Federal Estate Tax Session 3 DePaul University CFP® Program

Federal Estate Tax

Session 3

DePaul University CFP® Program

What Is Federal Estate Tax?

Federal estate tax (FET)is tax on certain transfers of property at death.Such property may include:

Cash Securities Real estate Business interests The principal of certain trusts Other assets

Whether or not an asset goes through probate does not determine FET inclusion

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Federal Estate Tax

Federal estate tax (FET) is an excise tax on the privilege of giving your property away.Federal estate tax is filed using Form 706Personal representative must file and pay the tax

Executor or administrator Form 706 required when:

Decedent’s gross estate >$5,250,000 million (2013) or Decedent’s gross estate plus adjusted taxable gifts >

$5,250,000 million (2013)Federal estate taxes are due within nine months from the date of the decedent's death

A 6-month extension for filing (not paying) is generally granted


Question 3-1

For which of the following estates would Form 706 most likely have to be filed?A.Lou’s because he died owning more than $3 million in property. (made no lifetime gifts)

B.Stu’s because he died owning more than $3 million in property and had gifted an additional $4 million to his children.

C.Sue’s because she died owning more than $3 million in property and had gifted an additional $4 million to her husband.

D.Rue’s because she died owning more than $3 million in property and had gifted an additional $1 million to her grandsons.


The Federal Estate Tax Formula

Federal Estate Tax Formula:Gross estate- Adjustments (debts, expenses, state death taxes, casualty loss)

= Tentative taxable estate (aka adjusted gross estate)- marital and charitable deductions (generally unlimited)- state death tax= Taxable estate+ Adjusted taxable gifts (post-1976)= Tax baseX tax rate= Tentative estate tax- Credits (applicable credit, prior gift tax, other)= Net estate tax due


Estate Tax Property Exemptions Over Time

Year Estate Tax Exemption Top Estate Tax Rate

1997 $600,000 55%

1998 $625,000 55%

1999 $650,000 55%

2000 $675,000 55%

2001 $675,000 55%

2002 $1,000,000 50%

2003 $1,000,000 49%

2004 $1,500,000 48%

2005 $1,500,000 47%

2006 $2,000,000 46%

2007 $2,000,000 45%

2008 $2,000,000 45%

2009 $3,500,000 45%

*2010 $5,000,000 or $0 35% or 0%

2011 $5,000,000 35%

**2012 $5,120,000 35%

2013 $5,250,000 40%


American Taxpayer Relief Act of 2012 (ATRA)

With the passage of the ATRA, Congress made the following items permanent: Effective exemption for combined bequests

and gifts set at $5 million Indexed that value for inflation ($5.25MM in

2013) Surviving spouses may claim unused

exemption of their deceased mates. Raised the maximum rate from 35% to 40%


Fewer Americans Subject to Estate Tax

The Tax Policy Center estimates that in 2013, just 3,800 estates—fewer than one in 700—will owe the tax. And they’ll pay a total of just $14 billion—half the revenue collected five years ago.

The higher 2013 tax rate (40%) makes no difference to the nearly 99.9 percent of estates that are exempt from estate taxes. Big estates will face a significantly higher tax bill - a $100 million estate will pay nearly $5 million more.


The Gross Estate

A decedent’s gross estate includes all property in which the decedent held an interest at death.The gross estate is calculated before ANY deductions are applied.Allowable deductions then reduce the gross estate.


Gross Estate Inclusion Examples

The following are examples of property included in a decedent’s gross estate:Fee simple property (individually owned)Joint tenancy property

One half included if spousal Non-spousal: proportion included if consideration

furnished by survivor can be provenDecedent’s fractional interest of TIC propertyRevocable trust property


Gross Estate Inclusion Examples

continued:Property in some “tainted” irrevocable trusts Life insurance

Owned by decedent Transferred within three years of death

Reversionary InterestsSurvivor annuities…….more


Question 3-2

Which of the following assets would not be included in Mark’s gross estate?

