Only two things are certain

Topics we will cover…

•

Types of Tax: Estate, Gift, Inheritance, GST & Income

•

Estate Planning Alternatives

•

Preparing the Fiduciary Return

•

Preparing the Estate Tax Return

Estate Tax

•

Assessed upon value of decedent’s holdings

•

FMV determined at DOD or AVD (can be elected only if

valuation decreases tax liability)

NOTE: AVD cannot be elected at death of 1

_{spouse if}

marital exemption used to eliminate estate tax liability

•

$5 million exemption (portable between husband/wife in 2011

& 12)

•

Form 706 due 9 months after DOD; can

be extended 6 months (Form 4768)

•

Tax liability must be paid 9 months

after DOD

History of Estate & Gift Taxes

•

Taxes imposed & repealed in 1800’s to finance wars

•

Taxes in 1900’s imposed to prevent the accumulation

and transfer of large estates

•

Estate Tax enacted in 1916 introduced DOD valuation,

funeral & administrative expenses,

“small estate” exemption & graduated rates

•

Gift Tax temporarily introduced in 1918

(repealed in 1926) & re-introduced in 1932

History (cont’d)

•

1948: 50% marital deduction

introduced (later increased to 100%)

•

1976: Estate & gift tax exclusions merged

& converted to the Unified Estate & Gift Tax

Credit (a.k.a. applicable exclusion)

•

1981: The annual gift tax exclusion raised to $10,000

•

1986: GST enacted in its current form

•

1997: Applicable exclusion raised to $1M, then raised

incrementally to $3.5 million by 2009 (unlimited by 2010),

finally re-set to $5M in 2010 & 2012

The only difference between death and taxes

is that death doesn’t get worse

every time Congress meets.

-Will Rogers

Gift Tax

•

Gift = Transfer for inadequate consideration

–

Payments to 3

_parties

–

Interest-free loans

–

Below-market sales

–

Irrevocable transfers to trust

–

Creation of joint tenancies

NOTE: Payment for tuition & medical expenses;

direct transfer to political organization ≠ Gift

•

Assessed on value of property transferred when

complete

Example of Below-market Loan

(Gift Tax)

Dad loans Son $200,000 to make down-payment on home. The loan is to be repaid in 5 years, without interest…

IRS presumes that Son should have been charged a fair rate of interest (computed at applicable federal rate)  Dad is liable for gift tax on interest that

should have charged but wasn’t

 Dad also liable for income tax on imputed interest while Son may

claim deduction for interest “paid”

 If Dad later forgives Son’s debt, he will be liable for gift tax on loan principal

Gift Tax (cont’d)

•

$13,000 annual exclusion ($5 million lifetime exclusion)

NOTE: Gift-splitting available to citizen spouses,

but must file individual returns

•

Form 709 due April 15

_if:

–

Gift > $13K

–

Future interest

–

Over $136K to non-citizen spouse

–

Partial interest to charity

•

Gift tax is cumulative – tax on each successive gift is

computed on total value of all gifts made

When is gift “complete”?

(Gift Tax)

Transferred Withdrawn

• Real property

• Mutual funds

• Stocks and bonds

• Bank, savings, credit union accounts

• Brokerage accounts

Inheritance Tax

•

Legacy or Succession Tax charged

to heir

•

Assessed by state in which decedent was

domiciled (not resident)

•

State may assess Pick-up Tax instead (calculated

as percentage of federal tax liability)

NOTE: Since federal credit for state tax

repealed in 2004, many states no longer

assess pick-up tax

Generation-Skipping Tax

• Assessed on value of property transferred to skip person (≥ 2 generations below transferor )

• NOT skip persons:

– Grandchild, if transferor’s child is deceased

– Spouses & former spouses

– Charitable trusts

• Reported on Form 709 if made during lifetime; Form 706 if made at

death

• $5 million exemption (not portable)

• Rate = top estate tax rate (35%), not graduated

NOTE: GST often exceeds estate tax that would have been

computed at graduated rates if property had been transferred & taxed at each generation

Income Tax

•

Report income attributable to decedent on

Form 1040; income attributable to estate

on Form 1041.

