ward owns a house and lot in an area of the city that is zoned for commercial use. On either side of and adjacent to this lot are office buildings 10 stories high. Each has a vacancy rate of 2% and was built about 10 years ago on two former res: At least the following factors should be considered:

The size of the lot is important because it will affect what can be built on it. The location is also important because the surrounding area already has been subjected to high-density use.
Because the property is not being utilized for its highest and best use, the actual use of the property is almost irrelevant. The critical factor in valuation is its potential use.
Zoning is important because although the area, including this property, is zoned for commercial use, the zoning laws may require that the lot be a minimum size for commercial building. Thus, the true comparables for this property are vacant lots of the same or similar size that are zoned for commercial use.
The selling prices of comparable property, if available, are of primary importance.
The fair market value of this property is obscured by several unusual facts: (a) to use the lot, the building must be razed, which means that the cost of the razing must be determined and factored in as a negative value; (b) if a multistory building can be built on a lot so small, additional building costs may have to be factored in because of the need to protect the adjacent buildings during construction; (c) the 2% vacancy rate of the adjacent buildings needs to be researched to determine whether it measures current demand or is based on long-term leases entered into 10 years ago or more
Answers 3Â–1 Describe the basic features of the federal estate tax. 1. Briefly describe the purpose and basic features of the federal estate tax. purpose Enacted in 1916, the federal estate tax was created to brin: Although this farm real estate was used in operating a farm at Bert's death, which constitutes a qualified use for purposes of Code Section 2032A, it was not owned and used as such by Bert or a member of his family for five out of the last eight years.
The qualified real property has a value of $450,000, and the qualified personal property has a value of $150,000Â—for a total of $600,000. The gross estate is $1.1 million. Since there are no debts or mortgages, neither the qualified real and personal property nor the gross estate must be reduced by any amount. $600,000 is more than 50% of $1.1 million.
The qualified real property has a value of $450,000 (the value is not reduced for debts and mortgages because there are none). The gross estate has a value of $1.1 million (the value is not reduced for debts and expenses because there are none). $450,000 is more than 25% of $1.1 million.
According to Bert's will, all of his property, including the farm real estate, passes to his spouse and two children equally. Spouses and children are qualified heirs for purposes of Code Section 2032A.
Bert operated the farm for only 10 months. Code Section 2032A requires material participation in the farming operation by the decedent or a family member for five out of the eight years preceding death.
Conclusion: Bert's estate does not qualify for the special valuation election under Code Section 2032A. Although factors b. through d. satisfy the requirements of the Code, factors a. and e. do not
46. Identify the five requirements that must be met for a transfer to qualify for a charitable estate tax deduction.: The gift must be made to a qualified charity.
It must be cash or property rather than services.
It must be a contribution in excess of any value the donor receives from the charity.
The property transferred to the charity must be included in the decedent's gross estate.
It must not be a gift of a partial interest, unless it is of a type authorized by the tax code
47. Define what is meant by the term marital deduction as it relates to the the estate tax. Discuss how the Code's current marital deduction differs from the marital deduction prior to 1982. definition of marital deduction: The marital deduction is an amount subtracted from a decedent's gross estate to arrive at the amount of the taxable estate. The deduction is based on the value of property transferred gratuitously in a qualifying form to the decedent's spouse
current versus past marital deduction amount: Until 1982, the marital deduction amount was limited. However, currently, 100% of the value of all property transferred from one spouse to another in a qualifying form is subtracted. This results in a taxable amount of zero for all qualifying transfers between spouses.
48. Identify the conditions that must be satisfied for a transfer to qualify for the estate tax marital deduction: For a transfer to qualify for the estate tax marital deduction, four conditions must be satisfied at the time of the transfer. The transfer must be made:

to the donor's legal spouse
to a U.S. citizen
in a qualifying manner; i.e., it must do one of the following:
give the recipient spouse control and enjoyment of the property that is tantamount to outright ownership, or
qualify for treatment as qualified terminable interest property (QTIP) and the QTIP election must be made
of property that is included in the decedent's gross estate
49. The concept of a terminable interest is important to understanding the marital deduction. Define terminable interest.: A terminable interest is an interest in property that will terminate upon a lapse of time or at the occurrence or nonoccurrence of a specified eventÂ—e.g., the interest is only a legal life estate, or a beneficial interest for a term of years.
What is the terminable interest rule: The terminable interest rule denies a marital deduction to offset the value of any terminable interest transferred to a spouse unless the transfer falls within a statutory exception (see 49c below).
List five exceptions to the terminable interest rule.: If a transfer falls within one of the exceptions to the terminable interest rule, even though the interest technically is a terminable interest, the transferor is allowed a marital deduction. Terminable interests that will qualify for the marital deduction are:

any property interest that is a terminable interest solely because the surviving spouse is required to survive the decedent spouse for a specified period, as long as the period does not exceed six months
a life estate with a general power of appointment
an estate trust (the recipient spouse is the sole beneficiary of the trust and all trust assets are paid to the recipient spouse's estate upon his or her death)
an income interest in a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT) where the transferor's spouse is the only noncharitable beneficiary
qualified terminable interest property (QTIP) where the marital deduction is elected
50. If a donor made a taxable gift of $1 million in 2003 and dies later in the same year, how much applicable credit amount can the donor/decedent take on his or her federal estate tax return?: He or she can take $345,800. Although the applicable credit amountof $345,800 was used for the gift, and, therefore, would not seem to be available for use in the estate tax calculation, the applicable credit amount is "restored" for the estate tax because the tax base for the estate tax will include the $1 million taxable gift. Note, however, that the applicable credit amount will only pay the estate tax attributable to this taxable gift, and thus will not be available to pay any tax generated by the decedent's taxable estate.
51. If a donor makes a taxable gift and has to pay $9,600 in gift tax out of pocket because he has exhausted his applicable credit amounton previous taxable gifts, what is the impact of paying this $9,600 on the donor's estate tax calculation?: If the donor dies within three years of the date of completing the taxable gift, the donor/decedent must add $9,600 to his gross estate under the gross-up rule (Code Section 2035). If the donor dies more than three years after the date of completing the taxable gift, the donor/decedent does not need to increase his gross estate by the $9,600. In either event, however, the donor/decedent will be entitled to a gift tax payable deduction pursuant to Code Section 2001(b)(2). This deduction will be in the amount of $9,600, unless the taxable gift was made in a year where the gift was taxed at a rate that is higher than the rates that would have been applied if the gift had been made in the year of death (in which event the deduction must be recalculated and will be smaller in amount).
59. A knowledge of the nature of QTIP treatment of property is important to understanding marital deduction and bypass planning. Identify the conditions that must be met for a transfer to receive QTIP treatment, and what is required to create a qualified: To receive QTIP treatment, three conditions must be met:

the recipient spouse must receive a qualified income interest
the recipient spouse must not be able to control where trust property goes after his or her death (e.g., by having a general power of appointment over trust property, or by trust property being payable to the recipient spouse's estate at death)
the decedent spouse's executor must make an irrevocable election to use this treatment
requirements for a qualified income interest: A qualified income interest is one in which:

the recipient spouse is entitled to all the income from the property
only the spouse can receive the income; therefore, it cannot be split with any other beneficiary
distribution of the income is mandatory; therefore, it cannot be accumulated
the income must be paid at least annually
no one has the power to appoint any part of the property to any person other than the surviving spouse
If the property is non-income producing, and if the recipient spouse is given a life estate in the property, the transfer will be eligible for the QTIP election.
65. Identify the estate tax implications of an outright (i.e., nontrust) bequest of cash or property to a qualified charity.: The estate will include the assets given to the charity in the gross estate. The estate will receive a charitable deduction for the value of what is given to the charity if the charity is given all of the decedent's interest in the asset. The estate will also get a charitable deduction for the present value of a remainder interest in a farm or personal residence given to a charity, unless the life estate in the farm or personal residence is given to the decedent's surviving spouse. In this event, the estate will receive a marital deduction for the entire value of the asset if the QTIP election is made. The value of the farm or personal residence as of the surviving spouse's date of death will be included in the surviving spouse's gross estate, which will receive a charitable deduction in the same amount.
66. Identify the estate tax implications of a testamentary charitable lead trust: The estate must include the assets of the trust in the gross estate but will receive a charitable deduction for the present value of the income interest that the charity will receive. If the remainder interest is given to the decedent's spouse, the estate will also be given a marital deduction for the present value of this interest. Otherwise, the remainder interest will be taxable
67. Identify the estate tax implications of a testamentary charitable remainder trust that names the decedent's spouse as the sole income beneficiary.: The estate must include the assets of the trust in the gross estate but will receive a marital deduction for the entire value of the trust assets. The value of the trust assets as of the date of death of the decedent's spouse will be included in the spouse's gross estate, which will receive a charitable deduction in the same amount
69. Identify the estate tax implications of a testamentary charitable remainder trust that names a person or persons other than the decedent's spouse as income beneficiaries: The estate must include the assets of the trust in the gross estate but is entitled to a charitable deduction for the present value of the remainder interest that will go to the charity. The present value of the income interest will be taxable.
70. John Adams was the sole owner of the family residence. In his will, he bequeathed a life estate in the residence to his wife, Jane, along with a power of appointment over the property that requires her to offer it to their children at a reasonable pr: John Adams (or his estate) is not entitled to a marital deduction for the transfer of a life estate in the residence and accompanying power of appointment to his wife, Jane. Because Jane could not appoint the property without first offering it to her children at a reasonable price, she has not been given a qualifying general power of appointment, which must be "exercisable by the surviving spouse alone and in all events" (Regs. 20.2056(b)-5).
72. At her death, Beth Doherty would like to have her cash/cash equivalent assets placed in trust for her husband, David, for life, with the remainder to her son, Don. She would like to name her husband as the trustee and give him the right either to dis: Beth Doherty (or her estate) is not entitled to a marital deduction for the funds that she placed in trust for the benefit of her husband. David, who Beth named as trustee, is permitted to accumulate the income and corpus, and the accumulated income will not be paid to his estate. To get a marital deduction (if corpus and accumulated income are not payable to the surviving spouse's estate), the surviving spouse must receive the right to all income for life, paid on a mandatory basis at least annually, no matter who is trusteeÂ—even if it is the surviving spouse. Furthermore, the surviving spouse must be given a general power of appointment (A trust), or the decedent spouse's executor must elect the marital deduction (QTIP trust).

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