A. His municipal bond portfolio

B. His IRA naming his wife, Anne as beneficiary.

C. A right to receive income until death from his grandmother’s trust

D. His jeep


Life Insurance Policies Included in Gross Estate

A policy of life insurance that insures the life of another and owned by the decedent at death is included in the gross estate. Generally, value of policy is replacement value but type of policy may determine valuation method:

Newly issued policies, the value = premiums paid. “Paid up” one-time, single premium policies, value

= carrier’s current cost for identical policy. Policies in force for some time on which additional

premiums are due, value = interpolated terminal reserve amount plus unearned premiums


Life Insurance Proceeds Generally Included in Gross Estate

The proceeds of a life insurance insuring the decedent’s life is included in the gross estate if the decedent held “incidents of ownership” at death. Incidents of ownership include:

Right to name/change beneficiary Right to assign ownership Right to make policy loans ….more

Proceeds are included in the gross estate for FET purposes regardless of who actually receives them.


When Life Insurance Is Not Included In The Gross Estate

Proceeds of life insurance on the decedent’s life will not be included in the gross estate when:The decedent gives away the policy more than 3 years prior to death retaining no incidents of ownershipThis includes the transfer to an irrevocable life insurance trust (“ILIT”)Life insurance where decedent held no incidents of ownership in the policy at death and decedent’s estate is not named beneficiary


Question 3-3

Six weeks after transferring his life insurance to an irrevocable trust, Rick was hit by a bus. What happens in terms of his gross estate?A.The insurance is not in his gross estate because it was held in trust.

B.The insurance is not in his gross estate because insurance is not a financial asset.

C.The insurance is not in his gross estate because Rick’s death, although within three years of the transfer was accidental.

D.The insurance is in his gross estate because Rick held incidents of ownership within three years of his death.


Other Assets Not Included in aDecedent’s Gross Estate

The following assets are not generally included in a decedent’s gross estateGifted property over which decedent retained no powers of control/enjoyment at death:Property over which decedent held only a non-general power of appointment


Property in the Gross Estate

Property in a decedent’s gross estate includes:Individually owned propertyOne’s fractional interest in TIC property50% of spousal JTWROS property50% of community property100% of non-spousal JTWROS property unless estate can prove survivor’s contribution


Property in the Gross Estate

Property in a decedent’s gross estate includes:Proceeds of life insurance with incidents of ownershipProceeds of life insurance transferred within 3 years of deathRetained interest propertyReversionary interest propertyPersonal effects


The Three-Year Rule

Certain transfers made within 3 years of death are included in the gross estate including:Gift tax actually paid by the decedent

Only the tax paid, not the amount of the gift To discourage reduction of the estate by the tax-

exclusive nature of the gift tax Known as “grossing up” the estate

Severance of a retained interest less than 3 years prior to deathLife insurance transferred by the insured to anyone, including a spouse or trust


Valuation of Assets for Federal Estate Tax Purposes

In determining the gross estate, assets are generally reported at fair market value (FMV)Decedent’s full or proportional interest shownCertain discounts may apply

Lack of marketability discount Lack of control discount (minority discount) Key person discount Co-ownership discount Blockage discount


The Alternate Valuation Date (AVD)

Some estates may elect to value the gross estate as of the date 6 moths after the date of death (AVD).To use the alternative valuation date, all three requirements must be met:

Electing the AVD must decrease the value of the GE Electing the AVD must decrease the amount of FET

actually due The PR who files the 706 must make the proper

election on the return. This election must be made within 1 year after the

due date of the federal estate tax return (including extensions).


Using the AVD

If the alternate valuation date value is elected it applies to all assets in the gross estate, except:Assets sold between death and the AVD are valued at sales priceAssets that diminish in value over time by their nature, e.g., annuities, royalties and MOG interests subject to depletion

Possible disadvantage: use of AVD will reduce the basis in the assets received by distributees


AVD Example

Butch dies on January 1, 2012, owning 100 shares of Technotawk Inc, common stock having a date of death value @$75 per share. On July 1, 2012 that stock has a FMV of $50 per share.

If Butch’s PR elects the AVD the stock is valuated at $5,000 in Butch’s estate

If Butch’s Will gives that stock to his daughter, her basis for capital gains purposes is $5,000


Question 3-4

Which of the following assets would possibly not qualify for AVD treatment on the Form 706?