•

Marginal tax rates for estate are comparable to those for

individual taxpayers, but effective tax rate is higher since

brackets are narrower

10% 15% 25% 28% 33% 35%

Single <8,375 <34,000 <82,400 <171,850 <373,650 >373,650 Married Joint <16,750 <68,000 <137,300 <209,250 <373,650 >373,650 Estates/Trusts N/A <2,300 <5,350 <8,200 <11,200 >11,200

What’s due when…

January 1st _{June 14}th

Date of Death

December 31st

Form 1041

Fiduciary Income Tax Return

due for 200 days

Max. Tax Rate: 35% on inc > $11K Personal Exemption: N/A Standard Deduction: N/A

Form 1040

Individual Income Tax Return

due for 165 days

Max. Tax Rate: 35% on inc > $374K Personal Exemption: $3,700 Standard Deduction: $5,800

Form 706 Estate Tax Return

due if assets valued > $5M in 2011 Max. Tax Rate: 35% of Net Estate

When a man on his deathbed was asked what

he wanted done with his ashes after being

cremated, he answered:

Just put them in an envelope

and mail them to the IRS.

Make sure to write on the envelope,

‘Now you have everything!’

Review of Estate Planning Options

• Intestacy Statutes – Apply if decedent dies without will

• Will - Specifies decedent’s wishes, but cannot supersede statutory rights of heirs or used to dispose of non-probate assets

• Revocable Trust – Used to transfer assets to beneficiaries without probate & ensure grantor’s assets can be managed in event grantor is disabled/incapacitated

• Joint Tenancy – Allows property

to pass directly to surviving co- owner (1/2 basis step-up)

• Estate can also be reduced by

Marital Estate Planning

•

A-B Trust

–

Use “A” Trust to

temporarily

shelter property at death

of 1

_{spouse (unlimited marital deduction)}

–

Use “B” Trust to

permanently

shelter assets up to

decedent’s applicable exclusion amount

•

A-B-C Trust

–

Used to pass property to surviving spouse & preserve

estate assets for third-party beneficiaries

•

Qualified Domestic Trust

–

Used to defer estate tax due upon death of 1

_spouse

until death of surviving non-citizen spouse

Special Needs

•

Third-party trusts established by relative or

court-appointed guardian for benefit of disabled

beneficiary without jeopardizing eligibility for

Medicaid

•

Property may not be bequeathed

to pet, but can be transferred to

trust with human beneficiary

responsible for animal’s care

Fiduciary Duties

•

Personal Representative must act on behalf of another

–

Executor: Named in will to manage affairs of decedent

–

Administrator: Court-appointed to manage affairs of

decedent

–

Trustee: Named in trust document

–

Guardian

: C

harged with care of another

–

Conservator

: C

ourt-appointed to manage affairs of living

person

–

Custodian: Must safe-guard assets

•

Duty of Loyalty – avoid conflicts of interest & self-dealing

•

Duty of Care – act prudently & cannot delegate fundamental

responsibilities

Selecting Fiduciary

•

Executor/trustee faces a “job”

which requires honor, honesty

& integrity

•

Select 1 0r 2 successor

representatives

•

State law may require personal representative to be

licensed or registered

NOTE: Bank employees, investment advisors,

attorneys, CPAs & EAs still exempt from

registration

in CA

if acting within scope of

Planning Documents

• Power of Attorney – allows one person (principal) to authorize

another (attorney-in-fact) to act on his behalf

– Durable remains effective after principal is incapacitated

– Springing become effectives when principal becomes disabled

– Healthcare used to appoint an agent to make health care

decisions

– Only valid during lifetime

– Form 2848 used for federal tax matters

• Will Supplements – used to provide

instructions not included in will/trust (e.g. identify personal property to be given to specific individuals)