A.An IRA owned by Fred, who died at age 77.

B.A municipal bond portfolio owned by Marilyn.

C.Rita’s house

D.Arthur’s mutual funds


Lack of Marketability and Minority Discounts

The value of business interests transferred to family members may be reduced by lack of marketability and/or minority discounts. A lack of marketability discount is a reduction in the value of the property due to the difficulty or inability of the owner to sell the property to a third person. A minority discount is a reduction in the value of the property since the interest does not provide for control of the entity.


Question 3-5

The minority interest discount is most likely to be available for valuating transfers of:

A.Real property

B.Publicly traded securities

C.Stock in a closely held business

D.Bonds


Lack of Marketability and Minority Discounts Example

Example, if Stu’s estate transfers an interest in his closely-held business valued at $18,000, the estate may use lack of marketability and minority interest discounts and perhaps reduce the value of the gift for estate tax purposes from $18,000 to $12,000.


Key Person Discount

The key person discount is an amount or percentage deducted from the value of an ownership interest to reflect the reduction in value resulting from the actual or potential loss of a key person, often the founder, in a business enterprise.Factors used to evaluate whether to apply a key-person discount include the:

Company’s relationships with customers and suppliers, Nature of the business, Key person’s actual duties and activities, and Quality and depth of the company’s management team.


Co-Ownership Discount

The co-ownership discount reflects a transferee receiving a fractional interest in real property.This reflects that all current owners may not have similar objectives.

Example: Your late mother left you her ½ interest in a building she owned with her sister (your aunt). Your aunt has no wish to sell the building and it may be difficult to find a buyer to co-own property with your aunt.

Discount reflects lower probability of turning the asset into immediate cash.


Blockage Discount

A blockage discount is a deduction from the price of a publicly traded stock. The discount may be available when the block of stock to be valued is so large (relative to the volume of actual sales on the existing market) that the block could not be quickly liquidated without depressing the market price.Value of gross estate is a “snapshot” on the date of death. Bill Gates’ 460MM shares of MSFT (10X daily volume is a different picture than someone else’s 400 shares.


Vaulating Publicly Traded Stocks

Publicly traded stocks are valuated at the average/mean of the high and low prices on the date of death multiplied by the number of shares the decedent owned. Not the settlement priceNote: If the death occurs on a day when the stock market is closed, then the average prices for the stock on the trading days immediately before and after the date of death are used


Stock Valuation Example

The closing price is not used. If a stock's price fluctuated between ten and twelve dollars on the date of death, the average of $11.00 per share is used for determining the value of the stock.

If the death occurred on a weekend or holiday when the market is closed, the high and low values for the trading date prior to the death and those of the next trading date are "re-averaged."


Question 3-6

For transfer tax valuation purposes, publicly traded stock is most likely to be valuated at its:

A.FMV

B.Settlement price

C.Closing tick

D.Mean price


Valuing Mutual Fund Shares

For mutual funds, the gross estate includes the "bid" value, or public redemption price, of the fund as of the date of death.

If the death occurs on a weekend or holiday, the fund is valued based on the public redemption or bid value as of the trading date preceding the date of death.


Valuating Bonds

Bonds must include accrued interest when their value is determined. Since bonds typically pay interest twice a year, unless the owner dies on the date of payment, the interest from the date of the last payment through the date of death must be computed and included.If there is no high and low value for a bond on the date of the death, the average of the closing price on the date of death and the closing price on the trading day preceding the date of death is used.


Valuating US Savings Bonds

United States Series E, EE, H, and HH, Savings Bonds are valued at the price for which they could be redeemed during the month of death. The redemption value of such bonds, which depends on both the month and year of purchase as well as the redemption date, is available on a website published by the federal government.


Single Life Annuties

Single(pure) life annuities are not included in the gross estate for FET purposes.Why?

Because payments stop on the death of the (one) annuitant.

Thus, nothing can be “transferred” to another party.

Also, nothing to include in probate estate.


Question 3-7

How is a single life annuity valued for Federal Estate Tax purposes?