• Ethical Wills – used to bequeath

The Fiduciary Return

(Form 1041)

•

Must file if gross income > $600 (estate) or

any

taxable

income (trust)

•

Trusts must use calendar year; estates may use fiscal year

•

6-month extension available (Form 7004)

•

No estimated tax payments due for 1

_{2 years after DOD}

(estate) or tax liability < $1,000 (trust)

•

Exemptions

–

Estate: $600

–

Simple Trust: $300

Trust Income

(Form 1041)

•

Accounting = amount income (not remainder) beneficiaries

entitled to receive from trust as per law or document—usually

dividends & interest but not capital gains

NOTE: If CGs taxed to trust, then trust’s basis increased

•

Income Distribution Deduction = used to determine how

allocation of tax between beneficiary & trust

NOTE: Beneficiary liable for tax on lesser of DNI or

actual distribution received

•

Distributable Net Income (DNI) = max amount taxable to

beneficiaries; excess treated as tax-free distribution of

principal

•

Tax-exempt Income = Life insurance benefits, muni bond

interest, personal injury comp., inc from discharge of debt

Example of Accounting Income

(Form 1041)

•

Trust earned $3,000 interest & $2,000 CGs &

paid fiduciary fees of $600

•

Trust instrument allocates interest/dividends to

“income”, CGs to “principal” & requires costs to

be allocated equally

•

Instrument also requires all income be

distributed to beneficiary each year

The beneficiary will receive:

$3,000 Interest

- 300

Fiduciary fees (50%)

DNI

(Form 1041)

Taxable Income

+

Tax-exempt Income

-

Allocated Expenses

+

Personal Exemption

+

Capital Losses

-

Capital Gains (if distrb’d or in yr of termtn)

-

Expenses Allocable to Tax-exempt Income

Who pays the tax?

(Form 1041)

• Trust has $10,000 dividends, $10,000 LTCGs & $1,200 fiduciary fees

• Trust is a simple trust required to distribute all income incl. CGs

NOTE: Distrbtns from complex trust are discretionary ($100 xmptn)

Trust Inc. 10,ooo + 10,000 – 1,200 = 18,800 Taxable Inc. 18,800 – $300 xmptn = 18,500 DNI 18,800

 Trust’s taxable inc after distribution = 18,800 – 18,800 = 0

 Beneficiary’s taxable income = 18,800

• If trust is not required to distribute capital gains…

Trust Inc. 10,ooo + 10,000 – 1,200 = 18,800 Taxable Inc. 18,800 – $300 xmptn = 18,500 DNI 18,800 – 10,000 = 8,800

 Trust’s taxable income after distribution = 18,800 – 8,800 = 10,000

Whose income is it?

(Form 1041)

Trust’s Inc. DNI Taxable Inc.

Ordinary Income    Tax-exempt Inc.    Dividends    Cap. Gains    Fiduciary Fees    Exemptions   

Deductions

(Form 1041)

• Trusts & estates entitled to many of same deductions as individual taxpayers on either 1041 or 706 (not both)

– Expenses in connection with administration of trust/estate

deductible without 2% AGI limitation (e.g. accounting fees, 1041 tax preparation, trust/will contest, bonding fees)

– Miscellaneous itemized deductions that would have been

subject to 2% AGI limitation if deducted by decedent, subject to same limitation if deducted by fiduciary (e.g. investment advice, property mngt., defense against creditors’ claims)

• Pro-rate deductible expenses if trust/estate has tax-exempt income

Non-ded Xpns = (Gross TE Inc / Gross Acctg Inc ) * Indirect Xpns

• Excess deductions in final year of estate/trust may be passed

through to beneficiaries ( Schedule as Misc. Item. Ded. Subject to 2% AGI)

Depreciation

(Form 1041)

Depreciation/depletion must be allocated between trust &

income beneficiaries on same basis as accounting income

is allocated

Trust instrument requires the following

distributions: 30% to Beneficiary #1, 20% to

Beneficiary #2, 50% accumulated by fiduciary.