A. At FMV

B. At its intrinsic value

C. At its alternate valuation day value

D. At zero


Survivor Annuities

The present value of a survivor’s interest in an annuity having a survivorship feature is included in the (transferor’s) decedent’s gross estate.Contracts include

Joint and survivor annuities Refund annuities Term certain annuities before term completed

If there is no survivorship feature, no amount is included in the decedent’s gross estate because no value is transferred by the decedent


Valuating Real Estate

The value of real property is determined by written appraisal. For a single family residence, the appraisal can be made by a local real estate broker or agent.

The appraisal should describe the property, its value, and how that value was determined.

Similar agents or brokers, using the same procedures and submitting the written appraisal as mentioned, can value unimproved property valued at $250,000 or less.


Valuating Commercial Real Estate

Commercial property, including office buildings, apartment complexes and farms need to be appraised by a qualified appraiser. Costs that would result from a sale, including future brokerage commissions, etc. are normally excluded from determining the value of real property. If the property includes or consists of a farm or ranch, any farm equipment, livestock, stored seeds and fertilizers as well as growing or harvested crops are valued separately.


Valuating Farm and Business Real Property

If a farm or real property used in a closely held business is part of the gross estate, and the requirements are met, the executor may elect to value the property at its special use value, rather than its fair market value. If a farm or real property used in a closely held business is part of the gross estate, the executor may elect to value the property at its special use value, rather than its fair market value. The real property is then valued at its discounted business use value, not its fair market value at its highest and best use.


Valuating Autos, Planes, and Boats

The value of all vehicles is determined individually using the sale price as of the date of death. The value of automobiles may be determined by consulting the "Kelley Blue Book" or similar publications, and RVs, motorcycles, mobile homes, boats, or planes have similar publications that can be used to determine their value.


Valuating Fine Art

Art objects, including paintings, sculptures, tapestries, silverware, and other artifacts, are subject to the general valuation rules for estate tax purposes. Documentation required depends on the value of the articles. An art object valued at no more than $100 may be grouped with other articles on a room-by-room appraisal, with a separate value given for each item named. An executor is also allowed to submit an aggregate value as appraised by a competent appraiser or dealer.


Valuating Fine Art

Continued:For articles with artistic or intrinsic value of more than $3,000 or a collection of similar articles valued at more than $10,000, the appraisal must be made under oath by an expert who must also attach a statement of qualifications.When an art object has a value in excess of $20,000, the valuation is automatically reviewed by the Art Valuation Group (National Office) of the Engineering and Valuation Branch of the IRS for possible audit. When the value is greater than $50,000 and substantiated valuation is desired, the IRS provides a procedure for obtaining this secure art value.


Valuating Foreign Currency

Foreign currency is valued at the commercial or retail exchange rate as of the date of death. If death occurs on a weekend or bank holiday, the average exchange rate on the date prior to the death and that following is averaged.Coins and bills having a value exceeding their face value, such as silver certificates or items in a coin or similar collection, are valued at their potential sales value instead of their face value.


Retained Life Estates

If a decedent gave property away but retained the right to income from, or use of, the transferred property, such property must be included in the decedent’s gross estate at the date of death FMV.Mere right to determine who will enjoy property constitutes a retained interest

Known as the “beneficial enjoyment rule”


Retained Life Estate Example

Charles establishes a trust naming himself as trustee. The trust provides that the trustee has discretion as to which of his children, all named as beneficiaries, receive distributions at specific times.The trust property must be included in Charles’ gross estate


Question 3-8

If Evan does not want his stock portfolio to be part of his gross estate he should:

A.Transfer it to an irrevocable trust with his brother as trustee.

B.Own it individually

C.Transfer it to an irrevocable trust naming himself as trustee.

D.Own it individually, but leave it to his wife under his Will.


Typical Beneficial Enjoyment Exposures

Transferors may control “beneficial enjoyment” of their transferred property under various arrangements Examples:

Transferor dies while serving as custodian before UGMA and UTMA proceeds are distributed to the emancipated minor

Transferor dies while acting as trustee of a 2503(c) minor’s trust before minor turns 21


Deductions From Gross Estate to Compute Adjusted Gross Estate

The following deductions are subtracted from the gross estate to determine the adjusted gross estate (AGE):Reasonable funeral expensesDecedent’s final medical expenses

Not reimbursed by medical insuranceEstate administrative expenses

Attorney and accountant fees, appraisal fees, etc.The decedent’s debtsCasualty losses not covered by insurance

To the decedent’s property occurring after death, but before the estate is settled


Deductions From the Adjusted Gross Estate

Several deductions are permitted from the tentative taxable estate (AGE) to determine the tentative taxable estate. They are:Marital deduction

Unlimited for property passing to U. S. citizen spouse

Charitable deduction Generally unlimited

State death tax deduction For amounts actually paid (formerly a credit)


The Taxable Estate

The taxable estate is the adjusted gross estate reduced by the marital charitable, and state death tax deduction.

It is not always the amount to which the estate tax rate applies.

Why? Because > 1976 taxable gifts must be added to

the taxable estate before the tax rate applies This reflects the cumulative nature of transfer tax

during and after lifetime


Question 3-9

In calculating Federal Estate Tax which of the following is multiplied by the tax rate?

A.The gross estate

B.The adjusted gross estate

C.The taxable estate

D.The tax base


2013 Transfer Tax Rates

For transfers occurring in 2013: Applicable Exclusion Amount - $5,250,000

Maximum Estate Tax Rate – 40% Gifts Tax Exemption Amount -$5,250,000

Maximum Gift Tax Rate – 40% Generation Skipping Tax Exemption Amount -

$5,250,000 GST Transfer Tax Rate – 40%


Estate Tax Calculation

2013 Estate Tax Calculation

Example: Rex, a widower, died in 2013 with a $7,500,000 tax base. His federal estate tax is calculated below:

Tax base = $7,500,000-Exemption 5,250,000 Taxable amount $2,250,000X tax rate @ 40% = $900,000

The FET due is $900,000 assuming no credits other than the applicable credit

The applicable credit was reflected in the exemption of $5,250,000.


The Applicable Credit

The estate tax credit operates like any tax credit reducing tax liability $1 for $1.

Even if the gift tax applicable credit was used (fully or partially) during a decedent’s life time, the FULL estate tax credit is used (required) on Form 706. Why?

Because > 1976 taxable gifts must be added to the taxable estate to produce the tax base.


Relationship of Estate Tax Credit and Exemption

The 2013 Federal Estate Tax credit amount is $2,045,800. In the absence of this credit, $2,045,800 would

be owed on transfers of $5,250,000 in property.

Thus, the $5,250,000 represents the property exemption.


Portability Permanent (ATRA)

A major EP concern has long been the division of asset ownership among married couples to take maximum advantage of the combined estate exemptions regardless of the order of death.

“Portability” refers to the ability of the surviving spouse to utilize the deceased spouses unused estate exemption without relying on a trust structure.

As long as there is proper post-mortem planning employed following the first death, there is no risk of losing the availability of the entire $10.5 million exemption.


Reporting the Portability

To report the portability the surviving spouse must file IRS Form 706, United States United States Estate (and Generation-Skipping Transfer) Tax Return, in order to take advantage of the deceased spouse's unused estate tax exemption. A widow/er can not transfer portability of the

estate tax exemption from a deceased spouse onto a new spouse.


Exemption Portability Example

Assume Ted and Gloria are married and have all of their assets jointly titled and their net worth is $8,240,000, Ted dies first and the federal estate tax exemption is $5,250,000 on the date of Ted's death

When Ted dies his estate won't need to use any of his $5,250,000 estate tax exemption since all of the assets are jointly titled and the unlimited marital deduction allows Ted to transfer his share of the joint assets to Gloria without incurring any federal estate taxes.

Assume that at the time of Gloria's later death the federal estate tax exemption is still $5,250,000, the estate tax rate is 40%, and Gloria's estate is still worth $8,000,000.

With full portability of the estate tax exemption between spouses, Ted's unused $5,250,000 estate tax exemption will be added to Gloria's $5,250,000 exemption, in turn giving Gloria a $10,500,000 exemption.