Depreciation of $4,000…

1,200

Depreciation to Bene 1

800

Depreciation to Bene 2

2,000

Depreciation to Trust

Charitable Contributions

(Form 1041)

Individuals Trusts & Estates

Ceiling 50% AGI Unlimited

Recipient Qualified Org. Any charitable purpose Locale US only Worldwide

Deductible Amount Amount Paid Amount set aside

When deductible? In year paid In year paid or prior (if elected) Source of funds Any income Taxable income only*

Authorization n/a Controlling Instrument

NOTE: Charitable contribution deductible only if donation made from taxable gross income under terms of trust/will

The Estate Tax Return

(Form 706)

•

No filing requirement if estate plus taxable gifts < $5M

(2011 & 2012; will revert to $1M exemption in 2013)

NOTE: May elect to file if only to establish

valuation & prevent potential disputes

•

Tax rate in 2011 and 2012 is 35% (will revert to 55% in

2013)

•

Due 9 months after DOD; extend 6

months (Form 4768)

•

SOL can be shortened to 18 months

(Form 4810)

Gross Estate

(Form 706)

• Decedent’s property wherever situated

• Examples

– Cash, investments, tax-exempt assets, business assets, real & personal property

– Jointly-held assets

– ½ of decedent’s community property

– Retirement assets, life insurance & annuities (all non-probate)

– Special interests & powers, incl. retained & reversionary interests, life estates, revocable transfers

– Income in Respect of Decedent (IRD)

• Deductions: if reasonable & necessary under state/federal laws

EXAMPLE: Interest expense incurred to maintain, rather than sell asset for 7 years disallowed because incurred for benefit of heirs, not estate

Valuation Rules

(Form 706)

• Vehicles based on retail, not trade-in value

• Inventory household items on room-by-room basis

• Reduce checking account balance by as-yet uncleared checks

• Uncashed gift checks to individuals are incomplete gifts

• Stocks/bonds valued on average of high & low selling prices

• Mutual funds valued at NAV

• For business interests consider net worth, earning power, dividend-paying capacity, goodwill, comparable securities

• May apply special use valuation (based on current use) to certain real property

IRD

(Form 706)

• Income earned by decedent before death but paid to estate after

death

– Deferred compensation & bonuses

– Retirement plan distributions & annuity payments

– Dividends

– Pre-death leasehold income

– Proceeds from sale of jointly-owned residence

• Retains same character when reported by estate as it would have if reported by decedent

• May be reduced by Deductions in Respect of Decedent (DRD)—

similar to allowable Schedule A Deductions

Heir’s Basis & Holding Period

(Form 706)

•

Inherited assets receive stepped-

up (down) basis to value on DOD

or AVD

•

Jointly-held assets receive ½ step-up

•

Community property assets receive full step-up

•

No step-up for IRD property

•

Capital gains from sale of inherited property are

always

Election for 2010

(Form 706)

• Although estate tax was repealed for 2010, last-minute legislation retroactively applies 2011 rules to decedent’s dying 1/1/10 – 12/16/10: $5 million exemption & stepped-up basis unless executor opts out…

• Executor may affirmatively elect to be exempt from estate tax & instead subject to carry-over basis rules under IRC §301(c)

• If elected, some assets may receive step-up:

– First $1.3 million

– Plus additional $3 million if assets transferred to surviving spouse

• File Form 8939 to report property acquired from decedent & allocate basis increase

– Originally intended to be submitted with decedent’s final 1040 by April 15th _but

form not yet available

– IRS website promises to post form “at least 90 days before it is required to be filed”

Estate Tax Formula

(Form 706)

Gross Estate (GE) = Value of

worldwide property

Taxable Estate (TE) = GE – Deductions

Tax Base = TE + Adjustable Taxable Gifts

Example of Estate Tax Calculation

(Form 706)