Since Gloria has "inherited" Ted's unused estate tax exemption and she can pass on $10,500,000 free from federal estate taxes at the time of her death, Gloria's $8,240,000 estate won't owe any estate taxes at all:

$8,000,000 estate - $10,000,000 exemption = $0 taxable estate


Question 3-10

Maurice was married to Joan. When he died in 2013, he had $3,250,000 in property all of which he left to Joan. Joan is quite wealthy from book royalties and when she dies twelve years later she is worth $20 MM. Two years after Maurice died, Joan married Dagwood who is living at the time of her death. Which of the following is true assuming exemption amounts remain constant?

A.Maurice’s unused $2 million can be rolled onto Joan’s estate.

B.Maurice’s unused $2 million can be rolled to Joan then subsequently rolled onto Dagwood’s estate

C.Joan’s estate would only enjoy the $5,250,000 exemption because Maurice died more than ten years prior to her death.

D.Joan’s estate cannot avoid federal estate tax entirely.


Credit for Gift Taxes Paid

Gift tax paid on gifts added to the taxable estate operates as a credit against federal estate tax otherwise due


Prior Transfer Credit

The prior transfer credit applies when property passes through two taxable estates within a 10-year window. A credit against the estate tax is allowed for

federal estate tax paid on the transfer of property to the present decedent.


Prior Transfer Credit Amounts

The amount of the credit is determined based on the amount of time between the two deaths. The Internal Revenue Code provides a percentage chart to determine the amount of applicable credit, expressed as a percentage of the prior tax allowed as a credit in the present estate:

Period of time exceeding Not exceeding Percent Allowable

0 years 2 years 100

2 years 4 years 80

4 years 6 years 60

6 years 8 years 40

8 years 10 years 20

>10 years none


Estate Tax Formula Example

Here is a sample calculation of the federal estate tax for Hank’s estate, assuming he dies in 2013:

Gross Estate $8,530,000 Less: Funeral and Administration Expenses -$30,000 Tentative Taxable Estate/AGE =$8,500,000 Less: Marital Deduction -$2,000,000 Less: Charitable Deduction -$1,000,000 Taxable Estate =$5,500,000 Add: Adjusted taxable gifts +$580,000 Tentative Tax Base: =$6,080,000 Less exemption -$5,250,000 Tax base: $830,000 X 40% = $332,000 Federal Estate Tax Payable $332,000


Sources for Estate Liquidity: Life Insurance

Estate liquidity is often among reasons why life insurance is considered in a financial plan. It provides cash upon the death of the decedent. With appropriate trust planning, life insurance may be

removed from the decedent’s gross estate: If acquired through ILIT, gift to trust is premium If transferred through ILIT, gift is replacement value,

and If transferor dies within three years of transfer, life

insurance must be included in transferor’s estate. Life insurance is often used to fund buy/sell

agreements Premiums not deductible Death proceeds not taxable

May trigger corporate AMT in entity buy/sell


Sources for Estate Liquidity: Asset Sales

Assets may be sold to provide estate liquidity. Stepped up basis available on most assets:

Exceptions: Cash Retirement accounts Income in respect to a decedent (IRD)

Large holdings in illiquid assets require greater liquidity planning

Closely held business interests Require business succession plan

Real property Collectibles


Question 3-11

Agnes’ estate is facing a significant federal estate tax liability. Which of the following among her assets would probably be least productive in generating liquidity to satisfy the tax obligation?

A. Her mutual fund portfolio

B. Her vested profit sharing account

C. Her business

D. Life insurance held in her trust


Powers of Appointment

Powers of appointment are granted through trusts and wills enabling the holder to determine who will receive/enjoy property subject to the power. Typically granted to trustees and executors

The holder may address the power in one of three ways:

Release the power Holder relinquishes right to hold the power

Lapse the power Not appoint property to self within a year May cause a deemed gift if holder could have

appointed property to self without restriction Exercise the power

By appointing it to self, or others May trigger gift tax if holder could have appointed

property to self, but appoints it to others


Exercise In Favor of Another Example

Harvey is trustee of a trust established by his Aunt Millie. Millie’s trust granted him the power to appoint the property to anyone he chooses, including himself. Harvey appoints $50,000 of trust property to his sister, Lilly. Harvey is deemed to have made a $50,000

gift to Lilly. Why?

Because he could have appointed the property to himself.


General Powers of Appointment

A power that can be exercised under any conditions is a general power of appointment. Implied under a general power of appointment is that the holder may exercise that power, thus appointing the property to: Him/herself His/her creditors His/her estate Creditors of his/her estate


Estate Inclusion of General Powers

Property subject to a general power of appointment is included in the estate of the holder of such power. Why?

If the holder had the right to assume the property, s/he had the power to transfer that property.

Thus TRANSFER tax applies At death, estate tax Lapsing a power during life, gift tax …attributable to year when power lapsed or

released


Special/Limited Powers of Appointment

If the holder may exercise the power, appointing the property only under specific conditions or only to a predetermined list of beneficiaries, the power becomes a special (limited) power of appointment. Implied in a special power of appointment is that the holder

may not appoint the property to: Him/herself His/her creditors His/her estate Creditors of his/her estate

Because the holder of the special power has no right to transfer the property to him/herself (or financial equivalents) the holder is not deemed to transfer property upon death or annual lapse

Thus, neither estate nor gift tax is triggered


Five or Five Power

Under a 5 or 5 power (also called a 5 and 5 power) the holder of an otherwise general power of appointment must include in his/her estate only the property subject to the 5 or 5 power. The 5 or 5 power enables the holder to appoint to

him/herself only the greater of: $5,000 or 5% of the trust principal (corpus)

Thus, only that amount is included in the holder’s estate upon death

Nothing is included for federal gift tax purposes upon the lifetime annual lapse of a 5 or 5 power


5 or 5 Power Example

Albert is granted a 5 or 5 power over a trust holding $2 million in property. When Albert dies, only $100,000 is included in his gross estate. $2,000,000 x 5% = $100,000

Greater than $5,000 Had Albert lived through the year not exercising his

power he would NOT be deemed to have made a gift to other beneficiaries

In the absence of the 5 or 5 power, the annual lapse of the right to appoint property to oneself is deemed a gift to other beneficiaries

May be subject to federal gift tax


Powers Subject to an Ascertainable Standard

If the holder’s right to appoint trust property to himself, and/or creditors is subject to an ascertainable standard, such property is not considered subject to treatment as a general power of appointment. The allowable ascertainable standards are (only): Health

Virtually all bona fide expenses including LTC Education Maintenance Support

Maintenance and support not required to be at basic levels


Why Is Ascertainable Standard Property Not Included in Gross Estate?

Ascertainable standard triggered withdrawals (HEMS) are not included in the recipients estate under the presumption that withdrawals for health, education, maintenance and support will be consumed

rather than transferred to another.


Characteristics Shared by Gift and Estate Tax

Gift and estate taxes are both: Cumulative for all taxable transfers Subject to a progressive tax rate

More transferred = higher transfer tax rate Each tax has applicable credit and exemption amount

2013 Gift tax credit is $ 1,945,800 representing $5,250,000 in lifetime transfer

2013 estate tax credit is $ 1,945,800 representing $5,250,000 in property transferred at death

Unlimited marital deduction Unlimited charitable deduction


Question 3-12

Which of the following operates under a progressive tax system?

A.Federal estate tax

B.Federal gift tax

C.Municipal interest tax

D.Both A and B


Characteristics Unique to Estate Tax

Certain characteristics are unique to federal estate tax including: Inability to split post death transfers

Although spousal exemption portability is available No annual estate tax exclusion Basis steps up

For income tax purposes when heir sells inherited property

Unlike the gift tax, the estate tax is considered “tax inclusive” because the donee receives the bequeathed property, less the estate tax owed on it.

Alternate valuation date may be available


Tax Exclusive Example

In 2013, Alice dies and leaves a bequest of $200,000 to her daughter, Tiffany. Since this is a bequest, the entire $200,000 would be liable for its share of the estate tax. In addition, since estate tax is measured tax inclusively. Given the 40% estate tax rate applied to $200,000, only $120,000 would actually go to Tiffany.


Documents

Federal Estate Tax Session 3 DePaul University CFP® Program