Decedent died in 2011, leaving a gross estate of $6M with no allowable deductions. He made $1.5M taxable gifts between 2002 & 2005…

$555,800 Gift tax liability on previously-made gifts – 345,800 Lifetime credit allowed on $1M gifts

$210,000 Gift tax previously paid during lifetime

$6M Gross estate (GE) $0 No deductions

$6M Taxable estate (TE)

+ 1.5M Previously made taxable gifts (ATG) $7.5M Tax base

$2,605,800 Tentative estate tax liability

– 1,730,800 Applicable credit based on $5M in 2011 $875,000 Tax

$210,000 Gift tax previously paid $665,000 Estate tax due now

The Gift Tax Return

(Form 709)

•

Due April 15th in year following transfer or file with 706

•

No return due if gift is excludable (e.g. if < $13K)

•

$5 million lifetime exclusion per donor

•

Tax-exclusive since assets used to pay tax are not part of

gift

Donee’s Basis & Holding Periods

(Form 709)

= Donor’s Carryover Basis + Allocable Gift Tax Paid

Donee received gift from Donor, whose basis was $100K; FMV at time of gift was $120K. Donor paid $5K gift tax…

Allocable Gift Tax = (FMV – Basis) / Basis * Gift Tax

= (120 – 100) / 100 * 5 = 1

Donee’s Basis = Basis + AGT = 100 + 1 = 101

•

Unless

selling at a loss: New basis will be lesser of

Donor’s Basis or FMV on date of gift

Selling Gifted Property

(Form 709)

& Donor’s Basis

Example # 3 Sell @ Gain

Donor’s Basis 100 100 100

FMV at time of gift 90 90 90

Donee’s Sales Price 80 95 120

Donee’s Basis 90*

* lower of FMV or Donor’s Basis since property was sold at

loss for less than FMV at time of gift

90 or 100** **Basis for gain is 100, but there is no gain—Basis for loss

is 90, but there is no loss

100***

***since Donee sold property at gain for

more than FMV at time of gift, Donee’s

basis is equal to Donor’s Donee’s Capital Gain

(Loss)

Gift Tax Calculation

(Form 709)

(Taxable Gifts during lifetime * Applicable Tax Rate)

– (Taxable Gifts in current year * Applicable Tax Rate)

= Tentative Tax (calculated at

cumulative

graduated rate)

– Credits (i.e. Applicable Credit Amount)

Gift & Estate Tax Example

(Form 709)

Assume $500K gifted in 2003 & $600K gifted in 2006…

$500,000 tax = $155,800 (not paid since < $345,800 lifetime credit) 600,000 gifted in 2006

$1,100,00 total gifts

$ 386,800 tentative tax on total gifts made in both years –155,800 tax on 2003 gift

$ 231,000 tax attributable to 2006 gift

$345,800 lifetime credit

-155,800 credit used in 2003 $190,000 unused credit available

$231,000 tax attributable to 2006 gift [see above] –190,000 unused credit [see above]

Gift & Estate Tax Example (cont’d)

(Form 709)

Assume taxable estate of $4.9 million on DOD in 2011…

$ 4.90M

estate in 2006

+ 1.10M

prior taxable gifts [see above]

$ 6.00M

tax base

$ 2,080,800

tentative tax on $6M tax base

–41,000

tax previously paid on gifts [see above]

$ 2,039,800

estate tax liability

–1,730,800

unified credit (based on $5M in 2011)

$ 309,000

tax due @ 2011

Call or e-mail…

Monica Haven, E.A., J.D.

(310) 286-9161 PHONE

(310) 557-1626 FAX

[email protected]

The information contained herein is for educational use only and should not be construed as tax, financial, or legal advice. Each individual’s situation is unique and may require specialized treatment. It is, therefore, imperative that you consult with tax and legal professionals prior to implementation of any strategies discussed.